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Indian Financial System

1 Thakur College Of Science & Commerce


E XECUTIVE S UMMARY

In 1990s, the balance of payments position facing the country had become
critical and foreign exchange reserves had depleted to dangerously low
levels i.e. $585 million, which was sufficient for financing just one week of
India's exports.

Since the initiation of reforms in the early 1990s, the Indian economy has
achieved high growth in an environment of macroeconomic and financial
stability.

The period has been marked by broad based economic reform that has
touched every segment of the economy. These reforms were designed
essentially to promote greater efficiency in the economy through promotion
of greater competition.

The story of Indian reforms is by now well-documented, nevertheless, what
is less appreciated is that India achieved this acceleration in growth while
maintaining price and financial stability.

As a result of the growing openness, India was not insulated from
exogenous shocks since the second half of the 1990s. These shocks, global
as well as domestic, included a series of financial crises in Asia, Brazil and
Russia, 9/11 terrorist attacks in the US, border tensions, sanctions imposed
in the aftermath of nuclear tests, political uncertainties, changes in the
Government, and the current oil shock. Nonetheless, stability could be
maintained in financial markets.



Indeed, inflation has been contained since the mid-1990s to an average of
around five per cent, distinctly lower than that of around eight per cent per
annum over the previous four decades. Simultaneously, the health of the
financial sector has recorded very significant improvement.

India's path of reforms has been different from most other emerging market
economies: it has been a measured, gradual, cautious, and steady process,
devoid of many flourishes that could be observed in other countries.
Reforms in these sectors have been well-sequenced, taking into account the
state of the markets in the various segments.

The main objective of the financial sector reforms in India initiated in the
early 1990s was to create an efficient, competitive and stable financial sector
that could then contribute in greater measure to stimulate growth.

For efficient price discovery of interest rates and exchange rates in the
overall functioning of financial markets, the corresponding development of
the money market, Government securities market and the foreign exchange
market became necessary. Reforms in the various segments, therefore, had
to be coordinated. In this process, growing integration of the Indian
economy with the rest of the world also had to be recognized and provided
for.

Till the early 1990s the Indian financial system was characterized by
extensive regulations such as administered interest rates, directed credit
programmes, weak banking structure, lack of proper accounting and risk



management systems and lack of transparency in operations of major
financial market participants. Such a system hindered efficient allocation of
resources.

Financial sector reforms initiated in the early 1990s have attempted to
overcome these weaknesses in order to enhance efficiency of resource
allocation in the economy.

Simultaneously, the Reserve Bank took a keen interest in the development
of financial markets, especially the money, government securities and forex
markets in view of their critical role in the transmission mechanism of
monetary policy. As for other central banks, the money market is the focal
point for intervention by the Reserve Bank to equilibrate short-term liquidity
flows on account of its linkages with the foreign exchange market.
Similarly, the Government securities market is important for the entire debt
market as it serves as a benchmark for pricing other debt market
instruments, thereby aiding the monetary transmission process across the
yield curve.

The Reserve Bank had, in fact, been making efforts since 1986 to develop
institutions and infrastructure for these markets to facilitate price discovery.
These efforts by the Reserve Bank to develop efficient, stable and healthy
financial markets accelerated after 1991. There has been close co-ordination
between the Central Government and the Reserve Bank, as also between
different regulators, which helped in orderly and smooth development of the
financial markets in India.



INDIAN FINANCIAL SYSTEM

 Introduction

 Features of Financial System

 Role of Financial System

 Back Drop of Financial System

 Indian Financial System from 1950 – 1980

 Indian Financial System Post 1990’s



INTRODUCTION

The financial system or the financial sector of any country consists of:-
(a) specialized & non specialized financial institution
(b) organized &unorganized financial markets and
(c) Financial instruments & services which facilitate transfer of funds.

Procedure & practices adopted in the markets, and financial inter
relationships are also the parts of the system. These parts are not always
mutually exclusive. For example, the financial institution operate in
financial market and are, therefore a part of such market. The word system
in the term financial system implies a set of complex and closely connected
or inters mixed institution, agents practices, markets, transactions, claims, &
liabilities in the economy. The financial system is concerned about money,
credit, & finance – the terms intimately related yet some what different from
each other. Money refers to the current medium of exchange or means of
payment. Credit or Loan is a sum of money to be returned normally with
Interest it refers to a debt of economic unit. Finance is a monetary resources
comprising debt & ownership fund of the state, company or person.



FEATURES OF FINANCIAL SYSTEM -:

1. It provides an Ideal linkage between depositors savers and
Investors Therefore it encourages savings and investment.
2. Financial system facilitates expansion of financial markets
over a period of time.
3. Financial system should promote deficient allocation of
financial resources of socially desirable and economically
productive purpose.
4. Financial system influence both quality and the pace of
economic development.

