Page 1 of 42

Lecture Session I
Topic:

Overview of Financial Markets

1. An Overview of Financial Markets and Institutions

Market

Institution or

Arrangement

That facilitates purchase and sale of

Goods and Services and

Other things

Financial Market

Place where

People and organizations

Wanting to borrow money

Are brought together with

Those having surplus funds

Location

May or may not have particular physical existence

NYSE physically located at Wall Street

OTC has no fixed place of existence

Consists of brokers throughout the country who track prices via computer and
Telecommunication lines

Role

Savings Mobilization

Investment

National Growth

Entrepreneurship growth

Page 2 of 42
Functions

Intermediary functions

Financial Functions

Intermediary Functions

Transfer of Resources

Enhancing Income

Productive Usage

Capital Formation

Price Determination

Sale Mechanism

Information

Financial Functions

Providing borrowers with funds for Investment

Providing the lenders with earning assets

Providing liquidity in the market

Constituents

Primary Market

Secondary Market

Money Market

Capital Market

Debt Market

Eurobond Market

Equity Market

Financial Services Market

Depository Market

Non Depository Market

Page 3 of 42
Primary Market

Deals with the issue of new securities

Secondary Market

Deals with existing claims

No new flow of funds for instruments

Ready market for trading in securities

Existing financial assets are bought and sold.

Helps lower transaction costs

Enhances the liquidity of the financial asset

Money Market

Short Term Financing

Nerve center of all operations of the central bank in the country

Reflects changes in short term parameters such as interest rates, monetary

policy, availability of short term credit etc.

Mechanism of liquidity adjustment

Money Market

Medium of exchange between

Holders of short term cash surpluses and short term cash deficits

Central bank conducts most of its operations in the money market

Low capital loss (money risk)

Low risk of default (credit risk)

Sub markets of Money market

Specialized sub markets such as

Central Banks

Commercial banks

Cooperative banks

Page 4 of 42

Savings banks

Discount houses

Acceptance houses

Bill market

Bullion market etc

Capital Market/Securities Market

Where long term funds are borrowed and lent.

Features of Capital Markets

Demand for long term Funds

Instruments like shares, debentures, bonds etc.

Supply of funds

Surplus units to deficit units

Savings are channelized into investments

Economic growth of the country

Price Mechanism

Companies that operate efficiently can sell securities at premium (incentives)

Debt Market

Markets where funds are borrowed and lent

Uses

INDIVIDUALS To finance new purchases like house, car etc.

CORPORATES Obtaining working capital and new equipment

GOVT. Finance various public expenditures

Eurobond Market

Market where bonds are denominated in currency other than that of the
country in which they are issued

Page 5 of 42

French firm may engage a German Investment banking syndicate to sell

dollar denominated bonds and so on

Equity Markets

Where ownership securities are issued and subscribed

Eg Bombay Stock Exchange

Financial Services Market

Consists of participants such as commercial banks etc that provide financial

services

Financial Services

ATM

Credit cards

Credit rating

Factoring

Leasing

Stock Broking etc

Depository Market

Consists of depository institutions that

Accept deposits from

Individuals and Firms

And use these funds to

Participate in debt market

Depositors loan money to depository institutions who

Use the funds to purchase other financial asset

Major types of Depository Institutions

Commercial Banks

Savings and Loan Associations

Page 6 of 42

Mutual savings banks

Credit Unions

Commercial Banks

Largest and most important depository Institutions

Have the largest and most diverse collection of assets

Main source of funds

Demand deposits and

Savings Deposits

Savings and Loan Associations

Mutual associations (owned by depositors)

To convert funds from savings accounts to mortgage loans

Purpose To ensure a market for financing housing loans

Mutual Savings Banks

Owned cooperatively

By members with a common interest

Eg. Company employees, union members or congregation members

Accepted deposits and made mortgage loans

Credit Unions

Cooperative depository institutions

Depositors are credited upon purchasing shares in the cooperative which they
own and operate

Non Depository Market

Carry out various functions in financial markets

Ranging from financial intermediation to selling insurance

Non Depository Market

Page 7 of 42

Mutual Funds

Insurance Companies

Pension Funds

Brokerage firms

Mutual Funds

Sell shares to investors

Invest proceeds in a variety of financial assets

Money market mutual funds invest in short term safe assets like Govt
Securities

Insurance Companies

Protect individuals against risk

Accept premium

In exchange for contracted payment in the event of ---

Hold long term assets like long term bond and commercial real estate

Pension Funds

Operated by private and Govt employers

Provide retirement income to employees

Regular contribution from employees via payroll deduction

Fund flowing in are in the nature of fixed deposits

Can accurately predict payouts

Hold portfolios consisting mostly of stocks and bonds

Pension Funds

Return on the assets are paid out to participating individuals when they reach
retirement age.

