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Financial market & services

The document provides an overview of the Indian financial system, including its key components and institutions. It discusses the major financial markets in India - the money market, capital market, foreign exchange market, and credit market. It also examines the role of various financial intermediaries that operate in these markets, such as investment bankers, stock exchanges, and primary dealers. Additionally, the document outlines the functions of important financial sector regulators like the Reserve Bank of India and its departments that are responsible for banking and non-banking supervision.

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FINANCIAL MARKETS AND INSTITUTIONS BY A . ARULDOS S VITHAKAN 1/30/2015 1
INDIAN FINANCIAL SYSTEN-AN OVERVIEW o Financial System of any country consists of financial markets, financial intermediation and financial instruments or financial products. o The term "finance" in our simple understanding it is perceived as equivalent to 'Money‘. But finance exactly is not money, it is the source of providing funds for a particular activity. o Finance refers to assessing the requirements of funds, identify sources , sourcing, deployment and evaluating the results of such investment with a view to improve performance in the future. o 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 a surplus/deficit/balanced budgetary situations. 1/30/2015 2
o 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. o 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. 1/30/2015 3
FINANCIAL MARKETS o Money Market- The money market ifs a wholesale debt market for low-risk, highly-liquid, short-term instrument. Funds are available in this market for periods ranging from a single day up to a year. This market is dominated mostly by government, banks and financial institutions. o Capital Market - The capital market is designed to finance the long-term investments. The transactions taking place in this market will be for periods over a year. o Forex Market - The Forex market deals with the multicurrency requirements, which are met by the exchange of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes place in this market. This is one of the most developed and integrated market across the globe. o Credit Market- Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term loans to corporate and individuals. 1/30/2015 4
FINANCIAL INTERMEDIATION o To ensure that financial assets reach the ultimate investor in order to garner the requisite amount. When the borrower of funds approaches the financial market to raise funds, mere issue of securities will not suffice. Adequate information of the issue, issuer and the security should be passed on to take place. There should be a proper channel within the financial system to ensure such transfer. o To serve this purpose, Financial intermediaries came into existence. o In the initial stages, the role of the intermediary was mostly related to ensure transfer of funds from the lender to the borrower. This service was offered by banks, FIs, brokers, and dealers. However, as the financial system widened along with the developments taking place in the financial markets, the scope of its operations also widened. 1/30/2015 5
FINANCIAL INTERMEDIARIES o Some of the important intermediaries operating ink the financial markets include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory organizations, etc. Though the markets are different, there may be a few intermediaries offering their services in move than one market e.g. underwriter. However, the services offered by them vary from one market to another. 1/30/2015 6
FINANCIAL INTERMEDIARIES Intermediary Market Role Stock Exchange Capital Market Secondary Market to securities Investment Bankers Capital Market, Credit Market Corporate advisory services, Issue of securities Underwriters Capital Market, Money Market Subscribe to unsubscribed portion of securities Registrars, Depositories, Custodians Capital Market Issue securities to the investors on behalf of the company and handle share transfer activity Primary Dealers Satellite Dealers Money Market Market making in government securities Forex Dealers Forex Market Ensure exchange ink currencies 1/30/2015 7
NATURE AND ROLE OF FINANCIAL SYSTEM STRUCTURE OF FINANCIAL SYSTEM FINANCIAL SYSTEM FINANCIAL INSTITUTIO NS BANKIN G NON BANKIN G Inter mediaries Non-inter mediaries FINANCIAL MARKETS PRIMAR Y CAPITAL MARKET EQUITY DEBT DERIVATIVE SECONDAR Y MONEY MARKET FINANCIAL INSTRUMENTS CLAIMS ASSETS SECURITIES FINANCIAL SERVICE 1/30/2015 8
EQUILLIBRIUM IN FINANCIAL MARKETS EQULLIBRIUM IS BASED ON THE ASSUMPTION THE WORLD IS PERFECT Financial market is expected to be perfect when:  There are large number of savers, investors and operators in the market.  All participants are rational.  All are well informed and there is smooth and faster flow of required information.  There is homogeneous expectations from all participants in the market.  There are no taxes.  There are no transaction costs.  The financial assets are infinitely divisible. 1/30/2015 9
DETERMINANTS OF SUPPLY AND DEMAND OF FUNDS o Aggregate savings by the household sector., business sector and the government in a given economy. o Savings is the difference between possible income and consumption expenditure.. o The level of current and expected income has a definite bearing on volume of savings . Other factors are age wise variations, certainty of income, inflation, desire to save for old age, tax benefits, economic development, desire to consume. o Demand for funds are dependent on investment climate, growth of economy, investment in working capital, expansion, new establishments of industry or service units,expoprts, technological changes capacity utilisation,investment in housing, infrastructure development, availability of internal funds, cost of capital etc. 1/30/2015 10