ROLE OF FINANCIAL SYSTEM:

The role of the financial system is to promote savings & investments in
the economy. It has a vital role to play in the productive process and in
the mobilization of savings and their distribution among the various
productive activities. Savings are the excess of current expenditure over
income. The domestic savings has been categorized into three sectors,
household, government & private sectors.

The savings from household sector dominates the domestic savings
component. The savings will be in the form of currency, bank deposits,
non bank deposits, life insurance funds, provident funds, pension funds,
shares, debentures, bonds, units & trade debts. All of these currency &
deposits are voluntary transactions & precautionary measures. The



savings in the household sector are mobilized directly in the form of
units, premium, provident fund, and pension fund. These are the
contractual forms of savings. Financial actively deals with the
production, distribution & consumption of goods and services. The
financial system will provide inputs to productive activity. Financial
sector provides inputs in the form of cash credit & assets in financial
for production activities.

The function of a financial system is to establish a bridge between the
savers and investors. It helps in mobilization of savings to materialize
investment ideas into realities. It helps to increase the output towards
the existing production frontier. The growth of the banking habit helps
to activate saving and undertake fresh saving. The financial system
encourages investment activity by reducing the cost of finance risk. It
helps to make investment decisions regarding projects by sponsoring,
encouraging, export project appraisal, feasibility studies, monitoring &
execution of the projects.



An overview of Financial System and Financial Markets in India
MINISTRY OF FINANCE

Financial Institutions RBI SEBI IRDA

Insurance company

Mutual Fund Venture Capital Capital Market
Fund

LIC & GIC &
Other Other
Commercial NBFC Money Market
Banks

Primary Secondary
Market Market

Development Investment Sectoral State Level
Banks Banks Banks Financial
Institution Government
Stock Security
Exchange Market



BACK DROP OF INDIAN FINANCIAL SYSTEM

At the time of independence, India had a reasonably diversified financial
system in terms of intermediaries but a somewhat narrow focus on terms of

Industry’s share in credit doubled,
agriculture, rural areas, SSI, exports still RRBs setup
neglected

1980s 1990s
1947 1970s
1960s

NABARD, EXIM, SIDBI,
Nationalisation of Banks to NHB setup
Credit to Industry / Govt
ensure credit allocation as per doubled
Neglected: long term, agricultural, and rural area credit plan priorities Highly segmented financial
Need for specialized FIs felt.
market, highly restricted
DFIs, SFCs, UTI, Co-op Banks setup.

intermediation, i.e., a lack of a long term capital market and the relative
neglect of agriculture in particular and rural areas in general.

As India embarked on a process of industrialization and growth, RBI set up
Development Financial Institutions (DFI’s) and State Finance Corporations
(SFC’s) as providers of long term capital. Agriculture’s need for credit was
met by cooperative banks. UTI was set up to canalize resources from retail
investors to the capital market.

In essence, the understanding that requirement of financial needs for
accelerated growth and development was best met by specialized financial



intermediaries who performed specialized functions influenced financial
market architecture.

To ensure that these specializations were adhered to, financial intermediaries
developed and promoted by the Reserve Bank of India had significant
restrictions on both the asset and liabilities side of their balance sheets.

In the 1950s and 1960s, despite an expansion of the commercial banking
system in terms of both reach and mobilization of resources, agriculture still
remained under funded and rural areas under banked. Whereas industry’s
share in credit disbursed almost doubled between 1951 and 1968, from 34 to
67.5%, agriculture got barely 2% of available. Credit to exports and small
scale industries were relatively neglected as well.

In view of the above, it was decided to nationalize the banking sector so that
credit allocation could take place in accordance in plan priorities.
Nationalization took place in two phases, with a first round in 1969 followed
by another in 1980.

By the mid-seventies it was felt that commercialized banks did not have
sufficient expertise in rural banking and hence in 1975 Regional Rural
Banks (RRBs) were set up to help bring rural India into the ambit of the
financial network. This effort was capped in 1980 with the formation of
National Bank for Agriculture and Rural Development (NABARD), which
was to function as an apex bank for all cooperative banks in the country,
helping control and guide their activities. NABARD was also given the
remit of regulating rural credit cooperatives.



Following with the logic of specialization, the 1980s saw other DFIs with
specific remits being set up – e.g. The EXIM Bank for export financing, the
Small Industries Development Bank of India (SIDBI) for small scale
industries and the National Housing Bank (NHB) for housing finance.

Long term finance for the private sector came from DFIs and institutional
investors or through the capital market. However both price and quantity of
capital issues was regulated by the Controller of Capital Issues.