Brokerage Firms

Bring buyers and sellers of stock together

Page 8 of 42

Function as intermediaries

Earn a fee for each transaction

Main function to serve as brokers in the

Secondary debt and Equity Markets

Financial Instruments

Money Market Instruments

Capital Market Instruments

Money Market Instruments

Commercial paper

Certificates of Deposits

Treasury Bills

Treasury Bonds

Repurchase Agreements

Eurodollars

Bankers acceptances

Commercial Paper

A form of direct short term finance

Issued by large creditworthy companies

Debt instrument sold by one company to another company or financial

institution

To raise immediate funds

Commercial Paper

Contains a promise

To pay back a higher specified amount

At a designated time

Page 9 of 42

In the immediate future

Avoids the process of applying for a loan

Engages in direct finance

Certificates of Deposit

Debt Instruments

Sold by banks and other depository institutions

A CD pays the depositor

A specified amount of interest

During the term of the certificate

Plus purchase price of the CD at its maturity

Treasury Bills

Short Term debt Instruments

Used by Govt to obtain funds

Issued in 3, 6, 12 month maturities

No regular interest payments

Sold at a discount

Ready market for these securities

Zero Default Risk

Treasury Bonds

Popular US Govt Securities

Include Treasury Bonds having a maturity of 1 to 10 years.

Zero Coupon bonds

Repurchase Agreements

Borrower sells and agrees to buy back a financial instrument, a govt. bond,
note or T-Bill

Popularly known as repo

Page 10 of 42

A short term loan backed by a security

Eurodollars

US Dollars deposited in banks located in other countries

Bankers Acceptances

Arrangement whereby

Bank promises to pay on a specific date, which is accepted and guaranteed

by another bank.

Essentially a letter of credit

Capital Market Instruments

Corporate Stock

Corporate Bonds

Mortgages

Commercial Loans

Municipal Bonds

Indian Money Market

Organized Money Market

Unorganized Money Market

Organized Money Market

Constituents include RBI, SBI, Commercial Banks, Finance Corporations, Bill

market and Bullion Market

Principal centers are Mumbai, Kolkata and Delhi

Banking System

Scheduled Banks

Non Scheduled Banks

Scheduled Banks

State Cooperative Banks

Page 11 of 42

Commercial Banks

Scheduled Commercial Banks

Consist of both foreign Banks and Indian Banks

Exist both in the Private sector and the Public sector

Rural Banking

Regional Rural Banks

RBI

Exercises adequate control over the operations of the organized money

market through various monetary and credit instruments such as

Cah Reserve Ratio

Statutory Liquidity Ratio

Credit Authorization Scheme

Non Resident Indian Investment Incentive Scheme

Unorganized Money Market

Indigenous Bankers and Moneylenders

Outside the control of RBI.

Indian Capital Market

Where Financial Securities are bought and sold

Shares, Bonds, Debentures etc.

Types of securities

Government Securities

Industrial Securities

Special Institutions

Finance

Development

Page 12 of 42

Promotion

Eg. IFCI, ICICI

Non Banking institutions like UTI, LIC, GIC

Bank for Agriculture Nabard

To cater to the financing needs of exporters and importers EXIM Bank

National Stock Exchange

Works on the standardized systems software used all over the world

Allows trading by Broker Members by simply sitting in their own offices

All Market Information available continously on the screen

Identity of the trader is concealed

Third Market

OTC Market

Any exchange listed security can be traded in this type of market

Prices are fixed through negotiation

Institutional investors are the main customers

Small brokers, dealers, private individuals and small odd lot customers who
are not members of an organized exchange can also actively take part in the
market

Fourth Market

Institutions and Wealthy Investors who buy and sell securities among
themselves, directly dispensing with brokerage services

Direct Deals through negotiated price

Only two parties and no broker

Global Financial Markets

Financial Markets

Integrated Worldwide

Uniform Trading practices

Page 13 of 42

It is possible for firms to raise funds in International Arenas

Global Financial Markets

Internal Market

External Market

Internal Market

National or Domestic market

Capital issues and issuers are domiciled within the boundaries of a particular
country

External Market

Foreign Market, International Market, Offshore Market, Euro Market

Deals with issues of securities not domiciled in the country but are sold and
traded throughout the world