FINANCIAL SYSTEM AND ECONOMIC DWVELOPMENT ECONOMIC DEVELOPMENT SAVINGS&INVESTMENT IN CAPITAL FORMATION SURPLUS SPENDING ECONOMIC UNITS INCOME MINUS CONSUMPTION+OWN INVESTMENT SURPLUS OR SAVING FINANCIAL SYSTEM DEFICIT SPENDING ECONOMIC UNITS INCOME MINUS CONSUMPTION+INVESTMENT DEFICIT OR NEGATIVE SAVING 1/30/2015 11
RELATIONSHIP BETWEEN FINANCIAL SYSTEM AND ECONOMIC DEVELOMENT  Credit creation theory.- Investments are made in anticipation of savings  Theory of forced savings— According to this theory investments are not determined by savings but it is savings which determine investments which can be increased automatically through monetary expansion The monetary expansion speed up development through four channels: 1.if resources are unemployed it would increase aggregate demand, output and savings. `2. If resources are fully employed it would generate inflation which will lower the rate of return on financial instruments or money. This will make the wealth holders to invest in physical capital. 3. Inflation changes income distribution in favour of profit earners which will increase savings'. Inflation tax effect- Inflation imposes tax on real money therby savings are transferred to Government fo investments. 1/30/2015 12
 Financial market Regulation Theory- According to this theory fincial market are prone to market failures and that government intervention make them to function better like RBI’s interest rate and monetary policy, SEBI guidelines.  Financial Liberalisation Theory- It is argued tha the Government intervention and control of financial sector not only lower the quantum of investments but also tne quality as finacial institutions are forced to have directed investments in government specified priority sectors which normally non productive assets . Also they are primarily in l sectors which do not contribute to economic development/GDP growthh 1/30/2015 13
RBI AND INDIAN FINANCIAL SYSTEM  Until 1994, different departments in Reserve Bank of India were exercising supervision over banks, non- banking financial companies and financial institutions.  Board for Financial Supervision was set up under the aegis Reserve Bank under Reserve Bank of India (Board for Financial Supervision) Regulations, 1994 with the objective of paying undivided attention to the supervision of the institutions in the financial sector.  Prior to 1993, the supervision and regulation of commercial banks was handled by the Department of Banking Operations & Development (DBOD). In December 1993 the Department of Supervision was carved out of the DBOD with the objective of segregating the supervisory role from the regulatory functions of RBI. 1/30/2015 14
 Department of Banking Supervision (DBS)  The Department of Banking Supervision at present exercises the supervisory role relating to commercial banks in the following forms:  Preparing of independent inspection programmes for different institutions.  Undertaking scheduled and special on-site inspections, off- site surveillance, ensuring follow-up and compliance.  Determining the criteria for the appointment of statutory auditors and special auditors and assessing audit performance and disclosure standards.  Dealing with financial sector frauds.  Exercising supervisory intervention in the implementation of regulations which includes – recommendation for removal of managerial and other persons, suspension of business, amalgamation, merger/winding up, issuance of directives and imposition of penalties. 1/30/2015 15
 Department of Non-Banking Supervision(DNBS)  Department of Non-Banking Supervision has following responsibilities:  Administration of Chapter IIIB of the RBI Act, formulating regulatory framework and issuing directions to the NBFCs (including residuary non-banking companies, mutual benefit companies, chit fund companies);  Administration of Chapter III-C of the RBI Act in respect of unincorporated bodies, Chit Funds Act in respect of chit fund companies, Prize Chits and Moneys Circulation Schemes (Banning) Act in respect of prize chits;  Identification and classification of NBFCs;  Registration of NBFCs under section 45-IA of the RBI Act;  On-site inspection and follow up;  Off-site surveillance and scrutiny of various returns;  Attending to complaints relating to NBFC sector; and  Initiating deterrent action against the errant companies 1/30/2015 16
SUPERVISORY PROCESS  On-site inspection  Supervision of overseas branches of Indian banks  Financial Institutions  Non-Banking Financial Companies  Off-site Monitoring & Surveillance System- Banks, All India Development Financial Institutions, Non-Banking Financial Companies 1/30/2015 17
BOARD FOR FINANCIAL SUPERVISION: CONSTITUTION  Board for Financial Supervision (BFS) was constituted on November 16, 1994 by the Governor as a committee of the Central Board of Directors of the Reserve Bank of India (RBI). It functions under the RBI (BFS) Regulations, 1994 exclusively framed for the purpose in consultation with the Government of India.  Advisory Council to BFS was constituted on November 16, 1994 and was in place till March 27, 1998.  The BFS also constituted an Audit Sub-Committee in January 1995  The supervision by BFS at present covers commercial banks, all India development financial institutions and non-banking finance companies. 1/30/2015 18