At least one indicator of the fact that the strategy paid off in deepening
financial intermediation is the near doubling of the M3/GDP (see For more
details on various types of money supplies) ratio from 24.1% in 1970/71 to
48.5 in 1990/91. Over the same period, bank credit to the commercial sector
as a proportion of GDP more than doubled from 14.3 to 30.2%. However
net bank credit to government (including lending by the Reserve Bank)
doubled as well, from 12 to 24.6%.

Therefore the deepening of financial intermediation had occurred with an
increase in the draft by both the commercial sector and the government on
financial resources mobilized.
At the end of the 1980s then the Indian financial system was characterized
by segmented financial markets with significant restrictions on both the
asset and liability side of the balance sheet of financial intermediaries as
well as the price at which financial products could be offered.



In the Indian context segmentation meant that competition was muted. In a
scenario where price was determined from outside the system and targets
were set in terms of quantities, there was no pressure for non-price
competition as well. As a result the financial system had relatively high
transaction costs and political economy factors meant that asset quality was
not a prime concern. Therefore even though the Indian financial system at
the end of 1980s had achieved substantial expansion in terms of access, this
had come at the cost of asset quality. In addition, was the fact that the draft
of the government on resources of the financial system had increased
significantly. This in itself need necessarily was not a problem but over this
period, i.e., the 1980s, the composition of government expenditure was
changing as well, with shift towards current rather than capital expenditure.
In addition, in the absence of a reasonably liquid market for government
securities, an increase in net bank lending to the government meant that the
asset side of banks’ balance sheets tended to become increasingly illiquid.

The impetus for change came from one expected and one unexpected
quarter - first, the importance of prudential capital adequacy ratios was
underlined by the announcement of BaselI norms (see ) That banks were
expected to adhere to; second the macroeconomic crisis of 1990-91.

The reform process that followed accelerated the process of liberalization
already begun in the 1980s and began a series of measured and deliberate
steps to integrate India into the global economy, including the global
financial network.



Briefly however, given the problems facing the financial system and
keeping in mind the institutional changes necessary to help India financially
integrate into the global economy, financial reform focused on the
following: improving the asset quality on bank balance sheets in particular
and operational efficiency in general; increasing competition by removing
regulatory barriers to entry; increasing product competition by removing
restrictions on asset and liability sides of financial intermediaries; allowing
financial intermediaries freedom to set their prices; putting in place a market
for government securities; and improving the functioning of the call money
market.

The government security market was particularly important not only
because it was decided the RBI would no longer monetize the fiscal deficit,
which would now be financed by directly borrowing from the market, but
also monetary policy would be conducted through open market operations
and a large liquid bond market would help the RBI sterilise, if necessary,
foreign exchange movements.



INDIAN FINANCIAL SYSTEM FROM 1950 TO
1980 –

Indian Financial System During this period evolved in response to the
objective of planned economic development. With the adoption of mixed
economy as a pattern of industrial development, a complimentary role was
conceived for public and private sector. There was a need to align financial
system with government economic policies. At that time there was
government control over distribution of credit and finance. The main
elements of financial organization in planned economic development are as
follows:-

1. Public ownership of financial institutions –
The nationalization of RBI was in 1948, SBI was set up in 1956, LIC came
in to existence in 1956 by merging 245 life insurance companies in 1969, 14
major private banks were brought under the direct control of Government of
India. In 1972, GIC was set up and in 1980; six more commercial banks
were brought under public ownership. Some institutions were also set up
during this period like development banks, term lending institutions, UTI
was set up in public sector in 1964, provident fund, pension fund was set up.
In this way public sector occupied commanding position in Indian Financial
System.

2. Fortification Of Institutional structure –
Financial institutions should stimulate / encourage capital formation in the
economy. The important feature of well developed financial system is



strengthening of institutional structures. Development banks was set up with
this objective like industrial finance corporation of India (IFCI) was set up
in 1948, state financial corporation (SFCs) were set up in 1951, Industrial
credit and Investment corporation of India Ltd (ICICI)was set up in 1955. It
was pioneer in many respects like underwriting of issue of capital,
channelisation of foreign currency loans from World Bank to private
industry. In 1964, Industrial Development of India (IDBI).

3. Protection of Investors –
Lot many acts were passed during this period for protection of investors in
financial markets. The various acts Companies Act, 1956 ; Capital Issues
Control Act, 1947 ; Securities Contract Regulation Act, 1956 ; Monopolies
and Restrictive Trade Practices Act, 1970 ; Foreign Exchange Regulation
Act, 1973 ; Securities & Exchange Board of India, 1988.