Rules are of the regulatory authorities where the security is issued

If an Indian firm wishes to raise capital in the Global Market, it has to follow
the regulations of Indian authorities

External Market

Yankee market in the US

Samurai market in Japan

Bulldog market in UK

Rembrandt market in Netherlands

Matador market in Spain

2. Capital Markets
Meaning

Market

For borrowing and Lending

Long term capital funds

Page 14 of 42

Also called the securities market

Dealings through securities like shares, debentures etc

Participants

Financial Intermediaries like insurance companies, investment companies ,

pension funds etc

Non Financial Business Enterprises

Evolution

Period between 1947 and 1973 marked the development of Infrastructure

1973 to 1980 was the New issues stage

1980 to 1992

Emergence of SEBI as a regulatory body

Credit rating institutions like CRISIL, CARE and ICRA were set up

IL &FS set up for Infrastructure Financing and Leasing Services

OTCEI to provide screen based stock exchange facility

From 1992

Structural Transformation started taking place

Technological operations in the realm of stock trading.

Financial Liberalization

Computerized online trading

Constitution of a depository to facilitate scripless trading

SEBI Act, 1992

SEBI was set up as a regulatory body of Indian Securities market in 1988 but
vested with statutory powers only in 1992 with SEBI Act.

Constituents of the Indian Capital Market

Gilt edged Securities Market

Industrial Securities Market

Primary Market

Page 15 of 42

Public Issue

Rights Issue

Private Placement

The Secondary Market

24 Stock Exchanges in India recognized by the Govt.

In addition a ringless and automated stock market operating at the National

Level known as OTCEI

New Financial Institutions

Venture Fund Institutions

Mutual Funds

Factoring Institutions

Credit Rating Institutions

OTCEI

National Stock Exchange

National Clearance and Depository System

National Securities Depositories Ltd

Stockholding Corporation of India

Venture Fund Institutions

Form of equity financing designed specially funding new and innovative

project ideas.

Many specialized financial institutions have promoted their own Venture

Capital Funds

Risk capital Foundation of IFCI, Venture fund of IDBI

SIDBI

TDICI Technology Development Infrastructure Corporation of India

Page 16 of 42
Mutual Funds

Invests funds pooled from shareholders

Gives them the benefit of a diversified portfolio

LIC, UTI

Banks like SBI, Canara Bank etc are carrying out the Business of Mutual Funds

Factoring Institutions

Assigning receivables

Factoring Institution undertakes the task of collecting book debts for and on
behalf of its clients.

RBI along with Govt. of India has notified factoring as an eligible banking
activity

SBI Factors and Commercial Services Private Ltd a subsidiary of SBI

Canbank Factors Ltd Subsidiary of Canbank

Credit Rating Institutions

Guidance to investors/creditors in determining the credit risk associated with

a debt instrument/credit obligation

By an independent , professional and impartial institution

CRISIL, ICRA

Onida Investment and Credit Rating Agency of India Ltd

Credit Analysis and Research Ltd. (CARE)

OTCEI

To allow trading of securities across electronic counters throughout the

country

Transparency of Transactions

Quick deals

Faster settlements

Better Liquidity

Page 17 of 42
NSE

Established under the Companies Act, 1956 in 1992

Provides a nation wide electronic screen based scripless and floorless

trading system in Securities

National Clearance and Depository System

Scripless Trading

Settlement of transaction takes place through a book entry as against the

Physical exchange of Securities

Three segments

National Trade Comparison and Reporting System

National Clearing System

National Depository System

National Trade Comparison and Reporting System

Prescribes the terms and conditions of the contract for securities market

National Clearing System

Aims at determining the Net cash and stock liability of each broker on a
settlement date

National Depository System

Arranges to provide for the transfer of ownership of securities in exchange for

payment by book entry on Electronic ledgers without any physical movement
of transfer deed.

