Financial Market and Instrument

INTRODUCTION
Financial System of any country consists of financial markets, financial intermediation and financial instruments or financial products. The meaning of finance and Indian Financial System and focus on the financial markets, financial intermediaries and financial instruments. The brief review on various money market instruments are also covered in this study. The term "finance" in our simple understanding it is perceived as equivalent to 'Money'. We read about Money and banking in Economics, about Monetary Theory and Practice and about "Public Finance". But finance exactly is not money; it is the source of providing funds for a particular activity. Thus public finance does not mean the money with the Government, but it refers to sources of raising revenue for the activities and functions of a Government. Here some of the definitions of the word 'Finance'. The American Heritage Dictionary of the English Language, Fourth Edition defines the term as under1:"The science of the management of money and other assets. 2:"The management of money, banking, investments, and credit. "; 3:"Finances monetary resources; funds, especially those of a government or corporate body 4:"The supplying of funds or capital The same dictionary as under- defines finance as a function 1:"To provide or raise the funds or capital for" financed a new car. 2:"To supply funds to" financing a daughter through law school. 3:"To furnish credit to". Another English Dictionary, defines the term as under1:"the commercial activity of providing funds and capital 2:"the branch of economics that studies the management of money and other assets" 3:"the management of money and credit and banking and investments"

Financial Market and Instrument All definitions listed above refer to finance as a source of funding an activity. In this respect providing or securing finance by itself is a distinct activity or function, which results in Financial Management, Financial Services and Financial Institutions. Finance therefore represents the resources by way funds needed for a particular activity. We thus speak of 'finance' only in relation to a proposed activity. Finance goes with commerce, business, banking etc. Finance is also referred to as "Funds" or "Capital", when referring to the financial needs of a corporate body. When we study finance as a subject for generalizing its profile and attributes, we distinguish between 'personal finance" and "corporate finance" i.e. resources needed personally by an individual for his family and individual needs and resources needed by a business organization to carry on its functions intended for the achievement of its corporate goals.

Indian Financial System

The economic development of a nation is reflected by the progress of the various economic units, broadly classified into corporate sector, government and household sector. While performing their activities these units will be placed in surplus/deficit/balanced budgetary situations there are areas or people with surplus funds and there are those with a deficit. A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. A Financial System is a composition of various institutions, markets, regulations and laws, practices, money manager, analysts, transactions and claims and liabilities.

Financial System

Financial Market and Instrument The word "system", in the term "financial system", implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. The financial system is concerned about money, credit and finance-the three terms are intimately related yet are somewhat different from each other. Indian financial system consists of financial market, financial instruments and financial intermediation.

Financial Market and Instrument

FINANCIAL MARKETS

The financial markets are in the forefront in developing economics. Efficient financial markets are a sine qua non for speedy economic development. The vibrant financial market enhances the efficiency of capital formation. The market facilitates the flow of savings in to investment vis-a Vis capital formation. Dr.Khan has opined that, A variegated financial market can appeal to the security, motivation and other such aspects of savers and attracts more savings by the creation of an array of attractive financial structure. The role of the financial markets in the financial system is quite unique. The relevance of the financial market in the financial is not merely quantitative but also supportive. Thus, the financial markets bridge one set of financial intermediaries with another set of players. Well-developed financial markets enlarge the range of financial services. More importantly, under appropriate conditions, financial (capital) markets can provide long-term finance to government and large business firms. Financial markets are never prefect. In allocating credit, they can make two mistakes: funding low- yielding projects and failing to fund high-yielding ones. In the

Financial Market and Instrument early stages of development, the governments of developing countries fearing that the costs of failing of fund good projects were likely to be high intervened to direct cedit. The primary role of government then shifts to making market signals more meaningful and, in particular, to preventing its own actions from distorting them. On occasions, the government may have a role to play as a promoter of financial institutions and markets in order to create a diversified and competitive financial system. Many high income and developing countries have used fiscal incentives to favour institutions and market.

Investment in Indian market

India, among the European investors, is believed to be a good investment despite political uncertainty, bureaucratic hassles, shortages of power and infrastructural deficiencies. India presents a vast potential for overseas investment and is actively encouraging the entrance of foreign players into the market. No company, of any size, aspiring to be a global player can, for long ignore this country which is expected to become one of the top three emerging economies

MARKET POTENTIAL
India is the fifth largest economy in the world (ranking above France, Italy, the United Kingdom, and Russia) and has the third largest GDP in the entire continent of Asia. It is also the second largest among emerging nations. (These indicators are based on purchasing power parity.) India is also one of the few markets in the world which offers high prospects for growth and earning potential in practically all areas of business. Yet, despite the practically unlimited possibilities in India for overseas businesses, the world's most populous democracy has, until fairly recently, failed to get the kind of enthusiastic attention generated by other emerging economies such as China.

DIVERSE MARKET
`The Indian market is widely diverse. The country has 17 official languages, 6

major religions, and ethnic diversity as wide as all of Europe. Thus, tastes and preferences differ greatly among sections of consumers.

Financial Market and Instrument

Therefore, it is advisable to develop a good understanding of the Indian market and overall economy before taking the plunge. Research firms in India can provide the information to determine how, when and where to enter the market. There are also companies which can guide the foreign firm through the entry process from beginning to end --performing the requisite research, assisting with configuration of the project, helping develop Indian partners and financing, finding the land or ready premises, and pushing through the paperwork required.

DEVELOPING UP-FRONT TAKES:

Market Study Is there a need for the products/services/technology? What is the probable market for the product/service? Where is the market located? Which mix of products and services will find the most acceptability and be the most likely to generate sales? What distribution and sales channels are available? What costs will be involved? Who is the competition.

CHECK ON ECONOMIC POLICIES:

The general economic direction in India is toward liberalization and globalization.

But the process is slow. Before jumping into the market, it is necessary to discover whether government policies exist relating to the particular area of business and if there are political concerns, which should be taken into account.

Integrating Financial Markets

A segmented financial system complicates the conduct of monetary policy and adversely affects resource allocation and growth to illustrate, suppose that interest rate ceilings are set at higher levels for non-bank financial institutions than for banks. A policy of credit restraint would then encourage the outflow of funds from the banking system. The income velocity (that is, ratio of GNP to money) of broad money (currency and demand deposits plus savings and time deposits) may increase, while that of narrow money (currency and demand deposits), which is used as reserve asset of non-bank financial

Financial Market and Instrument institutions, may fall. A redefinition of monetary and credit targets for purposes of financial management cannot sufficiently counteract the possible negative impact on the intermediation capability of a financial system that is segmented by excessive and inappropriate regulations. A long-term solution is to reform the domestic regulatory framework to eliminate the major causes of segmentation, such as inadequate licensing regulations, burden some reserve requirements and portfolio restrictions, unrealistic interest rate ceilings, and the operating inefficiencies of the regulated markets.

CLASSIFICATION OF FINANCIAL MARKET

Financial Markets perform an important function of mobilization of savings and channellising them into the most productive uses. The financial market in India can be divided into four broad categories: Money Market Debt Market Forex Market Capital Market

Financial Market and Instrument

MONEY MARKET

At the outset, it is necessary to examine what we mean by the term money market, which has sometimes been defined as an organization for dealings in loan market or borrowed funds. This is a very broad definition and has been adopted by a number of writers. It is also defined as follow: A money market is a mechanism through which short-term funds are loaned and borrowed and through which a large part of the financial transactions of a particular country or of the world are cleared. Broadly conceived, it includes the entire mechanism employed in financial business of all types. In the narrower sense, in which the term is generally used, however, a money market includes only dealings in more or less standardised types of loans, such as call loans and in credit instruments, such as acceptance and treasury bills, in which personal relations between lender and borrower are of negligible importance. In this sense, a money market is distinct from, but supplementary to the commercial banking system. The development of securities markets usually starts with trading in a short-term money market instrument, often a government security. Other money market instruments are interbank deposits, bankers acceptances, certificates of deposit and commercial paper issued by non-financial corporations. Money markets provide a non-inflationary way to finance government deficits. They also allow governments to implement monetary policy through open market operations and provide a market-based reference point for setting

Financial Market and Instrument other interest rates. Further more, money markets are a source of funds for commercial banks and other leading institutions.

Monetary Policy
Monetary policy in any country is largely determined by the institutional framework and environment in which it is expected to operate. It is necessarily moulded by the world in which it takes shape. The structure of the money market is the base on which depends the operation of the monetary policy. Monetary management is largely governed by such institutional factors as the use of credit, credit consciousness of the people and their preferences, the general banking structure and the development of the banking habit among the people as a whole. Any effective organization and the response of financial institutions in general and banks in particular depend upon the nature of the money market and the degree of cooperation between its various components. The structure of the money market is, therefore, abases for introducing monetary discipline and for implementing monetary discipline and for implementing monetary policies in any central banking is the unanimity with which all writers functioning of the central bank. An attempt has been made here to examine the effectiveness of the monetary policy in India in the context of the money market in this country.

Monetary Management
The monetary policy in India is a case study of monetary management in a developing economy with an unorganized money market. The study is, therefore, valuable for the undeveloped and under-developed countries as well as for developed countries. Since the monetary policy in India operates in the organized and unorganized sectors of money markets, the structural changes have to be analysed first .An objective analysis of the structure of the Indian money market, therefore, assumes great importance in the study of monetary policy and central banking activities.

Financial Market and Instrument

Features Of Money Market

It is a collection of market for following instruments- Call money, notice money, repos, term money, treasury bills, commercial bills, certificate of deposits, commercial papers inter-bank participation certificates, inter-corporate deposits, swaps, etc. The sub markets have close inter- relationship & free movement of funds from one sub-market to another. A network of large number of participants exists which will add greater depth to the market. Activities in the money market tend to concentrate in some centre, which serves a region or an area. The width of such area may vary depending upon the size and needs of the market itself. The relationship that characterizes a money market is impersonal in character so that competition is relatively pure. Price differentials for assets of similar type will tend to be eliminated by the interplay of demand & supply. A certain degree of flexibility in the regulatory framework exists and there are constant endeavours for introducing a new instruments / innovative dealing techniques. It is a wholesale market & the volume of funds or financial assets traded are very large i.e. in crores of rupees.

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Financial Market and Instrument INDIAN MONEY MARKET

Unorganized Sector

Organised Sector

Co-operative Sector

Chit Funds

Indigenous Bankers

Money Lenders

Nidhis

Reserve bank of India

Public sector banks

Private sector banks

Development banks

DFHI Ltd

LIC UTI I.F.C. IDBI

Nonscheduled Banks

Scheduled banks

Foreign banks

Indian banks

The organised sector of the Indian money market is comparatively well developed in terms of organised relationships and specialisation of functions. It more or less centres round the Reserve Bank of India; and the State Bank, commercial banks and cooperative banks are associated with it. The policies and operations of the State Bank and the

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Financial Market and Instrument cooperative banks are governed by the Reserve Bank and are also dependent on it for direct financial assistance. In fact, a substantial portion of the funds, which cooperative credit agencies lend out, is provided by the Reserve Bank. Financial intermediaries, such as the Industrial Financial Corporation, the Industrial Development Bank of India, State Financial Corporation, the Agricultural Refinance Corporation, etc., derive most of their resources from the Reserve Bank. The policies of these financial intermediaries are enunciated with the approvals of the Reserve Bank; even the personnel of some of them are supplied by the Reserve Bank. More important than all the above-mentioned institutions, is the inter-bank call-money market, which is regarded as the core of the Indian money market. "Although the magnitude of funds dealt in this market is not large in relation to the deposit resources of banks, perhaps this is the most sensitive sector of the money market." Then there are the treasury bills and bills of exchange, which absorb the surplus liquidity of the institutions in the organised sector As regards the agencies constituting the unorganised money. Market, it is necessary at the outset to clarify one important point ' regarding the nomenclature used to designate them. The term-unorganised money market conveys the impression that indigenous agencies providing credit have neither any system nor any organisation among themselves, nor any definite procedure regulating their lending practices. Infact, these agencies have been functioning for ages in almost all parts of this country, and have a time-tested organisation. They follow well-set patterns, both as regards their lending policies and their interest rates. Their native origin is mainly responsible for some of their unique features, which have few parallels among similar agencies in Europe.

