Chapter 4 – Money & Capital Markets in

India

Economic Analysis for Business Decision

MONEY MARKET

As per RBI definitions “ A market for short terms financial assets that are close substitute for money, facilitates the exchange of money in primary and secondary market”.

The money market is a mechanism that deals with the lending and borrowing of short term funds (less than one year).

A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded.

What is Money Market?

It doesn’t actually deal in cash or money but deals with substitute of cash like trade bills, promissory notes & govt papers which can converted into cash without any loss at low transaction cost.

It includes all individual, institution and intermediaries.

Continued…….

It is a market purely for short-terms funds or financial assets called near money.

It deals with financial assets having a maturity period less than one year only.

In Money Market transaction can not take place formal like stock exchange, only through oral communication, relevant document and written communication transaction can be done.

Features of Money Market

Transaction have to be conducted without the help of brokers.

It is not a single homogeneous market, it comprises of several submarket like call money market, acceptance & bill market.

The component of Money Market are the commercial banks, acceptance houses & NBFC (Non-banking financial companies).

Continued……..

To provide a parking place to employ short term surplus funds.

To provide room for overcoming short term deficits.

To enable the central bank to influence and regulate liquidity in the economy through its intervention in this market.

To provide a reasonable access to users of short-term funds to meet their requirement quickly, adequately at reasonable cost.

Objective of Money Market

o Development of trade & industry.o Development of capital market.o Smooth functioning of commercial banks.

o Effective central bank control.o Formulation of suitable monetary policy.

o Non inflationary source of finance to government.

Importance of Money Market

A variety of instrument are available in a developed money market. In India till 1986, only a few instrument were available.

They were• Treasury bills • Money at call and short notice in the call

loan market.• Commercial bills, promissory notes in the

bill market.

Instrument of Money Market

Now, in addition to the above the following new instrument are available:

Commercial papers.Certificate of deposit. Inter-bank participation certificates.Repo instrumentBanker's AcceptanceRepurchase agreementMoney Market mutual fund

New instrument

The call money market is an integral part of the Indian Money Market, where the day-to-day surplus funds (mostly of banks) are traded. The loans are of short-term duration varying from 1 to 14 days.

The money that is lent for one day in this market is known as "Call Money", and if it exceeds one day (but less than 15 days) it is referred to as "Notice Money".

Call Money Market

Banks borrow in this market for the following purpose

To fill the gaps or temporary mismatches in funds

To meet the CRR & SLR mandatory requirements as stipulated by the Central bank

To meet sudden demand for funds arising out of large outflows.

Call Money Market

Scheduled commercial banks Non-scheduled commercial banks Foreign banks State, district and urban, cooperative banks Discount and Finance House of India (DFHI) Securities Trading Corporation of India (STCI).The DFHI and STCI borrow as well as lend, likebanks and primary dealers, in the call market.

Participants in the call money market

Treasury bills, commonly referred to as T-Bills are issued by Government of India against their short term borrowing requirements with maturities ranging between 14 to 364 days.

(T-bills) are the most marketable money market

security. They are issued with three-month, six-month

and one-year maturities. T-bills are purchased for a price that is less than

their par(face) value; when they mature, the government pays the holder the full par value.

T-Bills are so popular among money market instruments because of affordability to the individual investors.

Treasury Bills

Banks, Primary Dealers, State Governments, Provident Funds, Financial Institutions, Insurance Companies, NBFCs, FIIs (as per prescribed norms), NRIs & OCBs can invest in T-Bills.

All these are issued at a discount-to-face value. For example a Treasury bill of Rs. 100.00 face value issued for Rs. 91.50 gets redeemed at the end of it's tenure at Rs. 100.00.

Who can invest in T-Bill

The term government securities encompass all Bonds & T-bills issued by the Central Government, and state governments.

These securities are normally referred to, as "gilt-edged" as repayments of principal as well as interest are totally secured by sovereign guarantee.

Gilt edged securities

A CD is a time deposit with a bank. Like most time deposit, funds can not withdrawn before maturity without paying a penalty.

CD’s have specific maturity date, interest rate and it can be issued in any denomination.

The main advantage of CD is their safety.