4. Participation in Corporate Management –
As participation were made by large companies and financial instruments it
leads to accumulation of voting power in hands of institutional investors in
several big companies financial instruments particularly LIC and UTI were
able to put considerable pressure on management by virtual of their voting
power. The Indian Financial System between 1951 and mid80’s was broad
based number of institutions came up. The system was characterized by
diversifying organizations which used to perform number of functions. The
Financial structure with considerable strength and capability of supplying
industrial capital to various enterprises was gradually built up the whole
financial system came under the ownership and control of public authorities
in this manner public sector occupy a commanding position in the industrial



enterprises. Such control was viewed as integral part of the strategy of
planned economy development.

INDIAN FINANCIAL SYSTEM POST 1990’S

The organizations of Indian Financial system witnessed transformation after
launching of new economic policy 1991. The development process shifted
from controlled economy to free market for these changes were made in the
economic policy. The role of government in business was reduced the
measure trust of the government should be on development of infrastructure,
public welfare and equity. The capital market an important role in allocation
of resources. The major development during this phase are:-

1. Privatisation of Financial Institutions –
At this time many institutions were converted in to public company and
number of private players were allowed to enter in to various sectors:

a) Industrial Finance Corporation on India (IFCI): The pioneer
development finance institution was converted in to a public
company.
b) Industrial Development Bank of India & Industrial Finance
Corporation of India (IDBI & IFCI): IDBI & IFCI ltd offers their
equity capital to private investors.
c) Private Mutual Funds have been set up under the guidelines
prescribed by SEBI.



d) Number of private banks and foreign banks came up under the RBI
guidelines. Private institution companies emerged and work under the
guidelines of IRDA, 1999.
e) In this manner government monopoly over financial institutions has
been dismantled in phased manner. IT was done by converting public
financial institutions in joint stock companies and permitting to sell
equity capital to the government.

2. Reorganization of Institutional Structure –
The importance of development financial institutions decline with shift to
capital market for raising finance commercial banks were give more funds
to investment in capital market for this. SLR and CRR were produced; SLR
earlier @ 38.5% was reduced to 25% and CRR which used to be 25% is at
present 5%. Permission was also given to banks to directly undertake
leasing, hire-purchase and factoring business. There was trust on
development of primary market, secondary market and money market.

3. Investors Protection –
SEBI is given power to regulate financial markets and the various
intermediaries in the financial markets.



FINANCIAL MARKET

 Money Market

 Call Money Market

 Commercial Paper

 Certificate of Deposit

 Treasury Bill Market

 Money Market Mutual Fund

 Capital Market

 International Capital Market



MONEY MARKET AND GOVT. SECURITIES MARKET

Money market deal with short term monetary assets and claims, which are
generally from one day to one year duration.

Govt. securities on the other hand are also called dated securities to denote
that they are generally long term in nature and are issued by state and central
govt. under their borrowing programmes and duration of more than one
year, generally of 5 years and above.

These securities being long term in nature are also traded in govt. securities
market between institution and banks also on the stock exchanges- debt
segments.

MONEY MARKET
One of the important function of a well developed money market is to
channelize saving into short term productive investments like working
capital. Call money market, treasury bills market and markets for
commercial paper and certificate of deposit are some of the example of
money market.

CALL MONEY MARKET
The call money markets form a part of the national money market, where
day –today surplus funds, mostly of banks are traded . The call money
loans are very short term in nature and the maturity period of this vary from
1 to 15 days. The money which is lent for one day in this market is known as



“call money”, and if it exceeds one day (but less than 15 days), is referred as
“notice money” in this market any amount could be lent or borrowed at a
convenient interest rate . Which is acceptable to both borrower and lender
.these loans are consider as highly liquid as they are repayable on demand
at the option of ether the lender or borrower.

PURPOSE

Call money is borrowed from the market to meet various requirements of
commercial bill market and commercial banks. Commercial bill market
borrower call money for short period to discount commercial bills.
Banks borrower in call market to:
1:- Fill the temporary gaps, or mismatches that banks normally face.
2:- Meet the cash Reserve Ratio requirement.
3: - Meet sudden demand for fund, which may arise due to large payment
and remittance.

Banks usually borrow form the market to avoid the penal interest rate for not
meeting CRR requirement and high cost of refinance from RBI. Call money
helps the banks to maintain short term liquidity position at comfortable
level.

LOCATION
In India call money markets are mainly located in commercial centers and
big industrial centers and industrial center such as Mumbai, Calcutta,
Chennai, Delhi and Ahmedabad. As BSE and NSE and head office of RBI



and many other banks are situated in Mumbai; the volume of funds involved
in call money market in Mumbai is far bigger than other cities.