 Corporate Governance and Management Guidance  Transparency and Disclosure  Internal controls and housekeeping in banks  Reconciliation of inter-branch accounts  Balancing of books  Reconciliation of Nostro accounts  Strengthening of internal audit /control system  Audit system in banks  Fraud monitoring  Core Principles for Effective Banking Supervision 1/30/2015 19
ASSIGNMENT -1 Discuss in brief the role, responsibilities and functions of various financial intermediaries in Indian Financial System Note: 1. Assignment must be in your own language, data / information can be gathered from text books and the net. 2. Assignment to be submitted lates by 29.06.2009 1/30/2015 20
SAVINGS AND INVESTMENTS Consumption and saving decisions  Desired consumption is the consumption amount desired by households  Desired national saving is the level of national saving when consumption is at its desired level: 1/30/2015 21
Consumption and saving decisions:  A person can consume less than current income, i.e., saving is positive.  A person can consume more than current income i.e., saving is negative 1/30/2015 22
 Consumption and saving decisions:  There is a trade-off between current and future consumption:  •The price of 1 unit of current consumption is 1 + r units of future consumption, where r is the real interest rate.  Consumption-smoothing motive: the desire to have a relatively even pattern of consumption over time. 1/30/2015 23
 Effect of changes in current income:  Increases in current income increase both  consumption and saving.  • Because the marginal propensity to consume— the fraction of additional income consumed—is less than 1.  When current income (Y) rises, Cd rises, but not by as much as Y, so Sd also rises. 1/30/2015 24
 Effect of changes in expected future income:  􀂾 Higher expected future income raises current  consumption even at the same current income level, so current saving declines.  Effect of changes in wealth:  Increase in wealth raises current consumption even at the same current income level, so current saving declines 1/30/2015 25
 Effect of changes in the real interest rate: A higher real interest rate has 2 effects.  • The Substitution effect on saving is positive because a higher rate of return is a greater reward for saving  .• The Income effect on saving is mixed: – It is negative for a net saver because it takes less saving toachieve a given amount in the future (target saving). – It is positive for a net borrower because a higher real interest rate represents a loss of wealth. 1/30/2015 26
 Effect of changes in the real interest rate:  Taxes and the real return to saving.  • The expected after-tax real interest rate is given by: - Effect of changes in fiscal policy: -Changes in fiscal policy affects desired  consumption through changes in both current and expected future income.  They directly affect desired national saving: 1/30/2015 27
 Effect of changes in fiscal policy: Government purchases:  Higher G financed by higher current taxes reduces after-tax income, lowering desired consumption.  • Higher G financed by higher future taxes also lowers desired consumption if people realize that future after-tax income will be lower. 1/30/2015 28
 Effect of changes in fiscal policy:  Taxes:  • A reduction in current taxes will increase current (disposable) income and desired consumption.  • However, consumers may realize that a tax cut today will result in higher taxes in the future, which willreduce future expected income. 1/30/2015 29
Effect of changes in fiscal policy:  􀂾 Taxes—3 possible situations:  • If the decline in future expected income is less than the increase in current income, desired consumption will rise. 1/30/2015 30
Effect of changes in fiscal policy: Taxes—3 possible situations:  • If the decline in future expected income exactly offsets the increase in current income, desired consumption will not change.  tax change affects only the timing of taxes, not their ultimate (present value) amount 1/30/2015 31
 Effect of changes in fiscal policy: Taxes:  • In practice, people do not fully see that future taxes will rise if taxes are cut today.  • Consequently, a tax cut today leads to increased desired consumption and reduced desired national saving. 1/30/2015 32
DETERMINANTS OF DESIRED NATIONAL SAVING  Rise in current income.  Increase in expected future income.  Increase in wealth.  Increase in real (after tax) interest rates 1/30/2015 33
INVESTMENT  Why is investment important?  􀂾 Investment fluctuates sharply over the business cycle.  • Need to understand investment to understand the business cycle. Investment plays a crucial role in long-term growth. 1/30/2015 34
 Investment is determined by changes in the  desired capital stock.  The desired capital stock is the amount of capital that allows firms to earn the largest expected profit.  • Depends on benefits and costs of additional capital. 1/30/2015 35
 The desired capital stock: The benefit associated with additional capital  depends on the future marginal product of capital,  • Because the marginal productivity of capital falls a K increase, the MPKf also falls as K increases. 1/30/2015 36
 The desired capital stock: The cost associated with additional capital is the real cost of using a unit of capital per year.  • This is called the user cost of capital, uc, which equals the sum of the real interest cost and depreciation. 1/30/2015 37