Anyone can earn more than a saving account interest.

Certificate of deposit (CD)

CP is a short term unsecured loan issued by a corporation typically financing day to day operation.

CP is very safe investment because the financial situation of a company can easily be predicted over a few months.

Only company with high credit rating issues CP’s.

Commercial paper (CP)

Repo is a form of overnight borrowing and is used by those who deal in government securities.

They are usually very short term repurchases agreement, from overnight to 30 days of more.

The short term maturity and government backing usually mean that Repos provide lenders with extremely low risk.

Repos are safe collateral for loans.

Repurchase agreement (Repos)

A banker’s acceptance (BA) is a short-term credit investment created by a non-financial firm.

BA’s are guaranteed by a bank to make payment.

Acceptances are traded at discounts from face value in the secondary market.

BA acts as a negotiable time draft for financing imports, exports or other transactions in goods.

This is especially useful when the credit worthiness of a foreign trade partner is unknown.

Banker's Acceptance

Purchasing power of your money goes down, in case of up in inflation.

Absence of integration. Absence of Bill market. No contact with foreign Money markets.

Limited instruments. Limited secondary market. Limited participants.

Disadvantage of Money Market

ORGANISED STRUCTURE 1. Reserve bank of India. 2. DFHI (discount and finance house of India).

3. Commercial banks i. Public sector banks SBI with 7 subsidiaries Cooperative banks 20 nationalized banks ii. Private banks Indian Banks Foreign banks4. Development bank IDBI, IFCI, ICICI, NABARD, LIC, GIC, UTI etc.

Structure of Indian Money Market

UNORGANISED SECTOR 1. Indigenous banks 2 Money lenders 3. Chits 4. Nidhis

III. CO-OPERATIVE SECTOR 1. State cooperative i. central cooperative banks Primary Agri credit societies Primary urban banks 2. State Land development banks central land development banks Primary land development banks

Structure of Indian Money Market

Integration of unorganised sector with the organised sector

Widening of call Money market Introduction of innovative instrument Offering of Market rates of interest Promotion of bill culture Entry of Money market mutual funds Setting up of credit rating agencies Adoption of suitable monetary policy Establishment of DFHI Setting up of security trading corporation of

India ltd. (STCI)

Recent development in Money Market

The money market specializes in debt securities that mature in less than one year.

Money market securities are very liquid, and are considered very safe. As a result, they offer a lower return than other securities.

The easiest way for individuals to gain access to the money market is through a money market mutual fund.

T-bills are short-term government securities that mature in one year or less from their issue date.

T-bills are considered to be one of the safest investments.

Summary

A certificate of deposit (CD) is a time deposit with a bank.

CDs are safe, but the returns aren't great, and your money is tied up for the length of the CD.

Commercial paper is an unsecured, short-term loan issued by a corporation. Returns are higher than T-bills because of the higher default risk.

Banker’s acceptance (BA) are negotiable time draft for financing transactions in goods.

Repurchase agreement (repos) are a form of overnight borrowing backed by government securities.

Continued…….

Reserve Bank Of India

Introduction

The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934.

It is the central bank of India.

It was originally constituted with a capital of Rs.5 crores. The entire share capital was contributed privately with the exception of the nominal value of Rs 2.2 lakh subscribed by the central bank.After independence, the reserve bank of India was nationalized.

RBI Central Office Building,

Mumbai

Raghuram RajanCurrent Governor

of R.B.I

Management Structure of Reserve Bank Of India

To manage the monetary and credit system of the country. 

To stabilizes internal and external value of rupee.  For balanced and systematic development of banking in the country. 

For the development of organized money market in the country. 

Objectives Of R.B.I

For proper management of public debts To establish monetary relations with other countries of the world and international financial institutions. For centralization of cash reserves of commercial banks.  To maintain balance between the demand and supply of currency.

For proper arrangement of agriculture finance.  For proper arrangement of industrial finance. 

1. TRADITIONAL FUNCTIONS

I --- ISSUER OF CURRENCY NOTES

The RBI has the sole right or authority or monopoly of issuing currency notes

These currency notes are legal tender issued by the RBI.