Indigenous Banking
The system of indigenous banking in India is of ancient growth and dates back to Vedic times, which may be taken to range between 2000 B.C. and 1400 B.C. Money lending was regarded as an ancient practice. That it was practiced even in the early Aryan days is evident from the references to money lending as one of the four honest callings, the other three being tillage, trading and harvesting. The researches of MacDonnell and Keith provide the main source of information regarding money lending during the

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Financial Market and Instrument Vedic and Pre-Vedic periods. Rina (debt) is often mentioned in the Rig Veda and in late Vedas, and indicates a normal condition in the Vedic society. On the subject of interest, the available information is sketchy. That interest was charged may be inferred from the fact that the usurer (kusidin) is referred to in the Shatapatha Brahmana and the Sutras. However, little is known about the rate of interest prevailing in Vedic times or the terms and conditions on which loans were advanced. The available evidence shows that rather low rates were generally prevalent and usurious rates were frowned upon. The money market in India is dominated by the unorganised sector. The only link that exists between the organised and unorganised sectors is through the commercial banks. Indigenous shroffs carry on their activities through the media of these commercial banks. In rural areas, they do so through cooperative credit societies. However, a number of credit societies are under the control of moneylenders. Infact, the Rural Credit Survey Report gives instances of moneylenders who are actively associated with cooperative credit agencies either as members or as office-bearers. Recently, more instances of their active interest have come to light. It seems that a growing number of spurious cooperative societies have been organised solely to enable these moneylenders to take advantage of the concessions they offer. The indigenous bankers use banks as intermediate agencies of their transactions and yet remain outside the orbit of central bank control. The unorganised market has of late been strengthened with the addition of unaccounted money, variously known as black money or unaccounted gains or untaxed assets. A conservative estimate places this amount at between Rs. 2,500 crore and Rs. 4,000 crore or more. As a result of the income velocity of money, considerable savings will be accruing in the unaccounted income sector. These savings seek outlets, which again escape from the tax-net and thus enlarge the unaccounted sector. In view of the plethora of liquid funds in the unaccounted sector and the high rates of return in the speculative holding of goods, the production circuit is severely disturbed. In an international context, there are high returns from in smuggling and out-smuggling of goods, drugs and precious metals. These highstaked, high-return activities are invariably financed from the unaccounted money. Likewise, unaccounted money is also found in real estate and also a useful source of finance for the political process. In the process, the unaccounted sector has acquired respectability and

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Financial Market and Instrument at the same time, running a parallel money market with a continued drain to the exchequer and violation of foreign exchange laws. The operation of the unaccounted income (money) sector is illustrated as follows

UNACCOUNTED MONEY MARKET

Speculative holding, gold, silver, diamonds, and other jewellery Foreign Exchange, underinvoicing of imports, overinvoicing of exports. Growth, stocks, Inventories of Commodity Financing of political parties Real Estate, vacant flat, agriculture land, sites etc. Holding of govt permits, imports, exports etc.

The unique aspect of unaccounted currency is that, except when hoarded, it never, remains permanently concealed, not for a continuously long term. A large portion of it is in circulation and constantly changes its character. The impact of unaccounted money on the money market is very significant. With its growth in the country, a number of mushroom indigenous bankers have sprung up, who are quite different from the traditional bankers; and it has been reported that they lend money at very high rates of interest. The indigenous money market has itself become a lawless market, and the old conventions have very little relevance to it. The unaccounted money as part of the indigenous money market is invested in property, small-scale industries, smuggling, and trade. This fact has further limited the effective implementation of the monetary policy. Unaccounted money has further strengthened the indigenous market in India. However, with the devaluation of the Rupee, the effective use of unaccounted money is expected to decline somewhat, though its impact on the market will continue as before since there is no direct link between the unorganised and organised money markets, it is essential to establish such a link. The link of commercial banks between the two markets is so weak that it is more advantageous to the unorganized market than to the organised sector.

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Financial Market and Instrument

Instrument in money market

1. Call/Notice Money 2. Treasury bills 3. Term Money 4. Certificate of deposit 5. Inter-Corporate Deposit 6. Commercial Papers 7. Ready Forward Contracts 8. Commercial Bills

Money Market Development

The development of the money market contributes to the efficiency of the financial sector by allowing financial institutions to transfer surplus funds to other financial institutions instead of directly financing inefficient borrowers or discouraging depositors; and by facilitating the management of bank liabilities through refinancing, thereby increasing the availability of long-term finance for investment. In addition, open-market operations could be conducted more effectively and their effects on banks' marginal cost of funds felt more rapidly. Specific policies to develop and strengthen money markets have been addressed in Fund programs of technical assistance. Such policies include strengthening broker-dealer services and their regulation, introducing money market instruments, reforming the central bank's discount window operations to support money market development consistent with monetary control, setting up auction systems in the primary market for money market financial instruments, and favourable tax treatment of interest income from financial assets.

Role of Reserve bank

The first thing to which the Reserve Bank of India has to assign -top priority is the introduction of effective monetary management and the coordination of the money market with a view to bringing indigenous bankers within the fold of its central banking policy. Even before the Reserve Bank was established, the Central Banking Enquiry 15

Financial Market and Instrument Committee considered it to be a matter of paramount importance. It had recommended the development of direct links between moneylenders and the Reserve Bank of India, in the same way in which it had established links with the joint-stock banks. "Such indigenous bankers as are engaged in banking proper or are prepared to shed their business other than banking should be eligible to be placed on the approved list of the Reserve Bank in the same manner as joint-stock banks." Some of the Provincial Banking Enquiry Committees had also suggested that Indigenous bankers should be linked with the central banking institutions; They should be treated as member banks on the approval list of banks;Commercial banks might discount their bills more easily; Indigenous bankers should be licensed. The scheme suggested the Central Banking Enquiry Committee recommended that the Reserve Bank should prescribe a standard which indigenous bankers must follow before they are given the concessions. The maintenance of proper books of accounts in the recognised manner and the submission of these books to the Reserve Bank for inspection and audit were two of the important eligibility conditions. Although commercial banks are expected to pay much greater attention than they did in the past to the needs of small borrowers of various types, it is unlikely that they will be able to displace indigenous bankers altogether. The Banking Commission does not think that such displacement is ever possible or practicable. A more useful course would be to adopt measures, which would enable these agencies to work in conformity with the overall credit policy of the Reserve Bank. The Reserve Bank of India is the central bank of the country. In order to exercise effective monetary management, the Bank has to introduce monetary discipline in the money markets. In this connection, its first and foremost task has been to consolidate commercial banking and extend banking facilities in the country. The apex bank stands committed today in this task. The mergers introduced by the Bank since 1970 should be strengthened and extended to more scheduled and non-scheduled banks, particularly to those that are sick. The branch expansion programmed should be planned so as to meet the needs of the various regions. The State Bank and its associates should be merged, the nationalized banks should be reorganized into viable units, and the link between the

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Financial Market and Instrument State Bank and commercial banks should be codified. Again, the Reserve Bank should acquire powers to control the other financial institutions in the country, which substantially influence the money market. A direct link between the unorganised and organised money markets must be established. Cooperative banks should be brought within the full control of the Reserve Bank. Only then the Central Bank will be able to implement its monetary policy more effectively. In a country like India, with large geographical dimensions, a huge population of over 68 crore and a large number of banking offices, cooperative banks and indigenous bankers, it is necessary that there should be regional central banks which would be effective with their constituents, subject to the overall control of the Central Monetary Authorities.

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Financial Market and Instrument

DEBT MARKET
Introduction
The object of this chapter is to set out briefly how the public debt of the government has been steadily rising and has become a matter of concern in recent years. In this backdrop, the mechanics of its management by the apex bank are discussed. If the country is really caught in the debt trap, what then are the policy alternatives to extricate itself from the fiscal crisis.

Debt Concepts
A variety of concepts is used to measure and assess the economic burden of debt. Debt stock, which is often reported as debt outstanding and disbursed, measures the total debt liabilities of the debtor. The payment obligation arising from this is debt service and comprises interest and principal payments. The debt stock does not necessarily predict the debt service. Two concepts describe the net effect of borrowing and repay-ments on the flow of financial resources.

Public Debt
Governments to meet the gap between budgeted receipts and payments raise public debt. Public debt has far reaching consequences upon production and distribution of a country. Public debt is thus government or state debt. The state generally borrows to: To meet budget deficits; To cover other expenses; and to finance development activities.

Classification of Public Debt

Public debts have been classified into two broad groups internal and external Internal debts are loans raised within the country. External debts are cumulative amount raised outside the country by the government and others.

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Financial Market and Instrument

Components of Internal Debt

Internal debt of the Government of India comprises of market loans, treasury bills, special securities issued to the Reserve Bank and International financial institution and others. Other liabilities (rupee debt under the public account) com-; prices of small savings, provident funds (State Provident Funds and Public Provident funds), other accounts (mainly postal insurance! and Life Annuity Fund, Special Deposits etc.) reserve funds.

The Structure of the Indian Debt Market

The Indian debt market includes the money market and the bond market. While the money market is fairly well developed with a wide range of instruments and a fairly large turnover, the secondary market for bonds has been primitive and stunted. The instruments traded in the debt market include Government of India Securities, Treasury Bills, State Government Securities; Government guaranteed bonds, PSU bonds, corporate debentures, commercial; papers and certificates of deposit. Principal issuers, instruments and investors in the debt market. The principal regulatory authorities of the debt market are Ministry of Finance and the Department of Company Affairs^ Government of India, the Reserve Bank of India and the Securitities and Exchange Board of India (SEBI). In addition, there are a associations of intermediaries such as brokers, merchant banker and fund managers in the securities industry, some of whom planning to evolve into self-regulatory organisation. A unique feature of our external debt lies in its structure is, probably, the reason why the IMF isn't terribly worried four per cent of our external debt is owed to multilateral institutions, like the World Bank and the IMF, and another 1 is owed to bilateral aid agencies

Components
Internal debt is of two components floating debt and permanent debt. While floating relates to Treasury bills, special floating loans and Treasury deposits receipts, permanent debt is in the form of market loans, compensation bonds and prize bonds. The Government securities issued may take the form promissory notes, stock certificates or entries in the subsidiary General Ledger Account, kept with the public 19

Financial Market and Instrument debt office of the Neither stock certificates nor promissory notes are bearer bo Interest on stock certificates is paid by warrants without the need certificates to be presented. Promissory notes are, however, to be presented interest warrants. at the Public Debt Office for issue of

Floatation of Loans
The centre and state governments budget every year f certain amount of market borrowings as part of the receipts or capital account. The loans are floated in the market at convenient times of the year so as to enable the market to absorb them. The Reserve Bank of India manages the public deposit of Government, both Central and State, among its various other function as bankers to the Government As part of these responsibilities the apex bank advises the governments on the quantum, term issue and the timing of the new loans of both the Central and Governments. The RBI also arranges for the floatation of the loans and their successful absorption in the market. The Bank coordinates the borrowing activities of the Centre and State Government respect of their timing and terms, etc. with those of semi-Govern bodies and financial institutions. The Central and State Government loans are floated in two or three installments every year at a time when the banks and o financial institutions are supposed to have excess funds particular during the slack season. The terms and conditions of the issue are framed by the RBI, consultation with the Government in tune with the market yields and other conditions. Thus, the coupon rates on the new issues floated in 1975 and 1976 were higher than in the earlier years upward adjustment of all interest rates in the recent past. Prior to the announcement of the loans, the Bank plans ahead in consultation with the prospective subscribers, the amounts likely to be contributed by each one of them. Accordingly, the RBI corresponds with the 1 major commercial banks; Provident Fund Commissioners etc obtain from them a prior commitment on their contributions to loans to be floated. The Bank would have already decided on the terms of issue, coupon rates, maturity of the loans, and the quantum likely to be offered under various maturities, in order to enable the banks to decide on these likely contributions. It is well known that banks do need the government securities for their liquidity requirements every year, in tune with the growth in their deposits and their

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Financial Market and Instrument requirements in terms of various maturities are broadly discussed by the banks with the apex bank, at this time. Within the Reserve Bank, the policy matters relating to floatation of new loans, terms, conditions, etc., including open market operations, referred to below are attended to by the Secretary's. Department. Public Debt Office of the Banking Department is responsible for the receipt of subscriptions to the government loans,' issue of receipts, payment of periodical interest, enforcement of! Securities for payment of interest etc. The Securities Department deals with the purchase and sale of securities on behalf of the' Government departments and agencies and the Reserve Bank of? India and the Safe Custody of these securities The rates of interest on the Government debt are generally lower than the usual market rates on private securities. This is the result of a deliberate policy of the Reserve Bank and the Government to keep the cost of servicing of Government debt low and also to facilitate long-term investment by the Government in the economy. Besides, the Reserve Bank also ensures that the maturity pattern in such that long-term debt of the Government is relatively larger than short and medium term debt. Thus, as at the end of March 1975 nearly 61% of the total marketable debt of the Government has been recorded to be of long-term nature. There is much less uncertainty today and much more stability in the market than it used to be before. But this is true to a certain extent only. The Reserve Bank issues loans as far as possible at par at small discounts where interest rate adjustments are not possible for such fractional amounts of less than one quarter. Thus, the Reserve Bank has by experience achieved considerable success in management of the Government debt viz., floatation of loan grooming of the market, open market operations etc.