 Changes in the desired capital stock:  Any factor that changes the user cost of capital willalso cause a change in the desired capital stock:  The real interest rate,  • The depreciation rate, or  • The price of capital. 1/30/2015 38
 Changes in the desired capital stock:  Any factor that shift the MPKf curve will also cause a change in the desired capital stock:  Technology, or  • The labor force. 1/30/2015 39
 Changes in the desired capital stock: Taxes and the desired capital stock:  • With taxes, the return to capital is (1 – τ) MPKf  • The desired capital stock is where the after tax return also cause a change in the desired capital stock: 1/30/2015 40
 Changes in the desired capital stock:  􀂾 Taxes and the desired capital stock:  • Tax-adjusted user cost of capital is uc/(1 – τ).  • An increase in τ raises the tax-adjusted user cost of Changes in the desired capital stock:  􀂾 Taxes and the desired capital stock:  • Tax-adjusted user cost of capital is uc/(1 – τ).  • An increase in τ raises the tax-adjusted user cost of 1/30/2015 41
INTEREST RATE STRUCTURE  Impact of interest rate is both in savings and investment in the economy- borrowing and lending decisions are primarily based on interest rate.  In the macro sense interest rate and interest income has vital role in the economy.  Savings and investments which are influenced by interest rates are the economic variables. 1/30/2015 42
ROLE OF INTEREST RATES  Reward to capital-a factor of production.  A return on savings  Cost to investments.  An instrument of monetary policy in credit control. In addition to influencing the cost and availability of funds from the supply side, interest rate also influence the quantum of investments from the demand side and thus determine the income and the employment in the economy. 1/30/2015 43
THEORIES OF INTEREST RATE  Keynes considered interest rate as monetary phenomenon.  He took money as an asset with opportunity cost , namely return on short term bonds.  In a partial equilibrium approach, we can assume that the forces in the real economic system remain constant and analyzed the financial factors which explain the interest rate.  Under this theory interest is the function of supply and demand in the economy  Transactions are generally pre cautionary or specuklative and the late is known as aset approach. 1/30/2015 44
NEO-CLASSICAL THEORY  According to this theory interest rate is also based on the expectations of the public and the rate of inflation in the economy.  According to Irwing Fisher interest rate is also a function of inflation as the nominal rate is affected by expected rate of inflation.  During inflationary periods the gap in the rates between organised financial system and the unorganised financial system widens.  Funds flow from organised to unorganised and vice versa inluence thecrates in both the sectors. 1/30/2015 45
INTEREST RATE STRUCTURE- FACTORS INFLUENCING INTEREST RATES  Since the risk for an investor is greater than a lender, interest on ownership capital must be more than on loan capital.  Difference in maturity periods.  Degree of default risk.  Tax provisions-incentives or disincentives.  Marketability-liquidity.  Sfety of funds. 1/30/2015 46
INTEREST RATES IN INDIA  Bank rate- the rate fixed by the central bank-RBI rate for advances to commercial and co-operative banks.  Normally bank rate is for discounting bills of exchanges etc,  In view if limited money and bills market bank rate is not the leader for interest rate and the refinance rate is the rate at which various windows of RBI provides refinance to banks. These rates are known as reference rates.  Bank rate is made active indicator of f bank funds.  Bank rate is revised by RBI under the RBI Act as needed 1/30/2015 47
MONEY MARKET ORGANISATION IN INDIA Money Market Organisation In India RBI FUNCTIONS ROLE MONEY MArket Institutional Development Primary Dealers Money Market Mutual Funds SU Markets CALL/BILLS/ T>Bills/CDs/CPs 1/30/2015 48
Reserve Bank Of India Functions: To Maintan Monetary stability Financial stability Stable payment system Promote development of financial infrastructure To ensure credit allocation to meet national economic priorities Regulate volume of money and credit ROLE Note Issue Govt.Banker Banbker’s Bank Regulator Ex.Control Authority Promotional Functions 1/30/2015 49
1. Regulator of money and credit/ Monetary authority. 2. Open market operations- sale and purchase of central and stae securities and Treasury Bills. 3. Bank Rate-Rate at which the RBI buy or rediscount bills 4. Refinance – to ease the liquidity issues in the system. 5. CRR-Cash which the banks has to keep with RBI as a percentage of their demand and time liabilities to ensure safety and liquidity of bank deposits. 6. SLR-Secondary and supplementary requirements to (i) restrict expansion of bank credit; (ii)ensure solvency of banks and (iii) augment bank’s investment in government securities. 7. Liquidity Adjustment Faculty- RBI was providing specific and sector based refinance like Export credit refinance, Collateralized Lending Faculty 8. i.e advance against excess (over SLR requirements) holdings of Government securities, T- Bills . 1/30/2015 50
 Based on the recommendation of Narasimhan committee RBI policy has changed from sector specific direct refinancing to indirect and general refinancing through changes in REPO Reverse REPO rates which would provide reasonable corridor for market play  Provisions of Interim LAF: -CLF at 0.25% of fortnightly aggregate deposits of 1997-98 which would be available for 2 weeks at Bank rate wef 21st April 1999. - An Additional amount equivalent to CLF would be available at 2% over Bank Rate- - Both CLF and ACLF are for 2 weeks. - Restriction on participation in money market was withdrawn - Scheduled commercial banks were eligible export credit refinance.at Bank Rate - Liquidity support were made available to primary dealers at B/Rfor 90 days. 1/30/2015 51