National Securities Depositories Ltd

Set up in 1996

To achieve a time bound dematerialization as well as rematerialization of

shares

In accordance with Depositories Act, 1996

Stock Holding Corporation of India

Page 18 of 42

Serves as a Central Securities Depository in respect of transactions on Stock

Exchanges

Also takes up the administration of clearing functions at a National Level

Recent Initiatives in the Capital Market

Settlement cycle shortened to T+3 effective April 1, 2002

Banning of all deferral products including badla

Introduction of a market wide circuit breaker system

Capital Market Instruments

Preference Shares

Equity Shares

Non Voting equity shares

Cumulative convertible preference shares

Company fixed deposits

Warrants

Debentures and Bonds

Preference Shares

Shares that carry preferential rights in comparison with ordinary shares

Regarding payment of Dividend

Claim on liquidation

Cumulative Preference Shares

Shares where the arrears of Dividend in times of lean or no profits can be

accumulated and paid in the year in which the company earns good profits

Non Cumulative Preference Shares

Where carry forward of arrears of Dividend is not possible

Participating Preference Shares

Page 19 of 42

Have the right to participate in the surplus profits or surplus assets on

liquidation of the company

Redeemable Preference Shares

Shares that are to be repaid at the end of the term of the issue

Fully Convertible cumulative preference shares

Shares consist of two parts Part A and Part B

Part A is compulsorily convertible

Part B will be redeemed at par/converted into equity shares after a lock in

period

Preference Shares with Warrants attached

Attached warrant entitles the holder to apply for equity shares for cash at a
premium

Equity Shares

No specific preferential rights

Represent proportionate ownership in a company

Stock Dividend

Dividends distributed as shares by capitalizing reserves

Participating Debentures

Debentures that entitle the holder to participate in Profits

Debt Equity Swaps

Offered from an issuer of debt to swap it for equity

Zero Coupon Note

Zero Coupon Debentures that can be converted into debt

SPN with detachable warrants

Secured Premium Notes

They are redeemable debentures that are issued with detachable warrants

Page 20 of 42
NCDs with detachable equity warrants

Non Convertible debentures with detachable equity warrants

Zero Interest FCDs

Zero Interest Fully convertible Debentures

FRBs

Floating Rate Bonds where the yeild is linked to a benchmark interest ratelike
the Prime rate in USA or the LIBOR in London.

Merchant Bankers

The intermediaries in the stock market who are responsible for Public Issue
Management are known as Merchant Bankers or Lead Managers

Underwriters

A set of all institutions and agencies

That provide the commitment to take up an issue of securities

In the event of a failure of an issue to get full subscription from the public, are
known as underwriters

Bankers to an Issue

Bankers who are engaged in the function of acceptance of applications for

shares and debentures along with application money from investors in
respect of issue of securities and refund of application money to investors to
whom securities could not be allotted, are known as Bankers to the issue.

Brokers to an Issue

Intermediaries that are responsible for procuring the subscription to the issue
from prospective investors are called Brokers to the Issue.

Registrars to an Issue and Share Transfer agents

Registrars carry out such functions as keeping a proper record of applications

and moneys received from investors

Assisting issuing companies in determining the basis of allotment of

securities in accordance with the stock exchange guidelines

Assisting in the finalization of allotment of securities

Processing and dispatching allotment letters

Page 21 of 42

Assisting in processing and dispatching refund orders, share and debenture

certificates etc

Functioning as depository participants

Share Transfer Agents

Maintaining records of holders of securities of the company on behalf of the

company

Handling all matters relating to transfer and redemption of the securities of

the company

Functioning as Depository Participants

Share Transfer Agents

Maintaining records of holders of securities of the company on behalf of the

company

Handling all matters relating to transfer and redemption of the securities of

the company

Functioning as Depository Participants

Debenture Trustees

Trustees who are appointed to safeguard the interest of debenture holders

Certificate of Registration has to be obtained from SEBI for this purpose

Debt Market

Where Fixed income securities of various types are issued and Traded

Government Securities

Zero Coupon Bonds

Coupon Bearing Bonds

Treasury Bills

STRIPS

Public Sector Bonds

Govt guaranteed Bonds

Debentures

Page 22 of 42

PSU Bond

Commercial Paper

Private Sector Bonds

Debentures

Bonds

Commercial Paper

Floating Rate Bonds

Zero Coupon Bonds

Inter Corporate Deposits

Certificates of Deposit

Secondary Debt Market

The markets where Bonds are bought or sold.

It is divided into Wholesale and Retail Debt Market

Wholesale Debt Market

Outright sale and purchase and Repo trade

Stock exchanges offer order driven screen based trading facilities for Govt
Securities

Most Trades are put through in brokers offices and reported to the exchange
through their electronic system which provides for reporting of negotiated
Deals and Cross Deals

Retail Debt Market

Comprises of individual Investors, small trusts and other legal entities besides
participants in the wholesale Market

3. Money Markets
Meaning

A market where short term funds are borrowed and lent

Dealings may be conducted with or without the help of brokers

Page 23 of 42

Funds are traded for a amaximum period of one year

Segments

Call money market

Collateral loan market

Bill Market

Acceptance Market

Discount market

Call money market

Extremely short period loans from overnight to a maximum of seven days.