Ownership of Debt
A survey of the ownership pattern of government securities conducted by the RBI's research department some years ago revaled more than 92 per cent of government securities were held by governmental and quasi-governmental institutions, while individuals accounted for the rest. A recent estimate by the same sources now pegged the former group's holding at 99 per cent. Thus, true assumption that an increase in interest

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Financial Market and Instrument rates on treasury bills and government securities will attract large amounts of savings from the household sector does not appear to be justified. On the contrary, i was feared that such a measure would increase the debt burden or the government rather than reduce the level of deficit financing..

Maturity Pattern of the Debt

Maturity-wise, there are three classes of loans, which the Central floats and State Governments short-term, medium-term and long-term. Short-term loans are for periods varying from 1 to 5 years, medium-term loans from 5 to 10 years and long-term loans above 10 years. The maturity pattern of the debt is arranged in such a way to suit the demands of the institutions. About 17% of the Central Government debt is of shortterm nature 22%of medium-term nature and 61% of long-term nature*The Government would prefer a larger amount of long-term debt as it would be suitable for developmental outlays. The maturities are now well distributed as between the various years. There are no double dated loans and none of the market loans are kept on tap and none are repaid before the maturity date. There are about 40 Central Government loans outstanding in which the Reserve Bank does open market operations and which are held by the Reserve Bank in its investment account. Of these, 9 are of short-term maturity with coupon rates varying from 23/4% to 43/4z dated loans with coupon rates varying from 4Vi % to 5V$%, and the rest are the long dated loans with coupon rates. As against these coupon rates on the Central Government loans, the State Government loans have a rate slightly higher by of the State Government loans are of short and medium dated nature.

Management of Public Debt Some Issues

The management of public debt of both the Centre and the States is the responsibility of the Reserve Bank as the Central Bank of the country and as a banker to the Government. This involves some problems:

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Financial Market and Instrument (I) Transfer Problem: Firstly, the interest burden is borne by the Government through taxes, which are paid mostly by the poorer sections, while the institutions and the richer classes of people hold the public debt. This would involve an inequitable transfer of funds from the poor to the rich. (II) Equity Between Present and Future Generation: Secondly, public debt involves transfer of resources from the public to the Government, when loans are raised from the present generation but the repayment of loans may benefit only the future generations. This would involve some inequity as between the present and future generations, in the sense that the burden is borne by the present generation and the benefits will flow to the future generations. (III) Interest Rates Problem: Thirdly, the management of public debt involves the problem of interest rate structure through the open market operations. This means that the interest rates in the market can be influenced by the Reserve Bank through the prices at which it buys and sells the Government securities. (IV) Problem of Liquidity in the Economy: Fourthly, the greater the public debt held by the RBI and the banks, the greater is the possibility of monetizarion of the debt. Money supply can be expanded and contracted by the open market purchase and sale of the government securities and through this process; the liquidity in the economy can be expanded or contracted. The holdings of government securities by theRBI provide potential for money creation. RBI's Concern In its annual report for 1994-95, the RBI has expressed deep concern over the pace of domestic debt accumulation of the government (Centre and States combined). The RBI feels that debt accumulation at this pace will have serious implications for the Centre and the States. It will result in higher interest payments and higher amortisation. Interest payments account for 52 per cent of revenue receipts for the" centre, 16 percent for the States and 29 percent for the centre and the states together, after adjusting for intergovernmental transfers. And, the burden of repayments is expected to be severe in the next ten years. The RBI foresees that the government ran the risk of setting into a vicious circle of borrowing at higher interest rates to service higher repayments. Thus, the

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Financial Market and Instrument RBI expressed serious concern over the prospect of the economy falling into an internal debt trap. Debt Market Reforms I. Banks and institutions be permitted to set up primary dealer counters to broad base holding of debt instruments at the retail level. II. The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) stipulations in inter-bank borrowings are abolished to encourage the emergence of a meaningful benchmark like the LIBOR. III. Debt market intermediaries are given access to institutional finance. IV. FIIs are allowed to participate in the debt market. 'Repos' transactions be reintroduced for listed debt securities with suitable safeguards. V. No restrictions are placed on the kinds of instruments in which Money Market Mutual Funds can invest. VI. There is a single regulatory authority, preferably SEBI, for! the debt market. VII. A single TDS rate is developed for all debt instruments. VIII. Private sector infrastructure companies are permitted to issue tax-free bonds. IX. Stamp duty on primary issues of debt securities need to be made uniform across all states. Stamp duty on secondary market'; transactions should be abolished. X. A municipal bond market is developed. Municipal bodies be | given powers to set levels for user charges for the services provided. Debt and Cash Management

This includes the discontinuance of Ad hoc Treasury Bills and introduction of Ways and Means Advances to the Central Government} brought to the forefront, the need for a sophisticated cash cash-management system by the Government and improvements in the debt management techniques by the Reserve Bank. To address these concerns, a Monitoring Group on Cash and Debt Management of the^ Central Government was set up comprising members of the; Government and the RBI, The Group reviews inter alia, the monthly fiscal deficit, progress of borrowing programmed, instruments borrowing, and cash position of the Central Government on ongoing basis.

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Financial Market and Instrument This issue was also discussed in the meeting with Finance? Secretaries of State Governments. In the light of the experience gained in respect of the Central Government, it was felt that it would be advantageous to conduct a similar exercise for State Government. To begin with a symposium will be organised by the RBI to enlighten/] the State Governments with more professional cash management, techniques. The symposium will also discuss the accounting arrangements and the need for improvement in this area, keeping inj view the change in technology.

Debt and Liquidity in the Financial System

In formulating and implementing monetary policy, the Reserve; Bank places before it a very important aspect, namely, the liquidity^ management at a shorter-term horizon. This facilitates the banking system to provide, in a flexible manner, the cash and payments needs| of the economy. A realistic and timely assessment of liquidity in the system is very essential for timely and effective decision making in j money, debt and forex management.

Instrument
Government securities (G-secs) are sovereign securities, which are issued by the Reserve Bank of India on behalf of Government of India, in lieu of the Central Government's market borrowing programme.

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Financial Market and Instrument

THE CAPITAL MARKET

The process of industrial development requires, as one of its accompanying structural changes, the development of a capital market. The capital market should be capable of meeting the requirements of credit and finance of the private entrepreneurs. The capital market should also help in sustained national industrial development. Indian capital market has been experiencing metamorphic changes for the last few years. The changes have become more pronounced in the last couple of years with the advent of liberalisation pertaining to the industrial policy, licensing policy, financial services industry, interest rates, etc. The competition has become very intense and real, thus affecting the industrial sector and financial services industry. As a result of this, in the area of capital market, and the more and more new financial instruments have been introduced by the companies accessing capital markets. In recent years, the development banks have been playing a major role and continued actively to participate in the development of capital market. Thus, development banks, capital market and industry are interlinked and interdependent. The economic growth reflects the combined effort and strength of these institutions. As such, the capital market in the 1980s has emerged as a rapidly growing source of investible funds to the corporate sector. Resources raised during the Seventh Plan were over Rs. 26,000 crore as compared to Rs. 4,700 crore raised during the Sixth Plan. During the last three years (1990-91 to 1992-93), total amount raised from the capital market including public sector undertakings (PSU) bonds aggregated to Rs. 39,848 crore. The growth of the Indian capital market has been impressive.

WHAT IS CAPITAL MARKET?

It is an organised market mechanism for effective and efficient transfer of money capital or financial resources from the investing class (a body of individual or institutional savers to the entrepreneur class (individual or institutions engaged in industry business service) in the private and public sectors of the economy.

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Financial Market and Instrument In a very broad sense, it includes the market for short funds. H.T. Parikh has referred to it as, "By capital market, I me, market for all the financial instruments, short-term and long-term & commercial, industrial and government paper. In the words of Goldsmith, "the capital market of a modern economy has two basic functions: first the allocation of saving among users and investment; second the facilitation of the Trans existing assets, tangible and intangible among individual economic units." Grant defines capital market in a broad sense as a series channels through which the savings of the community are made available for industrial and commercial enterprises and for p authorities. It embraces not only the system by which the public up long-term securities directly or through intermediaries but the elaborate network of institutions responsible for short-term medium-term lending." From the above definitions, it may be deducted that the fun of capital market is the collection of savings and their distribution industrial investment. Thus, capital formation is sine qua nt economic development. As such, the relationship between the ma instrument and services are integrated as well as inter-dependent. Capital market is generally understood as the market for 1ong- term funds. The capital market provides long-term debt and equity finance for the government and the corporate sector. By making 1 term investments liquid, the capital market mediates between conflicting maturity preferences of lenders and borrowers. The Capital market also facilitates the dispersion of business ownership and the reallocation of financial resources among corporations and industries.

Dimensions of Capital Market

The Capital market is directly responsible for the following activities: (1) Mobilization or concentration of national savings for economic development, (2) Mobilization and import of foreign capital and foreign investment capital plus skill to fill up the deficit in the required financial resources to maintain the expected rate of economic growth, (3) Productive utilization of resources, and

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Financial Market and Instrument (4) Directing the flow to funds of high yields and also strive for balanced and diversified industrialization. A nation embarking upon accelerated economic development and industrialization has to make planned efforts to develop organized and healthy money and capital markets with an adequate institutional set-up. Market for credit (money and capital market) and business enterprises must go hand-in-hand to ensure quick industrialization in a developing democratic country.

Importance of Capital Market

The pace of economic development is conditioned, among others things, by the rate of long-term investment and capital formation. And capital formation is conditioned by the mobilisation, augmentation and channelisation of investible funds. The capital market serves a very useful purpose by pooling the capital resources of the country and making them available to the enterprising investors. Well-developed capital-markets augment resources by attracting and lending funds on a global scale. The Euro-currency and Eurobond markets are international finance markets in terms of both the supply and demand for funds. The increase in the size of the industrial units and business corporations due to technological developments, economies of scale and other factors has created a situation wherein the capital at the disposal of one or few individuals is quite insufficient to meet the growing investment demands. A developed capital market can solve this problem of paucity of funds. An organised capital market can mobilise and pool together even the small and scattered savings and augment the availability of investible funds. While the rapid growth of joint stock companies has been made possible to a large extent by the growth of capital markets, the growth of joint stock business has in its turn, encouraged the development of capital markets. A developed capital market provides a number of profitable investment opportunities for the small savers.

Indian Capital Market Today

The Indian capital market with over 7,500 listed companies and 23.s/tock exchanges is second in size only to that of the USA, in terms & availability of industrial securities. The Indian capital market offers good potential for further expansion in

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Financial Market and Instrument terms of absorption of large capital flows. It is noteworthy that despite problems faced on account of irregularities in security transactions earlier this year, the Indian stock markets have shown creditable business resilience and recovery. As per the review published by Fortune International in its Autumn Special 1992 number, the Indian capital market has appreciated by 44 per cent in US dollar - terms an appreciation rate which was second only to that of the Philippines 71%. Comparable statistics for other emerging markets are: South Korea (-) 24 per cent, Indonesia (-) 5 per cent, Singapore 5 per cent, Malaysia 9 per cent, Hong Kong 39 per cent, etc. It is true that the price-earning ratio of 29 is comparatively high when compared with the prevailing ratios in the aforementioned markets. But it needs mention that in the Indian market; the PE ratio is influenced to a very large extent by 4 or 5 leading scrips. If one leaves out these scrips, the PE ratio would certainly compare favourably with those prevailing in other emerging markets. Infact, considering that active trading is confined to few hundred scrips; it is conceivable that with substantial inflow of foreign capital, many of the currently dormant scrips, mainly of medium-sized corporate bodies, would show growth potential. There are a couple of areas where some improvement will be necessary. The first is the factor of a long time between the transaction and the actual registration of transfer of securities at present. Secondly, the reporting and controlling system will have to be geared up to ensure compliance with the stipulations regarding upper limit for investment in a domestic company (24%) and by a particular investor (5%). The Reserve Bank authorities confirm that steps are being taken to overcome these problems. Following the recommendations of Chakravarty Committee Report on Monetary System, the RBI during the year, began the auction of 182 days treasury bills in the money market. The objective of this measure has been to broad base the development of money market by introducing new instruments, create an active secondary market, bring the interest rates on treasury bills to the market level and gradually reduce the monetisation of public debt.