PARTICIPANTS
Initially, only few large banks were operating in the bank market. however
the market had expanded and now scheduled , non scheduled commercial
banks foreign banks ,state , district, and urban cooperative banks , financial
institution such as LIC,UTI,GIC, and its subsidiaries , IDBI, NABARD,
IRBI, ECGC, EXIM Bank, IFCI, NHB , TFCI, and SIDBI, Mutual fund
such as SBI Mutual fund . LIC Mutual funds. And RBI Intermediaries like
DFHI and STCI are participants in local call money markets. However RBI
has recently introduced restriction on some of the participants to phase them
out of call money market in a time bound manner.

Participant in call money market are split into two categories

1:- BORROWER AND LENDER:-
This comprises entities those who can both borrower and lend in this
market, such as RBI, intermediaries like DFHI, and STCI and commercial
banks.

2:- ONLY LENDER: -
This category comprises of entities those who can act only as lender, like
financial institution and mutual funds.



CALL RATES

The interest paid on call loan is known as the call rates. Unlike in the case of
other short and long rates. The call rate is expected to freely reflect the day
to day availability and long rates. These rates vary highly from day to day.
Often from hour to hour. While high rates indicate a tightness of liquidity
position in market. The rate is largely subject to be influenced by sources of
supply and demand for funds.
The call money rate had fluctuated from time to time reflecting the seasonal
variation in fund requirements. Call rates climbs high during busy seasons in
relation to those in slack season. These seasonal variations were high due to
a limited number of lender and many borrowers. The entry of financial
institution and money market mutual funds into the call market has reduced
the demand supply gap and these fluctuations gradually came down in
recent years.

Though the seasonal fluctuations were reduced to considerable extent, there
are still variations in the call rates due to the following reason:

1:- large borrower by banks to meet the CRR requirements on certain dates
cause a gate demand for call money. These rates usually go up during the
first week to meet CRR requirements and decline afterwards.
2:- the sanction of loans by banks, in excess of their own resources compel
the bank to rely on the call market. Banks use the call market as a source of
funds for meeting dis-equilibrium of inflow and out flow of fund s.



3:- the withdrawal of funds to pay advance tax by the corporate sector leads
to steep increase in call money rates in the market.
COMMERCIAL PAPER

Commercial paper are short term, unsecured promissory notes issued at a
discount to face value by well- known companies that are financial strong
and carry a high credit rating . They are sold directly by the issuers to
investor, or else placed by borrowers through agents like merchant banks
and security houses the flexible maturity at which they can be issued are one
of the main attraction for borrower and investor since issues can be adapted
to the needs of both. The CP market has the advantage of giving highly rated
corporate borrowers cheaper fund than they could obtain from the banks
while still providing institutional investors with higher interest earning than
they could obtain form the banking system the issue of CP imparts a degree
of financial stability to the systems as the issuing company has an incentive
to remain financially strong.

THE FEATURES OF CP
1. They are negotiable by endorsement and delivery.

2. They are issued in multiple of Rs 5 lakhs.
3. The maturity varies between 15 days to a year.

4. No prior approval of RBI is needed for CP issued.

5. The tangible net worth issuing company should not be less than 4
lakhs
6. The company fund based working capital limit should not less than Rs
10 crore.



7. The issuing company shall have P2 and A2 rating from CRISIL and
ICRA.
CERTIFICATE OF DEPOSIT

Certificate of Deposits,. Instruments such as the Certificates of Deposit
(CDs introduced in 1989), Commercial Paper (CP introduced in 1989),
inter-bank participation certificates (with and without risk) were
introduced to increase the range of instruments. Certificates of Deposit
are basically negotiable money market instruments issued by banks and
financial institutions during tight liquidity conditions. Smaller banks
with relatively smaller branch networks generally mobilise CDs. As CDs
are large size deposits, transaction costs on CDs are lower than retail
deposits

FEATURES OF CD
1. All scheduled bank other than RRB and scheduled cooperative
bank are eligible to issue CDs.
2. CDs can be issued to individuals, corporation, companies, trust,
funds and associations. NRI can subscribe to CDs but only on a
non- repatriation basis.
3. They are issued at a discount rate freely determined by the
issuing bank and market.
4. They issued in the multiple of Rs 5 lakh subject to minimum
size of each issue of Rs is 10 lakh.



5. The bank can issue CDs ranging from 3 month t 1 year ,
whereas financial institution can issue CDs ranging from 1 year
to 3 years.

TREASURY BILLS MARKET:-

Treasury bills are the main financial instruments of money market. These
bills are issued by the government. The borrowings of the government are
monitored & controlled by the central bank. The bills are issued by the RBI
on behalf of the central government. The RBI is the agent of Union
Government. They are issued by tender or tap. The bills were sold to the
public by tender method up to 1965. These bills were put at weekly
auctions. A treasury bill is a particular kind of finance bill. It is a promissory
note issued by the government. Until 1950 these bills were also issued by
the state government. After 1950 onwards the central government has the
authority to issue such bills. These bills are greater liquidity than any other
kind of bills. They are of two kinds: a) ad hoc, b) regular.