Funds are demanded by brokers and dealers on stock exchanges

And are advanced by commercial banks without any collateral securities

Inter bank call money market

To meet their statutory obligations pertaining to Reserves

Collateral Loan Market

Money lent against securities or collatera

In the event of non payment, the collateral becomes the property of the
lender

Given for short periods vlasting a few months

Borrowers are mostly brokers and dealers in stocks and shares

Mostly advanced by commercial banks to private parties

Bill Market

Deals with purchase and sale of various types of bills

Treasury Bills and Bills of Exchange

Bill of exchange

Seller draws the bill upon the buyer

Buyer accepts it unconditionally

Page 24 of 42

Becomes property of the seller

May retain it with himself till maturity or

Get it discounted with banker

Then bill has to be paid by the buyer to the banker instead of to the seller

Acceptance Market

Consists of a draft issued by a bank and accepting/undertaking to make

payment of the money specified on the draft on demand

Discount Market

Where Bankers acceptances are discounted

Bankers acceptance is payable at a specified future date and not on demand

like a cheque

Financial Institutions in the Money Market

Commercial Banks

NBFCs

Acceptance houses

Central Bank

Commercial Banks

The most important segment of the money market

Use short term deposits for providing short term funds to trade and
commerce

They invest funds for discounting commercial and Treasury Bills

NBFCs

Insurance companies, Leasing companies etc.

Make a decisive impact on the money market institutions

Acceptance Houses

Institutions that specialize in the task of acceptance of commercial bills

Accept exchange bills on behalf of customers.

Page 25 of 42

These can be easily discounted in the money market

Discounting of such accepted bills is done by another specialized agency

known as discount houses

Central Bank

Governments Banker

Bankers Bank

DFHI

Discount and Finance House of India

Set up in 1988Takes an active part in operations by borrowing and lending

funds

Market maker

Mode of operation of Call Money Market

Those involving banks Telephonic Negotiations between borrowers and

lenders

Lender issues RBI Cheque in favour of borrowing bank

Acknowledged by Call money borrowing receipt

Reverse day borrower repays the amount by issuing RBI Cheque and lender
returns the duly discharged receipt

Mode of operation of Call Money Market

Those involving DFHI Borrowers and Lenders approach the DHFI spelling out
their terms

Results in exchange of Deal Settlement Advice (DSA)

Borrowing DFHI issues a call deposit receipt to the lender and in turn receives
an RBI Cheque

On reversal DFHI issues an RBI Cheque and the lender surrenders the duly
discharged call receipt.

Call Money Rate

Rate of interest on call funds

Page 26 of 42

Seasonal and daily variations requiring intervention by RBI and other

institutions

Commercial Paper

Debt Instruments

Issued by Corporate houses

For raising short term financial resources from the market

Unsecured

Issued at a discount

Multiples of Rs 5 lakhs

Attract Stamp duty

Issuing company has to bear all expenses

No prior approval of RBI is required

Beginning from 1996, Primary dealers were also permitted by the RBI to issue
CPs

As per guidelines issued by RBI, they are required to be graded by the

organization issuing them

Rate of interest varies greatly

No benchmark for the rate

Minimum maturity is 15 days

CP

CP

Satellite Dealers

Dealers who are enlisted with RBI to deal in the Govt securities market are
called satellite dealers

Allowed to issue CPs with prior approval of RBI.

Nature of CPs

In the form of usance promissory note

Page 27 of 42

Shall be negotiable by endorsement and delivery

Commercial Bill Market

Market for buying and selling commercial Bills

State of underdevelopment

Lack of bill culture, high stamp duty, inadequate credit rating, absence of an
active secondary market

RBI introduced Bankers scheme in 1952 with a view to developing the Indian
Bill market

However the bill market could not develop well

Certificate of Deposit

Marketable document

Of title to a time deposit

For a specified period

Negotiable Instruments

Maturity period from 15 days to one year

In the form of usance promissory notes

Negotiable by endorsement and delivery

A conventional time deposit is not freely negotiable.

CD

CDs

Launched in 1989

Institutions that are eligible to issue CDs are Scheduled commercial banks
(excluding RRBs) and all India Financial Institutions like IDBI,
IFCI,ICICI,SIDBI,IRBI,EXIM Bank etc

Maturity period from 3 days to 12 months

Issued at discount to face value

CDs

Stamp duty is payable on CDs

Page 28 of 42

No loans can be granted by banks against CDs

Offered at interest rates higher than time deposits of Banks

DFHI acts as a market maker

Offers bid rate, rate of discount at which it is prepared to buy CDs and offer
rate.