 Repo /reverse repo//ready forward/repurchase (Buy back) refers to transactions where two parties agree to sell and repurchase the same security  The seller agrees to sell specified security with an agreement to buy the same security at a future price and date.  Likewise a buyer agree to buy the same security with an agreement to sell the same security at a future date and price.  The same transaction is known as repo from the view point of the seller and reverse repo from the point of the buyer.  Repo is a collateralized short term borrowing and lending. 1/30/2015 52
 The terms of such a contract is in terms of repo rate representing the money market borrowing / lending rate.  Repo rate is the annual interest rate for the funds transferred by the lender to the buyer. Repo rate is generally lower than the B/R.  There are two legs in Repo transactions: 1.Borrower sells the security. The calculation is;  Total consideration = Deal rate*face value+ Accrued interest  In the second leg interest paid for borrowing-repo rate-is adjusted against the interest earned on the securities during the holding period to arrive at the reversal price. The calculation is:  Reversal price = Deal rate* face value+ ( interest for holding period-interest paid at repo rate)/face value  Total consideration = reversal price + face value+ Accrued interest. 1/30/2015 53
 Bank X entered into a repo with Bank Y for 10 crores for 14 days  Security chosen is 13.6% GS -2010. The repo rate is 5%  The agreed purchase price is 101.12.  The last coupon was paid 30 days ago.  You are required to calculate first leg and second leg net cash outflow and purchase price rate. 1/30/2015 54
Calculation for first leg: -Sale price 1011200000 -Accrued interest (30 Days) 113333 - cash out flow 1011313333 Calculation for second leg: -Repo interest income 1011313333*0.05*14/365 1939500 Cash in flow(1011313333+1939500) 1013252833 Les Accrued interest (14days) 163945 Purchase Price 1013099893 Rate =101.31 1/30/2015 55
 1. CALL MONEY MARKET-MOSTLY SURPLUS FUNDS OF BANKS ARE TRADED WITH MATURITY PERIOD OF 1-15 DAYS. IF FOR ONE DAY IT IS CALLED ‘CALL MONEY’ MORE THAN 1 DAY ‘NOTICE MONEY’. PURPOSE IS-1.TO MEET TEMPORARY GAP OR 2. TO MEET CRR OR 3.TO MEET SUDDEN DEMAND FUNDS. LOCATED IN COMMERCIAL CENTRES. PRTICPANTS ARE BANKS, ICICI, RBI ETC.  2. COMMERCIAL PAPER(CP) ARE S.T. UNSECURED PROMISSORY NOTES AT A DISCOUNT OF FACE VALUE ISSUED BY WELL KNOWN COMPAMIESAS PER RBI GUIDELINES. ISSUE EXPENSES INCLUDE STAMP DUTY (BASED ON PERIOD), BROKER’S FEESRATING AGENCIES FEES(CRISIL) 1/30/2015 56
 CERTIFICATE OF DEPOSITS-ISSUED BY BANKS AND ARE NEGOTIABLE  -RISK IS NIL  -NEGOTIABLE FREELY BY ENDORSEMENT  -ISSUED AT A DISCOUNT TO FACE VALUE.  -MYB IN BEARER FORM ALSO.  -ALSO ISSUED TO DEMAT FIRMS  -MINIMUM SIZE 1 LAKH.  -CD ATTRACT STAMP DUTY. MONEY MARKET MUTUAL FUNDS: - TO BENEFIT SMALL INVESTORS IN MONEY MARKET. BSE/NSE 1/30/2015 57
CAPITAL MARKET PRIMARY PLAYERS SECONDARY METHOD OF ISSUE QUANTUM OF ISSUE COST OF ISSUE LISTING TRADING SETTLEMENT CLEARING PUBLIC RIGHT BONUS PRIVATE PLACEMENT COMPANY BROKERS PUBLIC BOUGHT OUT DEALS 1/30/2015 58
 STOCK EXCHANGE-WHERE OUTSTANDING SECURITIES(ISSUED SHARES ) ARE TRADED. ORDER:  LIMIT ORDER-LIMITED BY FIXED PRICE.  BEST RTAE ORDER  IMMEDIATE OR CANCEL ORDER  LIMITED DISCRETIONARY ORDER.STOP LOSS ORDER  OPEN ORDER  ORDER IS EXECUTED ON TRADING DAYS. TRADING SYSTEM  TRADING BY ‘PUBLIC OUTCR’  OTCEI-SCREEN BASED TRADING. OTCEI RESTRICTED TO SMALL MIIDCAP COMPANIES. 1/30/2015 59
DEPOSITORIES-ARE AGENCIES WHO HOLD THE SECURITIES ON BEHALF OTHE INVESTORS IN ELECTRONIC FORM TO OVERCOME THE PROBLEM OF PHYSICAL MOVEMENT OF DOCUMENTS.  DEMATERIALISATION IS PROCESS BY WHICH PHYSICAL CERTIFICATESARE DESTROYED AND EQUIVALENT SECURITIES ARE CREDITED TO INVESTORS ACCOUNT.  CARRY FORWARD RESULTING IN DELAYS , DEFAULTS IS BANNED BY SEBI NAD A MODIFED CARRY FORWARD SYSTEM IS INTRODUCED.  SETTLEMENT TO BE MADE COMPULSORILY BYSEPTEMBER 3. 1/30/2015 60
SETTLEMENT PROCEDURE AT NSE  HAS A COMPUTRISED TRADING MECHANISM. TRADING IS DONE ON THE BASIS OF ORDERS IN THE SYSTEM AND BETWEEN 9.55 AM TO 3,30 PM.  TILL THE TRANSACTION IS EXECUTED, IDENTITY OF BROKER IS PROTECTED.  SETTLEMENT IS DONE THROUGH BOOK ENTRY TRANSFER IN DEPOSITORY.  IN THE CENTRAL DEPOSITORY FUNDS AND SECURITIES POSITION IS DEBITED/CREDITED THROUGH ELECTRONIC BOOK TRANSFER.  AT THE END OF THE DAY COMPUTER GENERATE A STAEMENT SHOWING NET POSITION FOR EACH MEMBER. 1/30/2015 61
GOVERNMENT SECURITIE MARKET  CENTRAL GOVERNMENT SECURITIES  STATE GOVERNMENT SECURITIES  SECURITIES GUARANTEED BY CENTRAL GOVERNMENT FOR ALL INDIA FINANCIAL INSTITUTIONS LIKE IDBI,ICISI,IFCI ETC.  SECURITIES GUARANTEED BY STATE GOVERNMENT FOR SATAE INSTITUTIONS LIKE SEBS, HOUSING BOARDS  TREASURY BILLS ISSUED BY RBI FORMS OF GOVERNMENT SECURITIES  STOCK CERTIFICATES  PROMISSORY NOTES  BEARER BONDS 1/30/2015 62
MARKET FOR GOVERNMENT SECURITIES  PRIMARY MARKET- RBI IS GIVEN THE TASK OF MANAJING THE PUBLIC DEBTIN THE ECONOMY  QUANTUM OF BORROWING IS SPECIFIED IN BUDGET.  AUCTION IS TIMED DURING HIGH LIQUIDITY PERIODS TO RAISE MAXI,UM AMOUNT AT BEST PRICE.  TERMS OF ISSUE INVOLVE COUPON, MATURITY TERMS AND NORMALL LONG TERM YIELD CURVE DRAWN BY RBI IS FOLLOWED.  INVESTORS-COMMERCIAL BANKS, FIs, LARGE CORPORATE BODIES, RBI, AND FIIs.  SECONDARY MARKET IS ACTIVE AFTER 1990s 1/30/2015 63