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Financial Market and Instrument

Capital
Savings

Development Market

Money

Market

The steady increase in the capital formation, which is slightly higher than the level of gross domestic savings, indicates that the development banks have been playing a significant promotional role in mobilising resources and channelling savings into productive investment. The enlargement of their coverage will definitely accelerate the growth process.

Capital market Instruments

The following instruments are being used for raising resources: 1. Equity shares 2. Preference shares 3. Non-voting equity shares 4. Cumulative convertible preference shares 5. Company fixed deposits 6. Warrants 7. Debentures/bonds 8. Secured premium notes (SPNs) 9. Euro Convertible Bonds (ECBs)/Global Depository Receipts

Capital Market Developments

The capital market has passed through a phase of substantial adjustment and advancements in recent years. A significant development was the entry of public sector enterprises in the power and telecommunication sectors in the capital market to raise larger resources by issue of tax-free bonds. Although this did not have any crowding out effect on the private sector borrowers, they faced stiffer competition in the market and had to come out with more attractive features attached to their issues.

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Financial Market and Instrument The drop in the stock prices experienced during the year also the marked a corrective phase, following the boom in 1985-86. However, it is seen as a temporary phase, which would in no way deter the long-term development of the market. High rate of savings, increasing presence of households for investment in financial assets, increasing diversity of financial instruments and growing securitisation of the financial market have been the basic factors providing enduring strength to the capital market. Besides, the need to raise the rate of industrial growth would require larger financial resources to be raised from the market. The market capitalisation of equity shares quoted on stock exchanges is currently estimated to be around 9 per cent of GNP. This is a relatively low figure by international comparison. The share of market capitalisation in GNP is 160 per cent in Japan, 65 per cent in USA, 122 per cent in U.K., 42 per cent in Taiwan, 95 per cent in Malaysia and 23 per cent in South Korea. The average priceearning (PE) ratio in India is currently in the range of 9 to 10 compared to 91 in Japan, 67 in South Korea, 32 in Malaysia and 15 in USA and Hong Kong. The lower size of market capitalisation and PE ratio in India are thus indicative of the potential for further development of the capital market in India. The capital market in the present decade has magnificently responded to meet the ever-growing capital needs of both the private and public sectors. Despite the ten-fold increase in the total capita raised from the market in the short span of seven years by the private sector alone, the total mobilisation was only 5% of the net household savings. There is no reason why the share of the household saving. Flowing into the capital market should not increase substantially in the coming years. The other factor, which must be kept in view, is that yield and earnings on equities in India are far higher than in most other countries where stock exchanges are fairly developed. Given the improvement in the general economic environment and better corporate results which are likely to follow in the wake of the massive investments in plant and technology that has taken place in the last five years, interest in corporate securities is likely to widen. The capital market has also undergone a sea change with its scale and scope of its activities also diversified in a multi-directional way. With the establishment of new institutions, the edifice of the capital market is strengthened and broad-based. With the

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Financial Market and Instrument significant increase in savings, many investment avenues have opened up in recent years. The review shows that the capital market in India has grown on its own impetus. The changes brought about in it since independence have strengthened it. The potential of the Indian capital market is immense which can help a great deal in establishing a welfare state in India by tapping public savings, engendering a sense of public participation as also management accountability to the public. Financial innovation has brought undoubted benefits to the customers of financial services. The markets have shown that they can adapt quickly and flexibly to changing circumstances; they will probably continue to do so. Achieving the objective of bringing immediate benefits to individual firms requires continued alertness to ensure that risks are adequately assessed and controlled and are priced appropriately. The technology which has nurtured these innovations is also available to help in controlling them, for efficient markets require not only the absence of distorting restrictions but also good information on which to base decisions and allocate resources. Experience has proved that no amount of fiscal and financial incentives alone, or even easy availability of finance, can bring success in industrialization efforts, unless other inputs like resourceful entrepreneurship, latest and efficient technology/know-how, professionals management, well-motivated and skilled manpower coupled with project counseling facilities and extension services are available at every stage during the lifecycle of a project. In its promotional and developmental role, it has been, and continues to be, the endeavor of development banks to provide these non-financial inputs to the best possible extent, consistent with their resources and capability. This apart, the development banks will continue to play a significant role in widening the savings market and capital market, and at the same time providing equal opportunities to employ the savings protectively thereby increasing employment, raising the level of income, reducing poverty and improving the standard of living of the people. In South Asia, India is the only capital market capable of growing into an international centre with its inherent strength, which very few markets possess. Both Singapore and Hong Kong are highly developed, but they do not possess inherent strength. With the centre of financial gravity shifting to the Middle East, India is sure to command increasing interest. But this can happen only if we are able to re-design our complex

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Financial Market and Instrument structure of regulations affecting the flow of capital. This would call (of a new vision and a new strategy. We would have to emerge out of the maze we have built for ourselves. A new order is emerging. We have opened up our closed economy on a selective basis. We have to cast our sight to a new horizon. Let us hope that we will be able to see the new vision and endeavour to achieve it in the coming years.

Strengthening the Capital Market

The Abid Hussain committee on development of capital market has suggested creation of two-tier stock exchanges along with a number of fiscal measures to streamline the stock market for bringing" stability and restoring investors' confidence. It has recommended long-term policy measures to bolster the capital market so mat industries with a proven track record could meet their financial needs from the growing capital market. The public sector financial institutions could then be made to cater to the needs of the newly emerging companies for survival and sustenance during their nascent phase. During the stock exchange boom of 1985-86, a number of listed companies disappeared overnight giving rise to the 'fly by night' phenomenon. The committee noted that merchant banks, which were found to have received commission in the process, largely promoted most of these companies. The committee recommended that all the companies should go through the registered merchant banks when they went public. The merchant banks should scrutinise the new companies entering the capital market, besides certifying that they were viable. This' would act as a safeguard on the listing of new companies . Yet another major recommendation dealt with the development of market makers, not prevalent in the exchanges now. The report proposed that merchant banks enter into a tie-up with the brokers to quote a cost-effective floor price. To finance the buying or selling of shares, it called for provision of institutional financing through commercial banks.The Committee recommended simplification of procedures involved in transferring of shares, which are considered to be complicated and cumbersome at present.This included the creation of a network of corporations akin

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Financial Market and Instrument to the proposed Stock Holding Corporation of India (SHCL) under the leadership of the IDBI so that private investors could freely transfer the shares. The report urged that a highly reputed national level institution be set up to undertake multiple memberships in stock exchanges throughout the country. The Committee also underlined the need to open new instruments such as non-voting shares with higher dividends than the voting shares. This would remove the fear of capture of managements of the companies as harboured by some efficiently run units. In case dividends were not declared for three consecutive years, these non-voting shares would automatically be declared as voting shares, thereby providing an element of control over the management for those non-voting shares. This would also facilitate Non-Resident Indians (NRIs) to come forward and participate in portfolio investment in the Indian market. For the profit-making public sector companies, entering the capital market with tax concessions, the Committee suggested unitisation by which a public financial institution would act as an intermediary in creating units through selling of 25% of the share capital. As and when there are dividends, the value of these units would automatically go up. The Committee also suggested that guidelines be evolved f the proper utilisation of mutual funds for equity raising instead buying debentures, as had been done by the State Bank of India and the Canara Bank in some cases. Apart from making equity a worthwhile investment, it is important that the share base itself is widened. At present, the mark for shares is limited to only urban areas and that too to a few major cities. There is considerable scope for raising resources from semi urban markets and even in the rural sector. The equity culture almost absent in these areas. There is an acute need to educate the public about the advantages of equity holding as also to provide facilities for purchases and sale of securities. For this purpose, The Following steps have been necessary: 1. Investment trusts or mutual funds have to be set up in semi -urban and even rural areas to be run on the same lines as the UTI to garner 2. The number of stock exchanges for cash transactions has been increased.

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Financial Market and Instrument 3. The financial institutions that also undertake underwriting operations have to undertake a publicity campaign to inculate public interest in equity investment.

Classification of Capital Market

Capital market divides in to two markets that are: 1. New Issue Market/ Primary Market 2. Stock Exchange/Secondary Market

New issue market

The industrial securities market is divided into two parts, namely, New Issue Market and Stock market. The new issue market derives its name from the fact that in makes available a new block of securities for public subscription. The new issue market provides additional funds for starting a new enterprise or for either expansion or diversification of the existing one. The main function of new issues market is to facilitate the transfer of resources from savers to entrepreneurs 1) Issues by new companies 2) New money issues split into three distinct serviced. Organisation Underwriting Distribution This calls for the presence of specialist agencies in the market. The money market is a short-term credit market. It also refers to the institutional arrangement facilitating borrowing and lending of short-term funds. Crowther has observed, "The money market is the collective name given to various firms and institutions that deal in the various grades of near money." A systematic presentation comprises of investment market, inter bank market, bills market, treasury bills market, and the Reserve Bank of India (RBI), financial institutions and banks also play a key role. Issues by old companies New non-money issues

From the operational standpoint of view, the general function of the new issue market is

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Financial Market and Instrument

Segment of Securities Markets

The major activity of the securities market is the mobilisation of funds from savings and their channelisation into investment. The principal instruments are equity shares, preference shares, debentures and bonds. The major characteristics of securities are their transferability and marketability. It comprises of two markets, namely, new issues market for primary market and stock market or secondary market. The investors in the primary issues or new issues would be only buying in the primary market but cannot sell there. Their activity is limited to major operations of buying and selling in the secondary market only. Investors or institutions and buyers and sellers would deal in the secondary market through the intermediaries or brokers. The issuers of securities are the corporate units, government and semi-government bodies and public sector undertakings. The public, savers, investors and institutions etc. can invest in both the primary and secondary markets. Their investments would be the sources of funds for the issuers of securities. The primary market is called new issues market or the capital market while the secondary market is called the stock market. In the primary market, the government and the public sector undertakings as well as corporate units borrow funds or issue capital in the form of securities, shares, bonds etc. The activity here refers to raising capital of ownership or debt nature. In this market, the primary savers or investors can keep their funds for a return. In the secondary market, they can buy and sell existing securities, invest and disinvest or rechannel funds from one company into another or one type of security into another. The secondary market is thus an important adjunct of the primary market. The activity in these two markets is interlinked and the indicators are also related, although separate in themselves. The new issues, which are floated in the primary market, are permitted to be issued to the public by the Controller of Capital Issues at a price, which is at par (face value) in the case of new companies or at a premium or par in the case of existing companies. The Capital Issues Controller is the authority to regulate the entry of issuers of securities into the capital market. But in the secondary market, the Union Ministry of Finance, Stock Exchange Division controls and regulates the stock markets and the

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Financial Market and Instrument stock exchange authorities. The stock markets are directly regulated by their own board of directors, namely, the Stock Exchange authorities, with the consent and approval of the government. The stock exchanges are recognised bodies to trade and deal in securities through their members who are brokers. The Stock Exchange authorities are selfregulatory bodies under the overall supervision of the Stock Exchange Division of the Government. In the primary market, the brokers act as underwriters, managers, registrars and even merchant bankers to the new issues. In the secondary market, the claims of a longterm nature of one year and above are traded both on the spot for forward trading basis. This trading imparts liquidity to investments and thus promotes savings and substantial investment. These claims can be converted into money at any time although at a loss of capital in various degrees. The linkage between the RBI and banks is through cash or claims on money. Similarly, there are linkages as between banks, financial institutions and brokers. The financial institutions can only change the velocity of circulation of money (cash and credit) while dealing in the primary and secondary markets, but the banks can influence both creation of money and its velocity. Basically, the functions of these markets are: 1. Provision for securitisation of the debt or capital issue, which promotes savings mobilisation through new capital issues 2. Extending facilities for trading (buying and selling) in the; securities so as to impart liquidity to these instruments s that investors can disinvest while new savers can invest an enter the market. This will facilitate the reallocation of-function as between securities or companies. 3. Making a quotation for a share available to the investors an complies so that their net asset values (NAVs) are know and they can be used for tax purposes 4. This market also enables the companies to raise more capita from the capital market than is possible without these facilities for disinvestments, trading and liquidity. 5. For the economy as a whole, these markets help mobilization of savings for financing of corporate and government investment in order that economic growth and rise in comes of the people can take place on a continuing basis.