Treasury Bills

Promissory notes

Issued by government

Under discount

For a fixed period

Not exceeding one year

Serve as an important tool of money management to infuse or absorb

liquidity from the monetary system

Types

Ordinary Treasury Bills

Adhoc treasury Bills

Ordinary Treasury Bills

Freely marketable and issued by Govt to public, , banks and other institutions

Adhoc Treasury Bills

Issued in favour of RBI only

Used by RBI as reserve

Against which RBI issues currency notes

Also serve as an avenue for staqte govts, , semi govt departments and
foreign central banks for parking temporary surplus and for earning income

Issue Procedure

91 day T-Bills are issued on tap basis throughout the week

Page 29 of 42

14,28,91 and 364 day T-Bill through fortnightly auction

The notification mentions the date of the auction and the last date for
submitting tenders

Issue Procedure

Investors are permitted to submit bids through separate tenders

Result mentioning the price upto which the tenders have been accepted is
displayed

Successful bidders are expected to collect letter of acceptance from RBI and
deposit the same together with a cheque on RBI.

SGL is maintained by RBI for facilitating purchases and sales of TBs by investors like
commercial banks , DFHI, STCI and other Financial Institutions
Issue Procedure

Where SGL facility is not available to certain investors, purchase and sale
takes place through DFHI

TBs sold to such investors are held by DFHI on their behalf

Auctioning Method

Uniform Price auction

Both competitive and non competitive bidders

State Govts, Provident Fund and Nepal Rashtra are non competitive bidders

Commercial Banks and other Financial institution comprise competitive

bidders

Price discovery takes place through the competitive bidders

TBs

High Liquidity

No default Risk

Availability on a steady basis

Less transaction costs

Rediscounting facilities offered by RBI

Page 30 of 42
Govt or Gilt edged Securities

Marketable debt issued by govt or semi govt bodies

Represents a claim on the govt

Dealing takes place through mechanism provided by RBI

Brokers and Dealers including banks approved by RBI are eligible to deal in
these securities

They offer wide ranging tax incentives to investors

It is an over the counter market

The issuers such as Central Govts and State Govts constitute Primary market

The secondary market comprises banks , financial institutions, insurance

companies, provident funds, trusts, individuals, primary dealers and RBI.

Forms

Inscribed stock

Stock certificates

Promissory note

Bearer bond

Trading

Trading is narrow

Mainly traded on the Bombay Stock Exchange

Issue Mechanism

The Public debt office of the RBI undertakes to sell Govt securities

Notification for issue of securities

Subscription: The offices of RBI and branches of RBI receive applications

Types of Trading

Page 31 of 42

Grooming: Gradual acquisition of securities nearing maturity through the

stock exchanges by the RBI in order to facilitate redemption. Purpose is to
keep the process of issue and redemption continous

Switching

Purchase of a security against sale of another security

Auctioning

Method of trading where

Merchants bid against one and another

Security is sold to the highest bidder

Trading Mechanism

Direct sales method

Securities General Ledger Method

Bank Receipts method

DS Method

Public Debt Office effects direct sale of Govt. Securities.

Loan amount is pre specified and the date of opening of subscription for Govt
loans

SGL Accounts method

RBI records transaction as book entries only in the ledger

In respect of each separate dealing, the purchasing banker maintains a

separate SGL account with RBI in respect of the purchase and the balance of
the Central Govt Securities

Selling banker effects transaction by filling out the prescribed SGL Form,
which is then lodged with RBI.

Bank Receipts Method

The bank selling Government securities issues a Bank Receipt

These are facilitated by the SGL where it is possible to avoid physical transfer
of securities

Repos

Page 32 of 42

Collateralized and therefore low interest rates

Securities dealers, commercial banks, DFHI, RBI, STCI and cooperative banks
are allowed to participate in the repos market.

Non bank financial companies, LIC, GIC, UTI and the corporates are also
allowed to participate in the repos market

Reverse Repo

Providing a return for holding securities

The repo and reverse repos market is dominated by the major players, the
banks who hold substantially huge portfolios of tradeable Govt securities

Government Bonds

Securities with Fixed coupon rates

Securities with variable coupon rates

Zero Coupon Bonds

Installment Securities

Securities with embedded derivatives

Tap stock

Partly paid stock

Capital Index Bonds

STRIPS

Dealers in Govt Bonds

Primary Dealers

Satellite Dealers

Primary Dealers

Banks and Institutions that are used by RBI for conducting the activities
relating to secondary market are called Primary Dealers

To apply for primary dealership, agencies such as subsidiaries of scheduled

commercial banks and all india financial institutions and companies
incorporated under the companies act, 1956 are eligible.