SETTLEMET PROCEDURE  RBI IS ACTING AS DEPOSITORY AND SETTLEMENTS ARE DONE BY THEM THROUGH SGL ACCOUNT.  IF INVESTOR DOES NOT HAVE SGL ACCOUNTTHEN IT NEEDS TO OPEN WITH ANY REGISTERED BANK .  TRANSHER IS THROUGH BOOK ENTRY.  SECURITY DEALS ARE CARRIED OUT ON EX-INTEREST BASIS AS PER THE BYE-LAWS OF THE STOCK EXCHANGES.  THIS ALSO LED TO ‘VOUCHER TRADING’-AMOUNT OF INCOME TAX DEDUCTIBLE AT SOURCEON THE ACCRUED INTEREST INCOMEOF GOVERNMENT SECURITIES ID KNOWN AS ‘VOCHER’  THUS SELLER IS TO GET=PRICE+INTEREST-TDS.  BUYER GETS TDS CERTIFICATE. 1/30/2015 64
TREASURY BILLS  TBs ARE ISSUED TO MEET SHORT TERM NEED OF THE GOVT. REVENUE COLLECTIONS ARE BUNCHED BUT EXPENDITURE IS DISPERSED. HENCE THIS NEED.  TBs ARE ISSUED IN THE FORM OF PROMISSORY NOTES OR SCRIP AND CREDITED TO INVESTORS SGL ACCOUNT  TBs ARE ISSUED IN FOUR TYPES 91-DAY,182 DAT, 14/28 DAY AND 364 DAY BILLS.  RBI DO OPEN MARKET OPERATIONS AND THE ECONOMY IS GRAETLY INFLUENCED BYGOVT. SECURITIES.  T-BILL YIELD CALCULATION:  FACE VALUE=100  BID RECEIVED BY RBI=88.24 FOR 364 DAY 1/30/2015 65
 THEN YIELD-k=F-P/P * 365/D.  K=YIELD  F=FACE VALUE  P=PRICE  D=MATURITY PERIOD IN DAYS  K=100-88.24/88.24 * 365/364=13.36% 1/30/2015 66
DISCOUNT AND FINANCE HOUSE OF INDIA(DHFI)  Role and Functions: (Ghore committee recommendations) -It should be the sole depositor of surplus funds of the banking system and Non-banking financial institutions. -It should use the surplus funds to even out the liquidity imabalances in the banking system subject to RBI guidelines. - It should create ready market for commercial bills, treasury bills , government guaranteed securities by being ready to purchase from banks or sell to banks such securities. The committee also recommended that this discount house is to be sponsored by commercial banks,LIC,UTI,GIC with participation by IDBI, ICICI, SFCs. 1/30/2015 67
 Till Vaghul committee reviewed and recommended no action was taken on this.  Eventually in April 1988 Discount and Finance House of India was set up with an authorised capital of Rs.250 crores. In a ratio of %:3:2 RBI, Psbs and Indian Financial Institutions have contributed Rs. 200 crores as paid up capita. In addition refinance facility with RBI and a line of credit of RS.100 crores from 28 PSBs on a consortium basis is the source of funds.  The role of the DHFI is both developmental and stabilizing  By developing active primary and secondary money markets it facilitates smoothening of short term liquidity imbalances.  It discounts and deals in not only commercial bills but a;so in TBs, and money market instruments.  It acts as a specialised money market intermediary  It undertakes short term buy back in Government and approved- dated securities 1/30/2015 68
 Role of DHFI is both developmental and stabilising.  It helps in smoothening of short term liquidity imbalances by devloping primary and secondary money markets.  It acts a s a specialised money market intermediary for stimulating activity in the money market instruments and developing secondary market for those instruments.  It not only deals in commercial bills but also in Treasury billsand other money market instruments.  It undertakes buy-back of governments and approved dated securities.  RBI provides re-finance facility to DHFI 1/30/2015 69
SECURITIES TRADING CORPORATION OF INDIA  STCI wa sset up in 1994 with the objective of providing good secondary market for debt instruments  It function as market maker at the long end of the market which means that it along with otherPDs has to take up part or whole of the auction of government securities.  It primarily concentrate on government securities..  DHFI was set up for Shoer term –TBs – government securities and STCE was set up for long-dated government securities. 1/30/2015 70
CAPITAL MARKET STRUCTURE • Stock market volatility touches every participant directly/indirectly in the capital market. General feeling is that the stock markets worldwide have become very fragile in the recent past on account of various developments such as Asian crisis. Brazil Real fall and Russian debacle. Many far-reaching stock reforms have been introduced in the Indian market for the last few years. These reforms, in turn, changed market structure. Changing market structure influences nature of stock price behavior. 1/30/2015 71
 PRIMARY SECURITIES MARKET  The primary capital market (PCM) plays an important role in the overall functioning of securities market. Despite several measures the primary market remained lackluster till recently and the pick up is gradual. According to the SEBI annual report fewer number of issues accessed the primary market during the year and the significantly lower than that of the Previous financial year. Share of the equity issues, in terms of number and amount Mobilized, however, was higher in this financial year compared to the previous one. More than three- fourths of the total amount was occupied second and no resourced were in the previous years, banks and financial institutions continued for 84.5% of the resourced mobilized compared to 68.1% in 2001-02. All other industries shared the remaining portion. 1/30/2015 72
PRIMARY MARKET ORGANISATION Primary Market ELIGIBILTY NORMS OTCEI Issue BOOK BUILDIN G PRICING OF ISSUE INDIAN DEPOSITORY RECEIPTS E-IPO Preferent ial issue 1/30/2015 73