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Financial Market and Instrument The new issues of companies are in the form of shares equity and preference shares debentures, etc. The securities issued by the companies and government are listed on the stock markets after they are floated and issued to the public. So far as the government and the semi-government securities are concerned, they are automatically listed for trading without any conditions or fees but in the case of corporate securities, the companies have to approach the respective stock exchanges where their registered office is located for the purpose of listing. A listing agreement is entered into, containing all the rules and regulations governing the conduct of the companies in respect of shares listed and the relations between the stock exchange and listed companies. The listed shares can be bought and sold and traded, which will lead to price formation for shares. The resultant price may be at par or face value or at a premium or discount of the face value depending upon the demand for and supply of these shares. These demand and supply forces may in turn depend on the physical and financial performance of the companies in question and their future prospects, etc.

Segment of Government Securities

In the securities market, an important segment is the gilt-edged market of which comprises, the Central and State Government securities, bonds of local bodies and semigovernment organisations. The Reserve Bank arranges for the issue of these securities through banks and financial institutions and acts as the manager and underwriter of the issues, particularly with respect to Central Government securities. As a part of its functions, the apex bank acts as a banker to the Central and State Governments and as manager of the public debt of the Central Government. In this context, it arranges for the accepting of subscriptions to the Central loans, issue of securities, servicing of these Securities and, repayment of loans, etc. As a part of the RBI credit control policy, the banks have to invest 38.5% of their aggregate deposits in the Central and State Government securities and other approved securities. Besides financial institution LIC, GIC, etc. have also to invest a part of their funds in government securities. It is thus necessary for banks and financial institutions to invest in government securities as a statutory obligation. But in view of the lower interest rates on these securities than those on other instruments of the corporate sector, the public and individuals are not much interested in these

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Financial Market and Instrument securities. Thus, the market in government securities is a captive one and of a limited nature. The secondary market in these securities is also limited to transactions as between the banks and the RBI and among banks and financial institutions. The market in these securities is Over The Counter (OTC), through telephones, personal contact, telex etc. and hence the data on prices and yields etc. are not properly reported to the stock exchange where they are quoted. But as the manager of the public debt of the Government and through the operations undertaken in the open market (called open market operations), the RBI collects some information on prices and compiles data on yields. The prices and yields on government securities are thus compiled and published by the RBI, regularly in their monthly and annual publications. the gilt-edged market, namely, primary and secondary sections, representing the issue of government securities, wholesale and trading in retail respectively. The players in the market are the RBI, banks, FIs and brokers. The RBI is the main lead manager and underwriter with respect to Central Government securities and a major holder of these securities. The banks and financial institutions, PFs and companies deal in these securities with or without the help of brokers. The RBI conducts open market operations of purchase and sale directly with banks and financial institutions or with the help of brokers.

Existing Malpractices
At present, there are many malpractices in both the primary and secondary markets. In the primary market, for example, there are many self-styled merchant bankers and investment consultants without sufficient expertise and infrastructure for proper service. Many issues and manipulation of prices are done on paper even before listing. There are other malpractices resorted to by bankers and registrars to the new issues. Allotments with or without premium are given to the favored persons. There are delays in finalising the allotments and despatch to allotment letters and refund orders before the due dates. The provisions of the Companies Act and other relevant Acts are not adhered to and no punitive action is taken against them. Many companies have violated the rules of stock exchanges and listing requirements and no punishment is meted out to them, as it is not possible under their rules and regulations. All these malpractices have resulted in increasing grievances of investors and a loss of confidence in the markets.

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Financial Market and Instrument Despite its regulation by the stock exchange authorities. The intermediaries or member brokers do not render proper service to the customers, do not show the brokerage charged and do not pass contract notes regularly and in time. Trading in the market is devoid of transparency and fair practices. There is a large element of rigging of shares, manipulation of prices of shares, insider trading and a large spread between the bid and offer prices of jobbers. There are other unfair practices also in the market such as delay in delivery of shares and in making payments for sales by the brokers to their customers, in addition to the problems of odd lots and poor liquidity of a number of shares in the secondary market. More recently, because it can operate only if it is recognised by the Government under the Securities Contracts (Regulations) Act, 1956 gross violations of the guidelines and lack of system has resulted in a scam of the century. The only way to rebuild investors' confidence in the market is to improve the system and reorient the system that it is efficient and prompt. Brokers are disciplined and accountable. The recognition is granted under Section 3 of the Act by the Central Government, Union Ministry of Finance. The powers of the Central Government under that Act are far-reaching and include the following in particular: 1. 2. 3. 4. 5. 6. 7. 8. Grant byelaws. Call for periodical returns from the Stock Exchange. Direct enquiries on the members or on the Stock Exchange. Liability of the Exchange to submit annual reports. Directing the Stock Exchange to make certain rules. Supersede the governing board of the Exchange. Suspend the governing board of the Exchange. Impose any other conditions or regulations for trading. and withdrawal of recognition, approval or change of

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Financial Market and Instrument

Objectives
The important objectives of the Act are the following: I. To empower the Central Government to control the stock exchanges in India, II. To provide reasonable uniformity in respect of the rules and bye-laws of the different stock exchanges in the country, III. To ensure orderly and healthy development of the stock exchanges IV. To protect the interest of the investors, V. To prevent unhealthy speculations and undesirable activities like the 1992 scam on the stock exchanges.

Bye-laws
Besides the above Act, the Securities Contracts (Regulation) Rules were also made in 1957 to regulate certain matters of trading on the Stock Exchanges. There are also byelaws of the Exchanges, which are concerned with the following subjects: Opening/Closing of the stock exchanges, timing of trading, regulation of blank transfers, regulation of badla or carry over business, control of the settlement and other activities of the Stock Exchange, fixation of margins, fixation of market prices or making up prices (Havala rates), regulation of taravani business (jobbing), etc., regulation of brokers' trading brokerage charges, trading rules on the Exchange, arbitration and settlement of disputes, settlement and clearing of the trading etc are other matters needing regulation to a certain extent.

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Financial Market and Instrument

INDIAN STOCK
Evolution

EXCHANGE

Indian Stock Markets are one of the oldest in Asia. Its history dates back to nearly 200 years ago. The earliest records of security dealings in India are meagre and obscure. The East India Company was the dominant institution in those days and business in its loan securities used to be transacted towards the close of the eighteenth century. By 1830's business on corporate stocks and shares in Bank and Cotton presses took place in Bombay. Though the trading list was broader in 1839, there were only half a dozen brokers recognized by banks and merchants during 1840 and 1850.The 1850's witnessed a rapid development of commercial enterprise and brokerage business attracted many men into the field and by 1860 the number of brokers increased into 60. In 1860-61 the American Civil War broke out and cotton supply from United States of Europe was stopped; thus, the 'Share Mania' in India begun. The number of brokers increased to about 200 to 250. However, at the end of the American Civil War, in 1865, a disastrous slump began (for example, Bank of Bombay Share which had touched Rs 2850 could only be sold at Rs. 87).

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Financial Market and Instrument At the end of the American Civil War, the brokers who thrived out of Civil War in 1874 found a place in a street (now appropriately called as Dalal Street) where they would conveniently assemble and transact business. In 1887, they formally established in Bombay, the "Native Share and Stock Brokers' Association" (which is alternatively known as The Stock Exchange "). In 1895, the Stock Exchange acquired a premise in the same street and it was inaugurated in 1899. Thus, the Stock Exchange at Bombay was consolidated.

Other leading cities in stock market operations:

Ahmedabad gained importance next to Bombay with respect to cotton textile industry. After 1880, many mills originated from Ahmedabad and rapidly forged ahead. As new mills were floated, the need for a Stock Exchange at Ahmedabad was realised and in 1894 the brokers formed "The Ahmedabad Share and Stock Brokers' Association". What the cotton textile industry was to Bombay and Ahmedabad, the jute industry was to Calcutta. Also tea and coal industries were the other major industrial groups in Calcutta. After the Share Mania in 1861-65, in the 1870's there was a sharp boom in jute shares, which was followed by a boom in tea shares in the 1880's and 1890's; and a coal boom between 1904 and 1908. On June 1908, some leading brokers formed "The Calcutta Stock Exchange Association". In the beginning of the twentieth century, the industrial revolution was on the way in India with the Swadeshi Movement; and with the inauguration of the Tata Iron and Steel Company Limited in 1907, an important stage in industrial advancement under Indian enterprise was reached. Indian cotton and jute textiles, steel, sugar, paper and flourmills and all companies generally enjoyed phenomenal prosperity, due to the First World War. In 1920, the then demure city of Madras had the maiden thrill of a stock exchange functioning in its midst, under the name and style of "The Madras Stock Exchange" with 100 members. However, when boom faded, the number of members stood reduced from 100 to 3, by 1923, and so it went out of existence. In 1935, the stock market activity improved, especially in South India where there was a rapid increase in the number of textile mills and many plantation companies were floated. In 1937, a stock exchange was once again organized in Madras - Madras Stock Exchange

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Financial Market and Instrument Association (Pvt) Limited. (In 1957 the name was changed to Madras Stock Exchange Limited).Lahore Stock Exchange was formed in 1934 and it had a brief life. It was merged with the Punjab Stock Exchange Limited, which was incorporated in 1936.

Indian Stock Exchanges - An Umbrella Growth:

The Second World War broke out in 1939. It gave a sharp boom, which was followed by a slump. But, in 1943, the situation changed radically, when India was fully mobilized as a supply base. On account of the restrictive controls on cotton, bullion, seeds and other commodities, those dealing in them found in the stock market as the only outlet for their activities. They were anxious to join the trade and numerous others swelled their number. Many new associations were constituted for the purpose and Stock Exchanges in all parts of the country were floated. The Uttar Pradesh Stock Exchange Limited (1940), Nagpur Stock Exchange Limited (1940) and Hyderabad Stock Exchange Limited (1944) were incorporated. In Delhi two stock exchanges - Delhi Stock and Share Brokers' Association Limited and the Delhi Stocks and Shares Exchange Limited - were floated and later in June 1947, amalgamated into the Delhi Stock Exchange Association Limited.

Post-independence Scenario:
Most of the exchanges suffered almost a total eclipse during depression. Lahore Exchange was closed during partition of the country and later migrated to Delhi and merged with Delhi Stock Exchange. Bangalore Stock Exchange Limited was registered in 1957 and recognized in 1963. Most of the other exchanges languished till 1957 when they applied to the Central Government for recognition under the Securities Contracts (Regulation) Act, 1956. Only Bombay, Calcutta, Madras, Ahmedabad, Delhi, Hyderabad and Indore, the wellestablished exchanges, were recognized under the Act. Some of the members of the other Associations were required to be admitted by the recognized stock exchanges on a concessional basis, but acting on the principle of unitary control, all these pseudo stock

44

Financial Market and Instrument exchanges were refused recognition by the Government of India and they thereupon ceased to function. Thus, during early sixties there were eight recognized stock exchanges in India (mentioned above). The number virtually remained unchanged, for nearly two decades. During eighties, however, many stock exchanges were established: Cochin Stock Exchange (1980), Uttar Pradesh Stock Exchange Association Limited (at Kanpur, 1982), and Pune Stock Exchange Limited (1982), Ludhiana Stock Exchange Association Limited (1983), Gauhati Stock Exchange Limited (1984), Kanara Stock Exchange Limited (at Mangalore, 1985), Magadh Stock Exchange Association (at Patna, 1986), Jaipur Stock Exchange Limited (1989), Bhubaneswar Stock Exchange Association Limited (1989), Saurashtra Kutch Stock Exchange Limited (at Rajkot, 1989), Vadodara Stock Exchange Limited (at Baroda, 1990) and recently established exchanges Coimbatore and Meerut. Thus, at present, there are totally twenty-one recognized stock exchanges in India excluding the Over The Counter Exchange of India Limited (OTCEI) and the National Stock Exchange of India Limited (NSEIL). The Table given below portrays the overall growth pattern of Indian stock markets since independence. It is quite evident from the Table that Indian stock markets have not only grown just in number of exchanges, but also in number of listed companies and in capital of listed companies. The remarkable growth after 1985 can be clearly seen from the Table, and this was due to the favouring government policies towards security market industry.

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Financial Market and Instrument

Growth Pattern of the Indian Stock Market

SR.No. 1 2 3

As on 31st December No. of Stock Exchanges No. of Listed Cos. No. of Stock Issues of Listed Cos. Capital of Listed Cos. (Cr. Rs.) Market value of Capital of Listed Cos. (Cr. Rs.) Capital per Listed Cos. (4/2) (Lakh Rs.) Market Value of Capital per Listed Cos. (Lakh Rs.) (5/2) Appreciated value of Capital per Listed Cos. (Lak Rs.)