Page 33 of 42

These agencies must be predominantly engaged in the securities business

particularly in the Govt. securities market.

Minimum net owned funds of Rs 50 crores

Roles and Obligations

Bidding

Underwriting

Offering Quotes

Achieving turnover

Maintaining Capital Adequacy ratios

Authorization Procedure

Primary dealers make an Application

Give the RBI an undertaking , agreeing to the terms of approval

RBI issues an authorization

Satellite Dealers

Would supplement the PD system and would later on become a primary

dealer

Would engage in the task of setting up a second tier in trading and

distribution of Govt securities

Derivatives Market
Participants

Page 34 of 42

End users

Dealers

End Users

Consist of corporations, govt entities, institutional investors and financial

Institutions

Dealers

Consist mainly of Banks and Securities firms with a few insurance companies
and financial institutions

An institution may participate in Derivatives trading both as an end user and

a dealer

Foreign Exchange Market

Market for sale and Purchase of Foregn Currencies

Does not have a Physical space

Trading in Foreign currencies takes place through the electronically linked

Network of Banks, Foreign Exchange Brokers and Dealers

Not to be found in one place

Are carried out primarily through the worldwide Interbank Market

Trading is generally done by Telephone , Telex or SWIFT (Society for

Worldwide Interbank Financial Telecommunication) system

An important segment of the FX Market is the inter bank market

3 Constituents of Interbank Market

Spot Market

Forward Market

Swap Market

Spot Market

Page 35 of 42

Currencies are vtraded vfor immediate delivary extending for a period not
exceeding two Business days after the completion of the transaction

Spot Market transactions account for a share of 60 per cent of the FX Market

Forward Market

Delivery of currencies takes place at a future date and the contracts for
selling and buying take place at the current date

Its Transactions account for 10 per cent of the FX Market

Swap Market

Exchange of Currencies

Comprises around 30% of the transactions in the FX Market

SWIFT

It is an International bank communications Network that links electronically

all brokers and traders in FX.

Five categories of Participants

Foreign exchange dealers

Individuals and Firms

Speculators and Arbitrageurs

Central Banks and Treasuries

Foreign Exchange Brokers

Foreign Exchange Dealers

Banks and Non Bank agencies

They are the actual market makers in the Foreign Exchange markets

Buy and sell Foreign currencies on a continuous basis

They trade with other banks in their own monetary centers and in other
centers of the world

Profit comes from buying foreign exchange at a bid price and reselling it at a
slightly higher offer/ask price

Individuals and Firms

Page 36 of 42

Exporters and Importers, International portfolio investors, MNC tourists etc

Speculators and Arbitrageurs

Speculators buy and sell currency to profit from anticipated changes in

Exchange rates without engaging in other sorts of Foreign Exchange dealings
for which Foreign Exchange is essential

Central Banks and Treasuries

National Treasuries or Central Banks may trade in currencies for the purpose
of affecting exchange rates

Foreign Exchange Brokers

Commission agents who bring together

Suppliers and buyers of Foreign currency

Transactions

Several types of Transactions

Significant among them are spot, forward and Swap Transactions

Spot Transactions

An interbank transaction

Where purchase, payment and delivery

Takes place on the following second business day

Rate quoted is called spot rate

Date of settlement is called value date

Forward Transaction

Where the specific amount of one currency is exchanged for a specified

amount of another currency,

At a future value date

Rate quoted is called forward rate

Normally quoted for value dates of 1,2,3,6 and 12 months

Swap Transaction

The simultaneous purchase and sale

Page 37 of 42

Of a given amount of Foreign Exchange

For different value dates

Rates and Quotations

The price of one currency expressed in terms of another currency

A statement of willingness to buy and sell at a specified rate and at a

specified value date is known as Foreign Exchange Quotation

Inter Bank Quotation

Foreign Exchange quotations stated by and among the banks trading foreign
exchange

European terms is where the foreign exchange rate is expressed in terms of

the US Dollar

Eg. Rs 46 / $1 means 46 Rupees per Dollar

Direct Quotation

The home currency per unit of Foreign currency is called Direct Quotation

Unit of Foreign currency is kept constant

Exchange rate is expressed as a change in the unit of home currency

Indirect Quotation

Foreign currency price of home currency unit is called Indirect Quotation

Unit of home currency is kept constant and any change is expressed in unit of
Foreign currency