o Eligibility Norms: o Should offer through offer documents-Prospectus or statement in lieu of prospectus; letter of offer in case of rights issue. o Draft Offer documents are to be filed with SEBI- through a merchant Banker in case of rights issue in exces ofRs.50 lakh o Fast track issues- In case of listed company filing of offer documents in case of public/rights issue provided certain conditions are fulfilled o Separate conditions are to be complied with in case of unlisted companies. 1/30/2015 74
PRIMARY MARKET INTERMEDIARIES BROKERSUNDERWRITERS MERCHANT BANKKERS & LEAD MANGERS DEBENTURE TRUSTEES BANKERS TO ISSUE PORTFOLIO MANAGERS PROHIBITION OF FAUDULENT TRADING REGISTRAR TO AN ISSUE&TRANSFE R AGENT PROHIBITION OF INSIDER TRADING 1/30/2015 75
SECONDARY MARKET ORGANISATION SECOND ARY MARKET STOCK BROKING BROKERS SUB-BROKESR FOREIGN BROKERS TRADING IN DERIVATIVES TRADING/ CLEARIN/SHORT SELLING/LENDING BORROWING CUSTODIAL SERVICES DEPOSITORY SYSTEM NSDL CDSL 1/30/2015 76
 CAPITAL RAISED DURING 2002-03  During the financial year 2002-03, primary market witnessed a decrease of 46.0% in the amount raised and also a decrease of 25.7% in the number of issues launched compared to the same period in 2001-02. A total of 26 issues (14 public issues and 12 rights issues) opened during the financial year 2002-03 raising Rs. 4070.29 crore (Rs. 3638.6 crore through public issues and 431.6 crore through rights issues). In 2001-02 a total of 35 issues opened for raising Rs. 7543.0 crore (20 public issues – Rs. 6501.8 crore and 15 rights issues – Rs. 1041.2). 1/30/2015 77
 INDUSTRY WISE CAPITAL MOBILIZATION  Three industries ciz. Banks / Fls, Engineering and Telecommunications accounted for 93.2 per cent of the resourced mobilized in 2001-02. In the current year, the same three industries accounted for 84.7 per cent of the funds raised. With the banks and Fls, increasing their share from 68.3 per cent to 84.5 per cent and companies in the Telecommunications sector and raising any resourced. In 2002-03 the three industries which accounted for 95.3 per cent of the resources where Banking / Fls, Information Technology, Paper and Pulp. 1/30/2015 78
 SECONDARY MARKET  During 2002-03, performance of Indian Stock market was, by and large, a lackluster one, S&P CNX NIFTY and BSE Sensex both registered  negative returns of 13.4 percent and 12.1 percent respectively over the previous year. Other board indicators also fell down.  Fall in the market in not specific too India alone and it appears a global phenomena. Turnover has been increasing and its reached peak in the month of December 2002. 1/30/2015 79
 DEVELOPMENT IN GOVERNMENT DEBT MARKET  Government securities market during the past financial year witnesses significant upturns in pries until mid-January 2003 when the trend was reversed. The pattern of downturn in yields was halted due to the war tensions and consequent uncertainly leading to a heavy selling pressure. According to the report on Macro Economic and Monetary Developments in 2002-03 published by the RBI Major developments in government securities market in 2002-03 were: 1/30/2015 80
 Introduction of the system of publishing a calendar by RBI that outlines the issue of date government securities every half-year. The calendar for the financial year 2002-03 was issued in March 2003.  Screen based order driven trading in government securities on the stock exchanges introduced on January 16, 2003.  CSGL account holders permitted to enter into repo transactions in government securities effective from March 3, 2003.  Guidelines for uniform accounting for repo/reverse repo transactions were issued by RBI.  Under the securities lending scheme, the clearing corporation of India limited (CCIL) has government securities from select members 1/30/2015 81
 FII INVESTMENT  Foreign institutional Investors (FIIS) were net buyers in equities at Rs. 1 56bn on January 07, 2004. According to data available from the Securities and Exchange Board of India (SEBI) web site, their purchases for the day stood at Rs. 8.0.16bn.  With this, they have poured in Rs. 15.19bn or US$333.7mn in Indian equities so far in January. Their cumulative investment in Indian equities in July stood Rs. 23.46bn or US$501.7mn. They have pumped in a net of Rs. 15.45mn or so far in the 2004. In the entire 2002, FIIs had poured in a net ot Rs36.77bn, or US$763.5mn.  The stock markets continue its upward surge. By the end of the September 2003 the BSE Sensex has added more than 1300 points and climbed up to 4302. In fact the pick up in stock prices in August 2003 has been the highest over the previous four months of the bull run. The trend continues into September except for a minor correction 1/30/2015 82
THE TRADE-OFF BETWEEN RISK AND RETURN  The return earned on investments represents the marginal benefit of investing.  Risk represents the marginal cost of investing.  A trade-off always arises between expected risk and expected return.  Valuing risky assets is a task fundamental to financial management  Three-step procedure for valuing a risky asset. 1. Determine the asset’s expected cash flows 2. Choose discount rate that reflects asset’s risk 3. Calculate present value (PV cash inflows - PV outflows) This three-step procedure is called discounted cash flow (DCF) analysis. 1/30/2015 83
 Effect of taxes on investment  • Do changes in the tax rate have a significant  effect on investment?  􀂾 One study found that after major tax reforms,  investment responded strongly with an elasticity of  investment to changes in the user cost of capita about –0.66. 1/30/2015 84