Currently it is in denominations of Rs. 2, 5, 10, 20, 50, 100, 500, and 1,000. The RBI has powers not only to issue and withdraw but even to exchange these currency notes for other denominations.

It issues these notes against the security of gold bullion, foreign securities, rupee coins, exchange bills and promissory notes and government of India bonds.

II---Banker and Debt Manager To Government

 The RBI being the apex monitory body has to work as an agent of the central and state governments.

It performs various banking function such as to accept deposits, taxes and make payments on behalf of the government.

It works as a representative of the government even at the international level. It maintains government accounts, provides financial advice to the government.

It manages government public debts and maintains foreign exchange reserves on behalf of the government. It provides overdraft facility to the government when it faces financial crunch.

III---BANKER TO BANKS

 The RBI being an apex monitory institution has obligatory powers to guide, help and direct other commercial banks in the country.

Every commercial bank has to maintain a part of their reserves with the RBI. The RBI controls the credit created by commercial banks by varying the proportion of reserves.

It facilitates the clearing & rediscounting of promissory notes, bills of exchange and cheques and also helps in inter bank transfer of funds.

Similarly in need or in urgency these banks approach the RBI for funds. Thus it is called as the lender of the last resort.

IV---CREDIT CONTROL

The RBI controls the credit creation by commercial banks. For this, the RBI uses both quantitative and qualitative methods.

By controlling credit, the RBI achieves the following:Maintains the desired level of circulation of

money in the economy.Maintains the stability in the price level

prevailing in the economy.Controls the effects of trade cyclesControls the fluctuations in the foreign exchange

rateChannelizes credit to the productive sectors of

the economy

2.PROMOTIONAL FUNCTIONS

Along with the routine traditional functions, central banks especially in the developing country like India have to perform numerous functions. These functions are country specific functions and can change according to the requirements of that country.Development of the Financial System : The financial system comprises the financial institutions, financial markets and financial instruments. The sound and efficient financial system is a precondition of the rapid economic development of the nation. The RBI has encouraged establishment of main banking and non-banking institutions to cater to the credit requirements of diverse sectors of the economy.

Development of Agriculture : In an agrarian economy like ours, the RBI has to provide special attention for the credit need of agriculture and allied activities. It has successfully rendered service in this direction by increasing the flow of credit to this sector.

Provision of Industrial Finance : In this regard the RBI has always been instrumental in setting up special financial institutions such as ICICI Ltd. IDBI, SIDBI and EXIM BANK etc for the adequate and timely availability of credit to small, medium and large industry is very significant. Collection of Data : Being the apex monetary authority of the country, the RBI collects process and disseminates statistical data on several topics..This data proves to be quite useful for researchers and policy makers.

Publication of the Reports : This RBI collects and publishes data on several sectors of the economy. The reports and bulletins are regularly published by the RBI. It includes RBI weekly reports, RBI Annual Report This information is made available to the public also at cheaper rates.

Promotion of Banking Habits : As an apex organization, the RBI always tries to promote the banking habits in the country. It institutionalizes savings and takes measures for an expansion of the banking network.

3. SUPERVISORY FUNCTIONS

The reserve bank also performs many supervisory functions. It has authority to regulate and administer the entire banking and financial system. Some of its supervisory functions are given below.

Granting license to banks : The RBI grants license to banks for carrying its business. License is also given for opening extension counters, new branches, even to close down existing branches.

Bank Inspection : The RBI grants license to banks working as per the directives and in a prudent manner without undue risk. In addition to this it can ask for periodical information from banks on various components of assets and liabilities.

Control over NBFIs : The Non-Bank Financial Institutions are not influenced by the working of a monitory policy. However RBI has a right to issue directives to the NBFIs from time to time regarding their functioning. Through periodic inspection, it can control the NBFIs.

Instruments of Monetary Policy

Bank Rate Policy – It refers to rate at which the central bank (i.e. RBI) rediscounts bills and prepares of commercial banks or provides advance to commercial banks against approved securities.

Open Market Operations- It refers to the purchase and/or sale of short term and long term securities by the RBI in the open market. The OMO is used to wipe out shortage of money in the money market

Variations in Reserve Ratios- SLR & CRR -RBI increases VRR during the inflation to reduce the purchasing power and credit creation. But during the recession or depression it lowers the VRR making more cash reserves available for credit expansion.