Ad hoc treasury bills are issued to the state governments, semi government
departments & foreign ventral banks. They are not marketable. The ad hoc
bills are not sold to the banks & public. The regular treasury bills are sold to
the general public & banks. They are freely marketable. These bills are sold
by the RBI on behalf of the central government.
The treasury bills can be categorized as follows:-



1) 14 days treasury bills:-
The 14 day treasury bills has been introduced from 1996-97. These
bills are non-transferable. They are issued only in book entry system
they would be redeemed at par. Generally the participants in this
market are state government, specific bodies & foreign central banks.
The discount rate on this bill will be decided at the beginning of the
year quarter.


These bills were introduced in 1998. The treasury bills in India issued
on auction basis. The date of issue of these bills will be announced in
advance to the market. The information regarding the notified amount
is announced before each auction. The notified amount in respect of
treasury bills auction is announced in advance for the whole year
separately. A uniform calendar of treasury bills issuance is also
announced.


The 91 days treasury bills were issued from July 1965. These were
issued tap basis at a discount rate. The discount rates vary between
2.5 to 4.6% P.a. from July 1974 the discount rate of 4.6% remained
uncharged the return on these bills were very low. However the RBI
provides rediscounting facility freely for this bill.


The 182 days treasury bills was introduced in November 1986. The
chakravarthy committee made recommendations regarding 182 day



treasury bills instruments. There was a significant development in this
market. These bills were sold through monthly auctions. These bills
were issued without any specified amount. These bills are tailored to
meet the requirements of the holders of short term liquid funds. These
bills were issued at a discount. These instruments were eligible as
securities for SLR purposes. These bills have rediscounting facilities.


The 364 treasury bills were introduced by the government in April
1992. These instruments are issued to stabilise the money market.
These bills were sold on the basis of auction. The auctions for these
instruments will be conducted for every fortnight. There will be no
indication when they are putting auction. Therefore the RBI does not
provide rediscounting facility to these bills. These instruments have
been instrumental in reducing, the net RBI credit to the government.
These bills have become very popular in India.

Money Market Mutual Funds (MMMFs)
The benefits of developments in the various in the money market like
cell money loans. Treasury bills, commercial papers and certificate of
deposits were available only to the few institutional participants in the
market. The main reason for this was that huge amounts were
required to be invested in these instruments, the minimum being Rs.
10 lack, which was beyond the means of individual money markets to
small investors.



MMMFs are mutual funds that invest primarily in money market
instruments of very high quality and of very short maturities.
MMMFs can be set up by very high quality and of very short
maturities. MMMFs can be set up by commercial bank, RBI and
public financial institution either directly or through their existing
mutual fund subsidiaries. The guidelines with respect to mobilization
of funds by MMMFs provide that only individuals are allowed to
invest in such funds.

Earlier these funds were regulated by the RBI. But RBI withdrew its
guidelines, with effect form March 7, 2001 and now they are
governed by SEBI.

The schemes offered by MMMfs can either by open – ended or close-
ended. In case of open- ended schemer, the units are available for
purchase on a continuous basis and the MMMFs would be willing to
repurchase the units. A close –ended scheme is available for
subscription for a limited period and is redeemed at maturity.

The guidelines on the on MMMfs specify a minimum lock – in period
of 15 days during which the investor cannot redeem his investment.
The guidelines also stipulate the minimum size of the MMMF to be
Rs. 50 crore and this should not exceed 2% of the aggregate deposits
of the latest accounting year in the case of banks and 2% of the long-
term domestic borrowings in the case of public financial institutions.



Structure of capital market
CAPITAL MARKET

Secondary Market
Primary Market

Listing Trading Practices of Settlements
& Clearing

Method of Quantum Costs of
Issue of Issue Issue

Public Right Issue Bonus Private
Issue Issue Placement

Players Operation



Companies (Issuer) Instruments

Interest Rates
Intermediaries (Merchant
Banks FIIs & Broker)
Procedures
Investor (Public)

CAPITAL MARKET

Capital market is market for long term securities. It contains financial
instruments of maturity period exceeding one year. It involves in long
term nature of transactions. It is a growing element of the financial
system in the India economy. It differs from the money market in terms
of maturity period & liquidity. It is the financial pillar of industrialized
economy. The development of a nation depends upon the functions &
capabilities of the capital market.
Capital market is the market for long term sources of finance. It refers to
meet the long term requirements of the industry. Generally the business
concerns need two kinds of finance:-
1. Short term funds for working capital requirements.
2. Long term funds for purchasing fixed assets.
Therefore the requirements of working capital of the industry are met by the
money market. The long term requirements of the funds to the corporate
sector are supplied by the capital market. It refers to the institutional
arrangements which facilitate the lending & borrowing of long term funds.