UNDERSTANDING RETURNS  Total return: the total gain or loss experienced on an investment over a given period of time  Components of the total return  Income stream from the investment  Capital gain or loss due to changes in asset prices  Total return can be expressed either in Rupee terms or in percentage terms.  Return on 30 shares of Rs.10 each =( 30*Rs.2,25) = 67.5=22.5%  Capital Gain( Purchase for RS.12 and current market price is 15 =  Rs.(15-12)*30 =RS.90= 30%  Total Return in Rs= 67.5+90 =157.50  Total Return in Percentage = 22.5+30 =%2.5% 1/30/2015 85
THE RISK DIMENSION Percentage Returns on Bills, Bonds, and Stocks, 1900 – 2006 Nominal% Reaal % Asset Class Average Best yr Worst yr Average Best yr Worst yr Bills 4.0 1.47 0.00 1.1 1.97 -15.1 Bonds 5.2 4.04 -9.2 2.3 35.1 -19.4 Stocks 11.7 5.76 -43.9 8.5 56.5 -38.0 COMPARISON Risk Premium % Stocks-Bills 11.7-4.0 7.7 Stocks-Bonds 11.7-5.2 6.5 Bonds-Stocks 5.2-4.0 1.3 Risk premium: the additional return that an investment must offer, relative to some alternative, because it is more risky than the alternative. 1/30/2015 86
WHY STUDY FINANCIAL MARKETS AND INSTITUTIONS? • They are the cornerstones of the overall financial system in which financial managers operate • Individuals use both for investing • Corporations and governments use both for financing 1/30/2015 87
OVERVIEW OF FINANCIAL MARKETS Primary Markets versus Secondary Markets Money Markets versus Capital Markets Foreign Exchange Markets 1/30/2015 88
MONEY MARKETS VERSUS CAPITAL MARKETS  Money Markets  markets that trade debt securities with maturities of one year or less (e.g. CD’s, Treasury bills)  Capital Markets  markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year 1/30/2015 89
FOREIGN EXCHANGE MARKETS  “FX” markets deal in trading one currency for another (e.g. dollar for yen)  The “spot” FX transaction involves the immediate exchange of currencies at the current exchange rate  The “forward” FX transaction involves the exchange of currencies at a specified date in the future and at a specified exchange rate 1/30/2015 90
OVERVIEW OF FINANCIAL INSTITUTIONS Institutions that perform the essential function of channeling funds from those with surplus funds to those with shortages of funds (e.g. banks, thrifts, insurance companies, securities firms and investment banks, finance companies, mutual funds, pension funds) 1/30/2015 91
TYPES OF FIS  Commercial banks  depository institutions whose major assets are loans and major liabilities are deposits  Thrifts  depository institutions in the form of savings and loans, credit unions  Insurance companies  financial institutions that protect individuals and corporations from adverse events 1/30/2015 92
 Securities firms and investment banks  financial institutions that underwrite securities and engage in securities brokerage and trading  Finance companies  financial institutions that make loans to individuals and businesses  Mutual Funds  financial institutions that pool financial resources and invest in diversified portfolios  Pension Funds  financial institutions that offer savings plans for retirement 1/30/2015 93
SERVICES PERFORMED BY FINANCIAL INTERMEDIARIES  Monitoring Costs  aggregation of funds provides greater incentive to collect a firm’s information and monitor actions  Liquidity and Price Risk  provide financial claims to savers with superior liquidity and lower price risk  Transaction Cost Services  transaction costs are reduced through economies of scale  Maturity Intermediation  greater ability to bear risk of mismatching maturities of assets and liabilities  Denomination Intermediation  allow small investors to overcome constraints imposed to buying assets imposed by large minimum denomination size 1/30/2015 94
SERVICES PROVIDED BY FIS BENEFITING THE OVERALL ECONOMY  Money Supply Transmission  Depository institutions are the conduit through which monetary policy actions impact the economy in general  Credit Allocation  often viewed as the major source of financing for a particular sector of the economy (e.g. farming and real estate) 1/30/2015 95
 Intergenerational Wealth Transfers  life insurance companies and pension funds provide savers with the ability to transfer wealth from one generation to the next  Payment Services  efficiency with which depository institutions provide payment services directly benefits the economy 1/30/2015 96
RISKS FACED BY FINANCIAL INSTITUTIONS Interest Rate Risk Foreign Exchange Risk Market Risk Credit Risk Liquidity Risk Off-Balance-Sheet Risk Technology Risk Operation Risk Country or Sovereign Risk Insolvency Risk 1/30/2015 97
REGULATION OF FINANCIAL INSTITUTIONS FIs provide vital financial services to all sectors of the economy; therefore, their regulation is in the public interest In an attempt to prevent their failure and the failure of financial markets overall 1/30/2015 98
GLOBALIZATION OF FINANCIAL MARKETS AND INSTITUTIONS  Financial Markets became more global as the value of stocks traded in foreign markets soared  Foreign bond markets have served as a major source of international capital  Globalization also evident in the derivative securities market 1/30/2015 99
FACTORS LEADING TO SIGNIFICANT GROWTH IN FOREIGN MARKETS  The pool of savings from foreign investors has increased  International investors have turned to U.S. and other markets to expand their investment opportunities  Information on foreign investments and markets is now more accessible (e.g. internet)  Some mutual funds allow ability to invest in foreign securities with low transaction costs  Deregulation has enhanced globalization of capital flows 1/30/2015 100