Bid Quotation

A quotation in one currency at which a dealer will buy another currency, is

known as an ask quotation

Cross Rates

Where the exchange rates of inactively traded currencies are determined

through their relationship with a widely traded third currency, it takes the
form of cross rates

Page 38 of 42
Forward Premium and Discount

Where the payment made for forward delivery is more than the payment for
the spot delivery of a foreign currency, the forward contract is said to be at a
premium

Futures contract

Standardized

Standard amount

Standard time

Standard place

Fixed price

Mechanics of Currency Trading

Contract: Transactions take place in the inter bank market through the
Telecommunications media

Two way Quote: one for buying and other for selling. The bank that proposes
the transaction is called the market maker

Bid ask rate

The rate at which the bank will pay to buy

The rate which the bank will require to sell

Taking Positions

If the market maker sells more than it buys short position

If the market maker buys more than it sells long position

Exchange Rates

Fixed Rate System

Semi fixed rate systems

Floating rate system

Fixed rate system

Gold Standard

Bretton Woods

Page 39 of 42

Pegged Rate

Currency board

Gold Standard

A countrys money supply is directly linked to the Gold Reserves owned by its
Central Bank

Bretton Woods

Based on Gold and Foreign Currency

IMF created its own currency, the SDRs for issue to members for settling
debts with one another

Pegged Rate

A country decides to hold the value of its currency constant in terms of

another currency usually that of an important trading partner

Currency Board

The board issues currency only to the extent that each unit of currency is
backed by an equivalent amount of Foreign currency reserves

Semi Fixed rate System

Bands

Target Zones

Pegs and Baskets

The crawling peg

Bands

Exchange rate is allowed to stay and float within a certain band

Central Bank is responsible for adjusting the interest rates to keep the
exchange rates within the band

Target Zones

Similar to bands

Except that the Govts commitment is non binding

Page 40 of 42

Possible for a govt to set a target zone unilaterally for its currency against
another currency

Or target zones can be agreed multilaterally by a group of countries

Pegs and Baskets

Exchange rate is pegged to a basket of currencies rather than just to a single

currency

The peg is set as the average exchange rate against several currencies

The Crawling peg

Mechanism for adjusting an exchange rate usually in a pre announced way

Central bank may allow depreciation at a desired rate.

Floating Rate System

Exchange rates are allowed to move with market forces

Merchant rate

The rate at which the foreign exchange dealing takes place between a bank
and the merchant business is called the merchant rate

Inter-bank rate

Also known as the base rate, it refers to exchange rate quoted between
banks

Two types of buying rates TT buying rate and Bill buying rate are quoted in
India

Telegraphic Transfer Rate

The rate applied when the transaction does not involve any delay in
realization of the foreign exchange by the bank

Bill Buying rate

The rate applied on the purchase of a foreign bill is called bill buying rate

These have a transit period

The bills buying rate is loaded with the forward margin

Nominal exchange Rate

Page 41 of 42

The rate that prevails at a certain time

Real Exchange Rate

Obtained by adjusting the nominal exchange rate for relative prices between
the countries under consideration

Effective Exchange Rate

A measure of appreciation or depreciation of the currency against the

weighted basket of currencies
Global Financial Markets

Meaning

The Financial Markets that operate outside the domain, regulations and
legislative framework of a country are collectively known as Global Financial
Markets

Trading takes the shape of the borrower from one country seeking lenders in
other countries in a specific currency

Important Constituents

Euro Currency Market

Export Credit facilities

International Bond Market

Institutional Finance

Euro Currency Market

Dominated by Euro dollar deposit in the form of bank deposit and loans

Dollar denominated time deposits available at foreign branches of US Banks

and also at some foreign banks are called Euro dollar deposits

The basis of Euro currency market is the banks in Europe accepting dollar
denominated deposits and making dollar denominated loans to customers

Export Credit Facilities

Made available through the medium of EXIM Banks

Play an important role in the extension of export credit facilities

Page 42 of 42
International Bonds Market

Also known as the Euro Bonds market provides facilities to raise long term
funds by using different types of instruments

Foreign bonds are also issued in domestic markets of some developed nations

Institutional Finance

Several International financial Institutions provide finance in foreign currency.

These include IMF, World Bank, IFC, ADB etc

Global Bond Market

An international market for the purchase and sale of bonds

Questions for Revision

1. What is meant by the following:

Market

Financial Market

Primary Market

Secondary Market

2. Write a short Note on any two of the following:

Money Market

Capital Markets in India

Debt Market

Foreign Exchange Market

3. Describe any five instruments used in the Financial Markets ?