I. Quantitative Tools

Prescription of margin requirements- It refers to the "proportion of the loan amount which is not financed by the bank". Or in other words, it is that part of a loan which a borrower has to raise in order to get finance for his purpose.

Consumer credit regulation -  RBI fixes the quota of credit for commercial banks. It means at maximum, how much volume of money a commercial bank can grant as loan for a particular activity. Thus by increasing this quota RBI can increase the credit supply in an economy and by decreasing quota RBI can restrict credit supply.

Moral suasion- It means persuasion and request. To arrest inflationary situation RBI persuades and request the commercial banks to refrain from giving loans for non-essential purposes. On the other hand, to counteract deflation central bank persuades the commercial banks to extend credit for different purposes.

2. Qualitative Tools

Direct action -This method is adopted when a commercial bank does not co-operate the central bank in achieving its desirable objectives. Direct action may take any of the following forms:

•Central banks may charge a penal rate of interest over and above the bank rate upon the defaulting banks;

•Central bank may refuse to rediscount the bills of those banks which are not following its directives;

•Central bank may refuse to grant further accommodation to those banks whose borrowings are in excess of their capital and reserves.

CAPITAL MARKET

The market where investment instruments like bonds, equities and mortgages are traded is known as the capital market.

The primal role of this market is to make investment from investors who have surplus funds to the ones who are running a deficit.

CAPITAL MARKET

The capital market offers both long term and overnight funds.

The different types of financial instruments that are traded in the capital markets are:

> equity instruments

> credit market instruments,

> insurance instruments,

> foreign exchange instruments,

> hybrid instruments and

> derivative instruments.

The nature of capital market is brought out by the following facts:

It Has Two Segments It Deals In Long-Term Securities It Performs Trade-off Function It Creates Dispersion In Business Ownership It Helps In Capital Formation It Helps In Creating Liquidity

Nature of capital market

There are two types of capital market:

Primary market, Secondary market

Types of capital market

It is that market in which shares, debentures and other securities are sold for the first time for collecting long-term capital.

This market is concerned with new issues. Therefore, the primary market is also called NEW ISSUE MARKET.

Primary Market

In this market, the flow of funds is from savers to borrowers (industries), hence, it helps directly in the capital formation of the country.

The money collected from this market is generally used by the companies to modernize the plant, machinery and buildings, for extending business, and for setting up new business unit.

It Is Related With New Issues

It Has No Particular Place

It Has Various Methods Of Float Capital: Following are the methods of raising capital in the primary market:

i) Public Issue ii) Offer For Sale iii) Private Placement iv) Right Issue v) Electronic-Initial Public Offer It comes before Secondary Market

Features of Primary Market

The secondary market is that market in which the buying and selling of the previously issued securities is done.

The transactions of the secondary market are generally done through the medium of stock exchange.

The chief purpose of the secondary market is to create liquidity in securities.

Secondary Market

If an individual has bought some security and he now wants to sell it, he can do so through the medium of stock exchange to sell or purchase through the medium of stock exchange requires the services of the broker presently, their are 24 stock exchange in India.

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It Creates Liquidity It Comes After Primary Market It Has A Particular Place It Encourage New Investments

Features of Secondary Market

Investment in long term financial instruments is accompanied by high capital market risks. Since there are two types of capital markets- the stock market and the bond market.

So risks are present in both the market.

CAPITAL MARKET RISK

Stock prices keep fluctuating over a wide range unlike the bank deposits or government bonds.

The efficient market hypothesis shows the effect of fundamental factors in changing the price of the stock market.

Risk in the Stock Market

The Efficient Market Hypothesis shows that all price movements are random whereas there are plenty of studies that reflect the fact that there is a specific trend in the stock market prices over a period of time.

Research has shown that there are certain psychological factors that shape the stock market prices.

Sometimes the market behaves illogically

to any economic news.

The stock market prices can be diverted in any direction in response to press releases, rumors and mass panic.

The stock market prices are also subject to speculation. In the short run the stock market prices may be very volatile due to the occurrences of the fast market changing events.