IMPORTANCE OF CAPITAL MARKET



Capital market deals with long term funds. These funds are subject to
uncertainty & risk. Its supplies long term funds & medium term funds to the
corporate sector. It provides the mechanism for facilitating capital fund
transactions. It deals I ordinary shares, bond debentures & stocks &
securities of the governments. In this market the funds flow will come from
savers. It converts financial assets in to productive physical assets. It
provides incentives to savers in the form of interest or dividend to the
investors. It leads to the capital formation. The following factors play an
important role in the growth of the capital market:-
• A strong & powerful central government.
• Financial dynamics
• Speedy industrialization
• Attracting foreign investment
• Investments from NRI’s
• Speedy implementation of policies
• Regulatory changes
• Globalization
• The level of savings & investments pattern of the household sectors
• Development of financial theories
• Sophisticated technological advances.

PLAYERS IN THE CAPITAL MARKET
Capital market is a market for long term funds. It requires a well structured
market to enhance the financial capability of the country. The market consist
a number of players. They are categorized as:-
1. Companies



2. Financial intermediaries
3. Investors.

I. COMPANIES:
Generally every company which is a public limited company can access
the capital market. The companies which are in need of finance for
their project can approach the market. The capital market provides
funds from the savers of the community. The companies can mobilize
the resources for their long term needs such as project cost, expansion
& diversification of projects & other expenditure of India to raise the
capital from the market. The SEBI is the most powerful organization to
monitor, control & guidance the capital market. It classifies the
companies for the issue of share capital as new companies, existing
unlisted companies& existing listed companies. According to its
guidelines a company is a new company if it satisfies all the following:-
a) The company shall not complete 12 months of commercial operations.
b) Its audited operative results are not available.
c) The company may set up by entrepreneurs with or without track record.
A company which can be treated as existing listed company, if its
shares are listed in any recognized stock exchange in India. A company
is said to be an existing unlisted company if it is a closely held or
private company.

II. FINANCIAL INTERMEDIARIES:
Financial intermediaries are those who assist in the process of
converting savings into capital formation in the country. A strong



capital formation process is the oxygen to the corporate sector.
Therefore the intermediaries occupy a dominant role in the capital
formation which ultimately leads to the growth of prosperous to the
community. Their role in this situation cannot be. The government
should encourage these intermediaries to build a strong financial
empire for the country. They are also being called as financial
architectures of the India digital economy. Their financial capability
cannot be measured. They take active role in the capital market. The
major intermediaries in the capital market are:-
a) Brokers.
b) Stock brokers & sub brokers
c) Merchant bankers
d) Underwriters
e) Registrars
f) Mutual funds
g) Collecting agents
h) Depositories
i) Agents
j) Advertising agencies

III. INVESTORS:
The capital market consists many numbers of investors. All types
of investor’s basic objective is to get good returns on their
investment. Investment means, just parking one’s idle fund in a
right parking place for a stipulated period of time. Every parked
vehicle shall be taken away by its owners from parking place after



a specific period. The same process may be applicable to the
investment. Every fund owner may desire to take away the fund
after a specific period. Therefore safety is the most important
factor while considering the investment proposal. The investors
comprise the financial investment companies & the general public
companies. Usually the individual savers are also treated as
investors. Return is the reward to the investors. Risk is the
punishment to the investors for being wrong selection of their
investment decision. Return is always chased by the risk. An
intelligent investor must always try to escape the risk & attract the
return. All rational investors prefer return, but most investors are
risk average. They attempt to get maximum capital gain. The
return can be available to the investors in two types they are in the
form of revenue or capital appreciation. Some investors will prefer
for revenue receipt & others prefer capital appreciation. It depends
upon their economic status & the effect of tax implications.

STRUCTURE OF THE CAPITAL MARKET IN INDIA
The structure of the capital market has undergone vast changes in recent
years. The Indian capital market has transformed into a new appearance over
the last four & a half decades. Now it comprises an impressive network of
financial institutions & financial instruments. The market for already issued
securities has become more sophisticated in response to the different needs
of the investors. The specialized financial institutions were involved in
providing long term credit to the corporate sector. Therefore the premier
financial institutions such as ICICI, IDBI, UTI, and LIC & GIC constitute



the largest segment. A number of new financial instruments & financial
intermediaries have emerged in the capital market. Usually the capital
markets are classified in two ways:-
A. On the basis of issuer
B. On the basis of instruments

On the basis of issuer the capital market can be classified again two types:-
a) Corporate securities market
b) Governments securities market
On the basis of financial instruments the capital markets are classifieds into
two kinds:-
a) Equity market
b) Debt market
Recently there has been a substantial development of the India capital
market. It comprises various submarkets.
Equity market is more popular in India. It refers to the market for equity
shares of existing & new companies. Every company shall approach the
market for raising of funds. The equity market can be divided into two
categories (a) primary market (b) secondary market. Debt market represents
the market for long term financial instruments such as debentures, bonds,
etc.