194 6 7 112 5 150 6 270

196 1 7 120 3 211 1 753

197 1 8 159 9 283 8 181 2 267 5

197 5 8 155 2 323 0 261 4 327 3

198 0 9 226 5 369 7 397 3 675 0

1985 14 4344 6174

1991 20 6229 8967

1995 22 8593 11784

9723

32041

59583

971

129 2

2530 2

11027 9

478121

24

63

113

168

175

224

514

693

86

107

167

211

298

582

1770

5564

358

170

148

126

170

260

344

803

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Financial Market and Instrument

Trading Pattern of the Indian Stock Market:

Trading in Indian stock exchanges are limited to listed securities of public limited companies. They are broadly divided into two categories, namely, specified securities (forward list) and non-specified securities (cash list). Equity shares of dividend paying, growth-oriented companies with a paid-up capital of at least Rs.50 million and a market capitalization of at least Rs.100 million and having more than 20,000 shareholders are, normally, put in the specified group and the balance in non-specified group. Two types of transactions can be carried out on the Indian stock exchanges: (a) spot delivery transactions "for delivery and payment within the time or on the date stipulated when entering into the contract which shall not be more than 14 days following the date of the contract: and (b) forward transactions "delivery and payment can be extended by further period of 14 days each so that the overall period does not exceed 90 days from the date of the contract". The latter is permitted only in the case of specified shares. The brokers who carry over the out standings pay carry over charges (cantango or backwardation), which are usually determined by the rates of interest prevailing. A member broker in an Indian stock exchange can act as an agent, buy and sell securities for his clients on a commission basis and also can act as a trader or dealer as a principal, buy and sell securities on his own account and risk, in contrast with the practice prevailing on New York and London Stock Exchanges, where a member can act as a jobber or a broker only.The nature of trading on Indian Stock Exchanges are that of age old conventional style of face-to-face trading with bids and offers being made by open outcry. However, there is a great amount of effort to modernize the Indian stock exchanges in the very recent times.

Over The Counter Exchange of India (OTCEI):

The traditional trading mechanism prevailed in the Indian stock markets gave way to many functional inefficiencies, such as, absence of liquidity, lack of transparency, unduly long settlement periods and benami transactions, which affected the small investors to a great extent. To provide improved services to investors, the country's first ringless, scripless, electronic stock exchange - OTCEI - was created in 1992 by country's premier financial institutions - Unit Trust of India, Industrial Credit and Investment Corporation of India, Industrial Development Bank of India, SBI Capital Markets, 47

Financial Market and Instrument Industrial Finance Corporation of India, General Insurance Corporation and its subsidiaries and Can Bank Financial Services. Trading at OTCEI is done over the centers spread across the country. Securities traded on the OTCEI are classified into: Listed Securities - The shares and debentures of the companies listed on the OTC can be bought or sold at any OTC counter all over the country and they should not be listed anywhere else. Permitted Securities - Certain shares and debentures listed on other exchanges and units of mutual funds are allowed to be traded Initiated debentures - Any equity holding at least one lakh debentures of particular scrip can offer them for trading on the OTC. OTC has a unique feature of trading compared to other traditional exchanges. That is, certificates of listed securities and initiated debentures are not traded at OTC. The original certificate will be safely with the custodian. But, a counter receipt is generated out at the counter, which substitutes the share certificate and is used for all transactions. In the case of permitted securities, the system is similar to a traditional stock exchange. The difference is that the delivery and payment procedure will be completed within 14 days. Compared to the traditional Exchanges, OTC Exchange network has the following advantages: OTCEI has widely dispersed trading mechanism across the country which provides greater liquidity and lesser risk of intermediary charges. Greater transparency and accuracy of prices is obtained due to the screen-based scripless trading. Since the exact price of the transaction is shown on the computer screen, the investor gets to know the exact price at which s/he is trading. Faster settlement and transfer process compared to other exchanges. In the case of an OTC issue (new issue), the allotment procedure is completed in a month and trading commences after a month of the issue closure, whereas it takes a longer period for the same with respect to other exchanges. Thus, with the superior trading mechanism coupled with information transparency investors are gradually becoming aware of the manifold advantages of the OTCEI.

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Financial Market and Instrument

National Stock Exchange (NSE):

With the liberalization of the Indian economy, it was found inevitable to lift the Indian stock market trading system on par with the international standards. On the basis of the recommendations of high-powered Pherwani Committee, Industrial Development Bank of India, Industrial Credit and Investment Corporation of India, Industrial Finance Corporation of India, all Insurance Corporations, selected commercial banks and others incorporated the National Stock Exchange in 1992. Trading at NSE can be classified under two broad categories: (a) Wholesale debt market and (b) Capital market. Wholesale debt market operations are similar to money market operations - institutions and corporate bodies enter into high value transactions in financial instruments such as government securities, treasury bills, public sector unit bonds, commercial paper, certificate of deposit, etc. There are two kinds of players in NSE: (a) Trading members and (b) Participants. Recognized members of NSE are called trading members who trade on behalf of themselves and their clients. Participants include trading members and large players like banks who take direct settlement responsibility. Trading at NSE takes place through a fully automated screen-based trading mechanism, which adopts the principle of an order-driven market. Trading members can stay at their offices and execute the trading, since they are linked through a communication network. The prices at which the buyer and seller are willing to transact will appear on the screen. When the prices match the transaction will be completed and a confirmation slip will be printed at the office of the trading member. NSE brings an integrated stock market trading network across the nation. Investors can trade at the same price from anywhere in the country since inter-market operations are streamlined coupled with the countrywide access to the securities. Delays in communication, late payments and the malpractices prevailing in the traditional trading mechanism can be done away with greater operational efficiency and

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Financial Market and Instrument informational transparency in the stock market operations, with the support of total computer, Unless stock markets provide professionals service, small investors and foreign investors will not be interested in capital market operations. And capital market being one of the major sources of long-term finance for industrial projects, India cannot afford to damage the capital market path. In this regard NSE gains vital importance in the Indian capital market system.

Future Developments:
In 1995, the President of India promulgated an Ordinance, which allowed for establishment of depositories. BSE in collaboration with Bank of India (BOI) will shortly establish a depository. BSE has applied for permission from SEBI to expand BOLT to other centres. Expansion of BOLT would bring more investors into the ambit of the capital market and consequently add depth to it.

50

Financial Market and Instrument

FOREX MARKET
It gives me immense pleasure to address this distinguished gathering of forex professionals from all over the country. Coming to these visually beautiful surroundings, it is easy to get oblivious to the fact that this state is a large contributor of invisibles for our balance of payments. Both tourism earnings and private remittances have had a significant impact on Keralas economy and the state has benefited substantially as a result of liberalisation since 1991. Putting numbers to this gain, as per a study by the Centre for Development Studies, Trivandrum1, the average yearly gain to the state since the start of reforms has been in the range of Rs. 2000 crore. perspective. Forex market in India is undergoing rapid transformation and exciting things are engaging us professionally. At the same time, it can no longer be seen in isolation it is increasingly getting integrated within the broad ambit of financial markets. Over the last fifteen years, momentous changes have happened in the financial sector, which are well known. While the initial reforms concentrated more on the institutions like banks or nonbanking financial companies, the recent years have witnessed emphasis on financial markets. With the financial markets in India acquiring greater depth and maturity in the recent years, the issue of greater integration of various market segments among themselves, on the one hand, and with the global markets, on the other, has come to the
1

51

Financial Market and Instrument forefront. In my address I intend to take stock of the major initiatives that have been taken to reform the financial markets in India in the past, reflect on the present scenario and articulate the future course of reforms. As you all are aware, the development of financial markets in India has been pursued for bringing about a transformation in the structure, efficiency, and stability of markets as also facilitating integration of markets. The emphasis has been on strengthening price discovery, easing of restrictions on flows or transactions, lowering of transaction costs, and enhancing liquidity. During the post-reform period, the structure of financial market has witnessed a remarkable change in terms of the types, the number and the spectrum of maturity of financial instruments traded in various segments of money, gilts and foreign exchange markets. I now dwell on the three segments of the financial markets, which fall directly under the purview of the Reserve Bank of India. As this is a gathering of Forex Professionals, it would be in the fitness of things to dwell on the reform process of the forex market first.

Importance of Foreign Exchange Markets:

Foreign exchange markets represent by far the most important financial markets in the world. Their role is of paramount importance in the system of international payments. In order to play their role effectively, it is necessary that their operations/dealings be reliable. Reliability essentially is concerned with contractual obligations being honoured. For instance, if two parties have entered into a forward sale or purchase of a currency, both of them should be willing to honoured their side of contract by delivering or taking delivery of the currency, as the case may be. The major foreign exchange markets that exist are: 1. 2. 3. 4. 5. Spot markets, Forward markets, Futures markets, Options markets, and Swaps markets.

52

Financial Market and Instrument Futures, Options and Swaps are called derivatives because they derive their value from the underlying exchange rates. Spot market refers to the transactions involving sale and purchase of currencies for immediate delivery. In practice, it may take one or two days to settle transactions. Forward market transactions are meant to be settled on a future date as specified in the contract. Though forward rates are quoted just like spot rates, but actual delivery of currencies takes place much later, on a date in future. Futures market is a localized exchange where derivative instruments called 'futures' are traded. Currency futures are somewhat similar to forward, yet distinctly different. Options are derivative instruments that give a choice to a foreign exchange market operator to buy or sell a foreign currency on or up to a date (maturity date) at a specified rate (strike price). Swaps, as the term suggests, are simply the instruments that permit exchange of two streams of cash flows in two different currencies. The most active foreign exchange market is that of UK (London), followed by that of USA, Japan, Singapore, Switzerland, Hongkong, France and Australis.All other markets, combined together, represent only about 15 percent of the total volume, traded globally

Indian Forex Market:

In an open economy environment, the foreign exchange market assumes critical importance for stability of the financial system since banks balance sheets are influenced by the foreign capital inflows and various other external transactions directly or indirectly through credit exposures. The Indian forex market has widened and deepened since the 1990s on account of implementation of various measures recommended by the High Level Committee on Balance of Payments in 1993 (Chairman: Dr. C.Rangarajan), the Expert Group on Foreign Exchange Markets in India in 1995 (Chairman: Shri O.P.Sodhani) and the Committee on Capital Account Convertibility in 1997 (Chairman: Shri S.S.Tarapore). With the transition to a marketdetermined exchange rate system in March 1993 and the subsequent gradual liberalisation of restrictions on various external transactions, ensuring orderly conditions in the forex market in India has become one of the key objectives. The Reserve Bank has

53

Financial Market and Instrument undertaken various measures towards development of spot as well as forward segments of foreign exchange market. As a result, the average gross daily turnover increased to US $ 12.1 billion in 2004-05 (April-March) from US $ 3.7 billion in 1996-97. The top 30 banks in India account for approximately 90 per cent of the overall turnover in the market.

Dealing in foreign exchange

Dealing in provided in this Act, rules or regulations made there under, or with the general or special permission of the Reserve Bank, no person shall(a) Deal in or transfer any foreign exchange or foreign security to any person not being an authorised person; (b) Make any payment to or for the credit of any person resident outside India in any manner;(c) Receive otherwise through an authorised person, any payment by order or on behalf of any person resident outside India in any manner.

Interaction between Forex, Government Securities and Money Markets:

The far-reaching financial sector reforms have also facilitated Indias movement to an open economy framework in which interaction between forex, Government securities and money market has become quite important. The opening of the economy has brought about gains in terms of inflows of foreign investments, which have contributed to growth and employment. However, these gains have also posed new challenges for managing the macro economy amidst large and volatile capital flows. This has had implications for monetary management. We have addressed this challenge with appropriate monetary-fiscal coordination. Suitable changes were made in the LAF scheme and MSS was introduced to address more enduring portion of the liquidity overhang. In view of the growing integration of markets across borders, it is imperative that domino effects are minimised by refining and upgrading the financial infrastructure in all its vital components, such as accounting standards, including income recognition and provisioning norms, disclosure standards and insolvency laws. This upgradation is to be attained in conformity with international best practices. In this regard, the Reserve Bank

54

Financial Market and Instrument has strengthened the consultative process for all major policy steps in a transparent manner by involving market participants and other experts.