Capital market risk in the bond market arises due to interest rate changes. There is an inverse relationship existing between the interest rate and the price of the bond.

Hence the bond prices are sensitive to the monetary policy of the country as well as economic changes.

Risk in the Bond Market

Capital market investment takes place through the bond market and the stock market.

The capital market is basically the financial pool in which different companies as well as the government can raise long term funds.

Capital market investment that takes place through the bond and the stock market may be elucidated in the following heads.

CAPITAL MARKET INVESTMENT

Capital market investments in the stock market

The stock market is basically the trading ground capital market investment in the following:

i) Company’s stocks ii) Derivatives iii) Other securities The capital market investments in the stock

market take place by: 1) Small individual stock investors 2) Large hedge fund traders. The capital market investments can occur

either in: 1) The physical market by a method

known as the open outcry.

2) Trading can also occur in the virtual exchange where trading is done in the computer network.

The investors in the stock market have the liberty to buy or sell the stock that they are holding at their own discretion unlike the case of government securities, bonds or real estate.

The stock exchanges basically function as the clearing house for such liquid transactions.

The capital market investments in the stock market are also done through the derivative instruments like the stock options and the stock futures.

Capital Market Investments in the Bond Market

The bond market is a financial market where the participants buy and sell debt securities.

The bond market is also differently known as the debt, credit or fixed income market.

There are different types of bond markets based on the different types of bonds that are traded. They are:

Corporate, Government and agency,  Municipal, Bonds backed by mortgages & assets, Collateralized Debt Obligation.

The bonds, except for the corporate bonds do not have formal exchanges but are traded over-the- counter.

Individual investors are attracted to the bond market and make investments through the bond funds, closed-end-funds or the unit investment trusts.

Another way of investing directly in the bond issue is the Exchange-traded-funds.

The capital market investment in the bond market is done by:

Institutional investors Governments, traders and Individuals.

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Mobilization of Savings & acceleration of Capital Formation

Promotion of Industrial GrowthRaising of long term CapitalReady & Continuous MarketsProper Channelisation of Funds Use of updated technology is possible

Importance/Significance/ Role of Indian Capital Market

“ Stock exchange is a market in which securities are brought and sold”

“ Stock exchange means any body of individuals whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.”

Stock Exchange

Provides a ready market for buying and selling of securities.

Directs flow of capital in the most profitable channels.

Facilitates speculation. Promotes industrial growth and economic

development. Promotes habit of savings and investment.

Functions of Stock Exchange

SEBI – ROLE AND FUNCTIONS

K.K.Jindal

SEBI was constituted in 1988 by a resolution of govt. of India.

It was made a statutory body by the Securities and Exchange Board of India Act 1992.

Objectives Regulating the business in stock markets and

other securities market. Registering and regulating the working of stock

brokers. Registering and regulating the working of

investment schemes.

Securities and Exchange Board of India

Promoting and regulating the self-regulatory organizations.

Prohibiting fraudulent and unfair trade practices relating to securities market.

Regulating substantial acquisition of shares and take over of the companies.

Regulating the business in stock exchanges and any other securities market.

Registering and regulating the working of collective investment schemes.

Promoting and regulating self-regulatory organizations.

Registering and regulating the working of stock brokers, sub brokers, share transfer agents, merchant bankers, underwriters, portfolio managers, investment advisors, and such other intermediaries who are associated with securities in any manner.

Functions of the SEBI

Promoting of investors education and training of intermediaries in securities market.

Prohibiting insider trading in securities. Regulating substantial acquisition of shares

and take over of companies. Calling information, undertaking inspection,

conducting enquiries and audits of the stock exchanges, intermediaries and self-regulatory organizations.

Functions of the SEBI

Inspection And Inquiries

Regulating Substantial Acquisition Of Shares And Take-overs

Performing Such Functions And Exercising Such Powers Under The Provisions Of The Securities Contracts (Regulation) Act, 1956 As May Be Delegated To It By The Central Government;

Levying Fees Or Other Charges For Carrying Out The Purposes Of This Section

Conducting Research For The Above Purposes

FUNCTIONS OF SEBI

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