Significant Policy Developments

Keeping in view the robustness of the external sector, a number of far-reaching changes have been effected in a phased manner in the recent years to liberalise the capital account, which include more flexible and liberal investments norms in order to promote Indian investment abroad and to enable Indian companies to reap the benefits of globalization and become globally competitive. The other measures relate to allowing two-way fungibility in the case of GDRs / ADRs, permission to Indian mutual funds to invest in overseas equity market subject to certain limits, permission to Indian companies to make acquisitions of foreign companies or make direct investment abroad in Joint Ventures/Wholly- owned Subsidiaries, permission to various participants in the foreign exchange market, including FIIs, to avail forward cover subject to genuine underlying exposure, permission to residents to open foreign currency denominated account, etc . Alongside the measures taken to encourage overseas investment by resident corporates, steps were taken to contain and calibrate debt-creating inflows. The thrust of the new ECB policy is to encourage investment in the real sector and infrastructure while at the same time restricting debt flows for purposes other than those adding to the capital stock. RBI also encouraged the setting up of CCIL to reduce settlement risk. CCIL has functioned as an efficient enabler of settlement offering netting and operational benefits, in addition to substantial risk mitigation. CCIL settled over 900,000 deals for a gross volume of USD 900 billion in the last year alone

55

Financial Market and Instrument A number of primary instrument in different market are available such as money market and securities market. The following chart gives a bird view of various instruments.

56

Financial Market and Instrument

Instrument

Short term (1 Year) and below Money Market Instrument Call Money/ Money at short notice Treasury Bills Bank Deposit Certificate of Deposits (CD) Commercial Papers (CPs) Commercial Bills Inter Bank Participation Certificate (IBPC) Term Money

Long & Medium Term (Above 1 Year) Equity, Debt Instrument, Mutual Funds. Equity Equity Shares (PSU/Corporate) Preference Shares Debt Instruments Government Dated Securities. (Central, State, Other Trustee Securities & Special Securities) Other Approved Securities Bonds (PSUs) (Taxable Tax-Free) Debentures (NCDS, PCDS) Mutual Funds (Units)

57

Financial Market and Instrument

SHORT TERM INSTRUMEENT

1.CALL MONEY MARKET
Call/Notice money is an amount borrowed or lent on demand for a very short period. If the period is more than one day and upto 14 days it is called 'Notice money' otherwise the amount is known as Call money' 1. The call market enables the banks and institutions to even out their day to day deficits and surpluses of money. 2. Commercial banks, Co-operative Banks and primary dealers are allowed to borrow and lend in this market for adjusting their cash reserve requirements. 3. Specified All-India Financial Institutions, Mutual Funds and certain specified entities are allowed to access Call/Notice money only as lenders. 4. It is a completely inter-bank market hence non-bank entities are not allowed access to this market. 5. Interest rates in the call and notice money markets are market determined. 6. In view of the short tenure of such transactions, both the borrowers and the lenders are required to have current accounts with the Reserve Bank of India. i 7. It serves as an outlet for deploying funds on short-term basis to the lenders having steady inflow of funds .

2.TREASURY BILLS MARKET:

In the short term, the lowest risk category instruments are the treasury bills. RBI issues these at a prefixed day and a fixed amount These are four types of treasury bills.

58

Financial Market and Instrument

14-day Tbill- maturity is in 14 days. Its auction is on every Friday of every week. The notified amount for this auction is Rs. 100 crores. 91-day Tbill- maturity is in 91 days. Its auction is on every Friday of every week. The notified amount for this auction is Rs. 100 crores. 182-day Tbill- maturity is in 182 days. Its auction is on every alternate Wednesday (which is not a reporting week). The notified amount for this auction is Rs. 100 crores. 364-Day Tbill- maturity is in 364 days. Its auction is on every alternate Wednesday (which is a reporting week). The notified amount for this auction is Rs. 500 crores.

59

Financial Market and Instrument A considerable part of the government happen through tbills of various maturities. Based on the bids received at the auctions, RBI decides the cut off yield and accepts all bids below this yield. The usual investors in these instruments are banks who invest not only to part their short-term surpluses but also since it forms part of their SLR investments, insurance companies and FIs. FIIs so far have not been allowed to invest in this instrument. These Tbills which are issued at a discount can be traded in the market. Most of the time, unless the investor requests specifically, they are issued not as securities but as entries in the Subsidiary General Ledger (SGL) which is maintained by RBI. The transactions cost on Tbills are non-existent and trading is considerably high in each bill, immediately after its issue and immediately before its redemption. The yield on Tbills is dependent on the rates prevalent on other investment avenues open for investors. Low yield on Tbills, generally a result of high liquidity in banking system as indicated by low call rates, would divert the funds from this market to other markets. This would be particularly so, if banks already hold the minimum stipulated amount (SLR) in government paper. 3.BANK DEPOSIT: The bank are permitted to keep deposit with other banks for a period of 15 days and above. The rate of interest on such deposit are free to be determine by 2 banks between themselves through negotiations. These redeposit are not reckoned for the purpose cash reserve ratio requirements like call/ notice money transaction and the deposits transaction of the banks is evidenced by way if deposit receipts these are not transferable but they could be pre maturely closed at the discretion of the lender.

4.CERTIFICATES OF DEPOSITS MARKET

After treasury bills, the next lowest risk category investment option is the certificate of deposit (CD) issued by banks and FIs. Allowed in 1989, CDs were one of RBI's measures to deregulate the cost of funds for banks and FIs. A CD is a negotiable promissory note, secure and short term (upto a year) in nature. A CD is issued at a discount to the face value, the discount rate being negotiated between the issuer and the 60

Financial Market and Instrument investor. Though RBI allows CDs upto one-year maturity, the maturity most quoted in the market is for 90 days. The secondary market for this instrument does not have much depth but the instrument itself is highly secured. CDs are issued by banks and FIs mainly to augment funds by attracting deposits from corporates, high net worth individuals, trusts, etc. the issue of CDs reached a high in the last two years as banks faced with reducing deposit base secured funds by these means. The foreign and private banks, especially, which do not have large branch networks and hence lower deposit base use this instrument to raise funds. The rates on these deposits are determined by various factors. Low call rates would mean higher liquidity in the market. Also the interest rate on one-year bank deposits acts as a lower barrier for the rates in the market.

5. COMMERCIAL PAPER
For many corporations, borrowing short-term money from banks is often a labored and annoying task. Their desire to avoid banks as much as possible has led to the widespread popularity of commercial paper. Commercial paper is an unsecured, shortterm loan issued by a corporation, typically for financing accounts receivable and inventories. It is usually issued at a discount, reflecting current market interest rates. Maturities on commercial paper are usually no longer than 9 months, with maturities of 1-2 months being the average. For the most part, commercial paper is a very safe investment because the financial situation of a company can easily be predicted over a few months. Furthermore, typically only companies with high credit ratings and credit worthiness issue commercial paper. Over the past 40 years, there have only been a handful of cases where corporations have defaulted on their commercial paper repayment. Commercial paper is usually issued with denominations of $100,000 or more. Therefore, smaller investors can only invest in commercial paper indirectly through money market funds. Bills of exchange are negotiable instruments drawn by the seller (drawer) of the goods on the buyer (drawee) of the goods for the value of the goods delivered. These bills are called trade bills. These trade bills are called commercial bills when they are accepted

61

Financial Market and Instrument by commercial banks. If the bill is payable at a future date and the seller needs money during the currency of the bill then he may approach his bank for discounting the bill. The maturity proceeds or face value of discounted bill, from the drawee, will be received by the bank. If the bank needs fund during the currency of the bill then it can rediscount the bill already discounted by it in the commercial bill rediscount market at the market related discount rate. The RBI introduced the Bills Market scheme (BMS) in 1952 and the scheme was later modified into New Bills Market scheme (NBMS) in 1970. Under the scheme, commercial banks can rediscount the bills, which were originally discounted by them, with approved institutions (viz., Commercial Banks, Development Financial Institutions, Mutual Funds, Primary Dealer, etc.). With the intention of reducing paper movements and facilitate multiple rediscounting, the RBI introduced an instrument called Derivative Usance Promissory Notes (DUPN). So the need for physical transfer of bills has been waived and the bank that originally discounts the bills only draws DUPN. These DUPNs are sold to investors in convenient lots of maturities (from 15 days upto 90 days) on the basis of genuine trade bills, discounted by the discounting bank.

6. COMMERCIAL BILLS
Bills of exchange are negotiable instruments drawn by the seller (drawer) of the goods on the buyer (drawee) of the goods for the value of the goods delivered. These bills are called trade bills. These trade bills are called commercial bills when they are accepted by commercial banks. If the bill is payable at a future date and the seller needs money during the currency of the bill then he may approach his bank for discounting the bill. The maturity proceeds or face value of discounted bill, from the drawee, will be received by the bank. If the bank needs fund during the currency of the bill then it can rediscount the bill already discounted by it in the commercial bill rediscount market at the market related discount rate. The RBI introduced the Bills Market scheme (BMS) in 1952 and the scheme was later modified into New Bills Market scheme (NBMS) in 1970. Under the scheme, commercial banks can rediscount the bills, which were originally discounted by them

62

Financial Market and Instrument With approved institutions (viz., Commercial Banks, Development Financial Institutions, Mutual Funds, Primary Dealer, etc.). With the intention of reducing paper movements and facilitate multiple rediscounting, the RBI introduced an instrument called Derivative Usance Promissory Notes (DUPN). So the need for physical transfer of bills has been waived and the bank that originally discounts the bills only draws DUPN. These DUPNs are sold to investors in convenient lots of maturities (from 15 days upto 90 days) on the basis of genuine trade bills, discounted by the discounting bank.

7. INTER-BANK PARTICIPTAION MARKET

Apart from CPs, corporates also have access to another market called the inter corporate deposits (ICD) market. An ICD is an unsecured loan extended by one corporate to another. Existing mainly as a refuge for low rated corporates, this market allows funds surplus corporates to lend to other corporates. Also the better-rated corporates can borrow from the banking system and lend in this market. As the cost of funds for a corporate in much higher than a bank, the rates in this market are higher than those in the other markets. ICDs are unsecured, and hence the risk inherent in high. The ICD market is not well organised with very little information available publicly about transaction details.

8. TERM DEPOSIT
Inter bank market for deposits of maturity beyond 14 days and upto three months is referred to as the term money market. The specified entities are not allowed to lend beyond 14 days. The development of the term money market is inevitable due to the following reasons

Declining spread in lending operations Volatility in the call money market Growing desire for fixed interest rates borrowing by corporate Move towards fuller integration between forex and money market Stringent guidelines by regulators/management of the institutions

LONG-TERM DEPOSIT
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Financial Market and Instrument

Equities Shares
A public limit company manages by board of director appoint by equity shareholder. Equity holders are entitled for a dividend from the profit of the company. Equity holders bear the final risks of corporate performance. The shares are traded at a premium or at a discount, depending on the status of the company. According to company act 1956, A shares is share in the share capital of the company. Shares are transferable and therefore described as a moveable property. A shares certificate is given to the shareholder as a document to shareholder. Every company shall within three month after the allotment of shares, issued share certificate to the applicant who has been allotted shares and who has faithfully regard to the particular sharews issue. Equity holders enjoy voting rights and in good time a better dividend. Similarly due the transferable nature it is traded on the stock exchange. The transfers gets registry which is generally a shares transfer agent commonly known as registrar to share transfer. There is a danger of bad delivery of shares The shares is trade able and therefore, subject to the vagaries of the markets forces. Shares are dealed on the recognized on stock exchange of the prices from time to time on the trading floor where deals take place. These deals are passed through the recognized members.(Stock Broker)of the respective stock exchange. In order to overcome the problem faced in transfer of physical stock,national securities depository limited.(NSDL).,Sponsor by national stock exchange and other institution has come into existence.NSCL through depository participant(DP) provides for dematerialisation of shares, where by all stock and stock registers are maintained in electronic form. Similar organization is also being promoted by Bombay stock exchange. SEBI has already made to deal in several leading stock only dematerialize form.

64

Financial Market and Instrument

Preference Shares
Preference Shares holders assumed only limited risks, since the rate of dividend is predetermined and payable in a arrears in preference to dividend of equity shares. They also receive precedence over equity holders, in case of liquidation of a company. Preference in case of liquidation of a company. Preference Shares holders, how ever, have no voting rights and cannot participate in the management of the company. Though the shares are marketable they are not widely traded on account of the fixed dividend. In India, only redeemable preference shares can be issues where the capital is repaid to the shareholder after the fixed period, say after three or five years. The redemption period cannot exceed twelve years. For these reason, preference shares have became more of a debt instrument, with the risks confine to the return on investment,that is.,fixed dividend, payment of which is divident of the company. Dividend paid on equity and preferences shares is currently exempt from income tax, and hence effective post tax return, depending on the tax. Status of the investors, is higher then the actual dividend. Warrants are forms of equity instrument, which in title the holder to converts the warning in to equity, at a fixed priced, or at market prices prevailing on a particular date. The preference shares are of the following kinds:1) Cumulative preference shares where the dividend are allowed to be accumulative when the company resources are not adequate in a given year or so and then carried forward to the paid of the future profits. 2) Redeemable preference shares where the shares are redeemed on a given date. There are non-cumulative and irredeemable shared which are not issued and hence their description is not relevant. In the case of the redeemable shares the company informs the preference shares holder before the date of the redemption to send the share certificates duly discharged and pre-receipt for redeeming the share and making payment thereof. Like the equity shares and the preference shares also can be transfer and procedure and rules for the trasnsfer are the same as are in the case of the equity shares.

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Financial Market and Instrument

Government securities
The Government securities comprise dated securities issued by the Government of India and state governments. The date of maturity is specified in the securities therefore it is known as dated government securities. The Government borrows funds through the issue of long term-dated securities, the lowest risk category instruments in the economy. These securities are issued through auctions conducted by RBI, where the central bank decides the coupon or discount rate based on the response received. Most of these securities are issued as fixed interest bearing securities, though the government sometimes issues zero coupon instruments and floating rate securities also. In one of its first moves to deregulate interest rates in the economy, RBI adopted the market driven auction method in FY 1991-92. Since then, the interest in government securities has gone up tremendously and trading in these securities has been quite active. They are not generally in the form of securities but in the form of entries in RBI's Subsidiary General Ledger (SGL). The investors in government securities are mainly banks, FIs, insurance companies, provident funds and trusts. These investors are required to hold a certain part of their investments or liabilities in government paper. Foreign institutional investors can also invest in these securities up to 100% of funds-in case of dedicated debt funds and 49% in case of equity funds. Till recently, a few of the domestic players used to trade in these securities with a majority investing in these instruments for the full term. This has been changing of late, with a good number of banks setting up active treasuries to trade in these securities. Perhaps the most liquid of the long term instruments, liquidity in gilts is also aided by the primary dealer network set up by RBI and RBI's own open market operations.

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Features:
RBI, as an agent of the Government, manages and services these securities through its Public Debt Offices (PDO) located at various places. At present, there are dated securities with a tenor up to 20 years in the market. These securities are open to all types of investors including individuals and there is an active secondary market. These securities are eligible for SLR requirements. These securities are repoable. These include the following1. Financial institutional bonds 2. Public sector unit bonds 3. Corporate bonds/debentures As compared to the large size of government securities market both in terms of primary market as well as secondary market, the corporate bond market is not so big. The corporate bond market consists of issuers of three different categories- government owned financial institutions (FIs), government owned public sector units (PSUs) and private corporates. The FIs, which do not have access to retail deposits like banks, depend on bond issues for raising funds. There are highly rated and hence quote the lowest rate of funds. Next in line are the PSUs, though a lot of PSUs are in the high-risk category. Due to their poor financial condition, only the better managed PSUs approach the markets to raise the funds. The PSUs are also given an advantage in terms of tax breaks for the investors on investments in specified PSU bonds. These bonds referred to as taxfree bonds, obviously get traded at lower yields. Investments in rest of PSU bonds are taxed like any other bonds. Private Corporates also access the bond market to raise funds. This phenomenon has increased of late as the primary capital markets have been dull for the last two years. This has diverted a lot of corporates to issue bonds. 67

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The investors in these markets are mainly banks, FIs, mutual funds etc. before 1997, banks faced a 5% ceiling on their investment in corporate debentures. Subsequently this has been removed. Simultaneously banks have been warned about their non-performing assets (NPAs) among their regular advance. This has forced a majority of them to invest in debentures giving a fillip to this market. Most of the bond issues are institutional in nature with the issuer approaching institutional investors and placing the bonds rather than making a public issue, mainly to save on issue expenses. The investment of FIIs in this category will have to fall within the overall limit of 49% for the equity funds, and 100% for debt funds. Trading in these bonds is quite thin with some activity confined to FI bonds, some PSU bonds and the top rated corporates.

Outstanding debt instruments as on 31stMarch, 2005 The rates in these markets differ for different issuer categories. While top rated private corporates and PSUs are treated on par, FIs pay less coupon on their issues. In line with the general trend in the interest rates in the economy, the rates on these bonds have come down from the high levels in 1995 and 1996. This downward trend has been mainly due to higher liquidity with the banking system along with the new found enthusiasm of banks for bonds in comparison to loans due to capital adequacy requirements.

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CORPORATE SECURITIES Debentures and bonds

Debentures are debt instruments, issued by corporate bodies, literally with a charge on specific assets. However, the literal meaning has been lost in practice and debentures and bonds can be issued with or without security. It is fairly common that the debts instruments are also issued with a floating charge or a lien on assets where security is more of a technical nature to give comfort to the investors.In India, conventionally debentures are debt instruments issued by corporates in private sector, while institutions in public sector, which distinction really has no meaning in international market, issue bonds. Bonds, though issued by public sector companies, do not guarantee by the government, unless it is so mentioned specifically in the terms of the issue, also on the face of the bond. In domestic market, there are material differences in debentures and bonds. Relevant provisions of company law and are transferable only by registration. Bonds on the other hand are negotiable instruments governed by law of contracts, and are generally transferable by endorsement.

Bonds
Zero Coupon bonds are bonds issued at discount to face value and redeemed at par. These were issued first on January 19, 1994 and were followed by two subsequent issues in 1994-95 and 199596 respectively. The key features of these securities are:

They are issued at a discount to the face value. The tenor of the security is fixed. The securities do not carry any coupon or interest rate. The difference between the issue price (discounted price) and face value is the return on this security. The security is redeemed at par (face value) on its maturity date.

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Floating Rate Bonds are bonds with variable interest rate with a fixed percentage over a benchmark rate. There may be a cap and a floor rate attached thereby fixing a maximum and minimum interest rate payable on it. Floating rate bonds of four year maturity were first issued on September 29, 1995, followed by another issue on December 5, 1995. Recently RBI issued a floating rate bond, the coupon of which is benchmarked against average yield on 364 Days Treasury Bills for last six months. The coupon is reset every six months .

The key features of these

securities are: They are issued at face value. Coupon or interest rate is fixed as a percentage over a predefined benchmark rate at the time of issuance. The benchmark rate may be Treasury bill rate, bank rate etc. Though the benchmark does not change, the rate of interest may vary according to the change in the benchmark rate till redemption of the security. The tenor of the security is also fixed. Interest /Coupon payment is made on a half yearly basis on its face value. The security is redeemed at par (face value) on its maturity date. Bonds with Call/Put Option:
First time in the history of Government Securities market

RBI issued a bond with call and put option this year. This bond is due for redemption in 2012 and carries a coupon of 6.72%. However the bond has call and put option after five years i.e. in year 2007. In other words it means that holder of bond can sell back (put option) bond to Government in 2007 or Government can buy back (call option) bond from holder in 2007. This bond has been priced in line with 5 year bonds.

Capital indexed Bonds are bonds where interest rate is a fixed percentage over the wholesale
price index. These provide investors with an effective hedge against inflation. These bonds were floated on December 29, 1997 on tap basis. They were of five year maturity with a coupon rate of 6 per cent over the wholesale price index. The principal redemption is linked to the Wholesale Price Index. The key features of these securities are:

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They are issued at face value. Coupon or interest rate is fixed as a percentage over the wholesale price index at the time of issuance. Therefore the actual amount of interest paid varies according to the change in the Wholesale Price Index. The tenor of the security is fixed. Interest /Coupon payment is made on a half yearly basis on its face value. The principal redemption is linked to the Wholesale Price Index.

Government Securities:
Dated Securities : This generally fixed maturity and fixed coupon securities usually carrying semiannual coupon. These are called dated securities because these are identified by their date of maturity and the coupon, e.g., 11.03% GOI 2012 is a Central Government security maturing in 2012, which carries a coupon of 11.03% payable half yearly. The key features of these securities are: They are issued at face value. Coupon or interest rate is fixed at the time of issuance, and remains constant till redemption of the security. The tenor of the security is also fixed. Interest /Coupon payment is made on a half yearly basis on its face value. The security is redeemed at par (face value) on its maturity date. Interest /Coupon payment is made on a half yearly basis on its face value. The principal redemption is linked to the Wholesale Price Index.

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Units:
Unit Trust of India and Mutual Funds collect savings from public by sale of units/certificates and reinvest the funds in various equity and depts Securities, under specific schemes. The income derived from such investments is distributed as dividend to the unit holders. The unit holders, who are the ultimate investors, thus benefit from: a) Professional expertise of the fund manager, and. b) Diversification of risks by spreading the investment over a range of securities, despite the modest size of individual investments. The Unit Trust of India and other Mutual Funds operate various schemes, which is either engaged in general investment business (cutting across different industries) or are dedicated to specific sectors (Such as money markets fund or to specific type of securities-bond funds, equity funds,etc.)The latter are specialized funds and are of relatively recent origin in Indias MAGNUM funds,DSP bonds growth,JM Equity growth are some of the existing points, to ill rates both the quality. The mutual funds may also specialize in providing a steady income (maximization of earnings) or capital appreciation (growth schemes), by suitably structuring their investments portfolios. Mutual funds may run schemes, which are closed-end, or open-ended schemes. Closed-end schemes are term based, i.e, alter expiry of a fixed term the investment assets are liquidated and the proceeds are distributed to the subscribers (i.e. holders of units/certificates). NAV in turn is arrived at from the current commission of the fund (the later is generally determined as a provide ready liquid to the substances). Some other schemes operating on these lines are Birla Income Plan,PNB Premium Plus and UTI index Equity Fund. The mutual funds offer two-way quotes for buying and selling the units under open-ended schemes. Mutual funds are generally sponsors by banks, financial institution and other registered companies. They are governed by guidelines issued by Reserve Bank of India and Securities Exchange Board of India (SEBI). Some of the prescriptions under the guidelines is:

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Financial Market and Instrument Prudential exposure limits (eg. To hold not over 5% of companys equity), Relationship between sponsor and the mutual fund, and. Constitution of assets Management Company to undertake deployment of funds. Mutual funds were quite active in capital market in the early 90s.With the introduction of the money market mutual funds and revival of stock markets, we may expect better performance from mutual funds in the near future.

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CONCLUSION:
The reforms have been successful in bringing significant improvements in various financial market segments improving their depth, liquidity and efficiency. The money market is now reasonably developed with a wide array of instruments. The character of the Government securities market has changed from being a captive market to a broadbased, deep and liquid market enabling the Reserve Bank to pursue its monetary policy through market-based instruments. Various reform measures have resulted in sharp growth of the foreign exchange market. Reforms have also been successful in creating and sustaining orderly conditions in the market. These factors have led to increased interlinkages across financial institutions and markets. In the more recent period, the various segments of the financial market in India have, by and large, exhibited stability. RBI will endeavour to provide an enabling environment for healthy development of financial markets. The enabling environment also encompasses harmonization of reforms in financial sector with the real sector. Large gaps exist in demand supply of infrastructure services such as transport, electricity, ports etc. It needs to be emphasized that sound macroeconomic policies and a competitive domestic sector improve the capacity of the economy to absorb higher capital inflows, reduce the cost of capital, translate external flows into higher investment levels and provide cushion against unexpected shocks in more liberalized external markets. With progressive financial sector reforms, various segments of the financial market, including Forex, money and G-Sec markets, have made tremendous strides. A calibrated approach towards financial sector liberalization has been the hallmark of financial sector reforms process and has paid rich dividends to the economy by insulating it from the vagaries of international capital flows and the contagion effect of various crises faced by emerging market economies in the 1990s Thus, there are number of instrument available in the market for conducting business transaction.

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BIBLOGRAPHY & REFERENCE BOOKS FINANCIAL MARKETS FINANCIAL MARKETS& SERVICESFINANCIAL SYSTEMFINANCIAL MARKETSAN OVERVIEWROLENT, ROBIN VASANT DESAI VASANT DESAI INDIAN INSTITUDE OF BANKERS

MAGAZINES FINANCIAL CHARTERED ANALYST WEBSITES www.stci.com www.nse.com www.bse.com www.hdfc.com

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