PRIMARY MARKET
To meet the financial requirement of their project company raise their
capital through issue of securities in the company market.



Capital issue of the companies were controlled by the capital issue control
act 1947. Pricing of issue was determined by the controller of capital issue
the main purpose of control on capital issue was to prevent the diversion of
investible resources to non- essential projects. Through the necessity of
retaining some sort of control on issue of capital to meet the above purpose
still exist . The CCI was abolished in 1992 as the practice of government
control over the capital issue as well as the overlapping of issuing has lost
its relevance in the changed circumstances.

SECURITIES & EXCHANGE BOARD OF INDIA

INTRODUCTION:
It was set up in 1988 through administrative order it became statutory body
in 1992. SEBI is under the control of Ministry of Finance. Head office is at
Mumbai and regional offices are at Delhi, Calcutta and Chennai. The
creation of SEBI is with the objective to replace multiple regulatory
structures. It is governed by six member board of governors appointed by
government of India and RBI.

OBJECTIVES OF SEBI:
1. To protect the interest of investors in securities.
2. To regulate securities market and the various intermediaries in the
market.
3. To develop securities market over a period of time.

POWERS AND FUNCTIONS OF SEBI:



(1)ISSUE GUIDELINES TO COMPANIES:-
SEBI issues guidelines to the companies for disclosing information
and to protect the interest of investor. The guidelines relates to issue
of new shares, issue of convertible debentures, issue by new
companies, etc. After abolition of capital issues control act, SEBI was
given powers to control and regulate new issue market as well as
stock exchanges.

(2)REGULATION OF PORTFOLIO MANAGEMENT
SERVICES:-
Portfolio Management services were brought under SEBI regulations
in January 1993. SEBI framed regulations for portfolio management
keeping securities scams in mind. SEBI has been entrusted with a job
to regulate the working of portfolio managers in order to give
protections to investors.

(3)REGULATION OF MUTUAL FUNDS:-
The mutual funds were placed under the control of SEBI on January
1993. Mutual funds have been restricted from short selling or carrying
forward transactions in securities. Permission has been granted to
invest only in transferable securities in money market and capital
market.

(4)CONTROL ON MERCHANT BANKING:-
Merchant bankers are to be authorized by SEBI, they have to follow
code of conduct which makes them responsible towards the investors



in respect of pricing, disclosure of/ in the prospectus and issue of
securities, merchant bankers have high degree of accountability in
relation to offer documents and issue of shares.

(5)ACTION FOR DELAY IN TRANSFER AND REFUNDS:-
SEBI has prosecuted many companies for delay in transfer of shares
and refund of money to the applicants to whom the shares are not
allotted. These also gives protection to investors and ensures timely
payment in case of refunds.

(6)ISSUE GUIDELINES TO INTERMEDIARIES:-
SEBI controls unfair practices of intermediaries operating in capital
market, such control helps in winning investors confidence and also
gives protection to investors.

(7)GUIDELINES FOR TAKEOVERS AND MERGERS:-
SEBI makes guidelines for takeover and merger to ensure
transparency in acquisitions of shares, fair disclosure through public
announcement and also to avoid unfair practices in takeover and
mergers.

(8)REGULATION OF STOCK EXCHANGES
FUNCTIONING:-
SEBI is working for expanding the membership of stock exchanges to
improve transparency, to shorten settlement period and to promote



professionalism among brokers. All these steps are for the healthy
growth of stock exchanges and to improve their functioning.

(9) REGULATION OF FOREIGN INSTITUTIONAL
INVESTMENT (FIIS):-
SEBI has started registration of foreign institutional investment. It is
for effective control on such investors who invest on a large scale in
securities.

TYPES OF ISSUE
A company can raise its capital through issue of share and debenture by
means of :-
PUBLIC ISSUE :-
Public issue is the most popular method of raising capital and involves
raising capital and involve raising of fund direct from the public .

RIGHT ISSUE :-
Right issue is the method of raising additional finance from existing
members by offering securities to them on pro rata basis.

A company proposing to issue securities on right basis should send a
letter of offer to the shareholders giving adequate discloser as to how
the additional amount received by the issue is used by the company.

BONUS ISSUE:-



Some companies distribute profits to existing shareholders by way of
fully paid up bonus share in lieu of dividend. Bonus share are issued in
the ratio of existing share held. The shareholder do not have to nay
additional payment for these share .

PRIVATE PLACEMENT :-
private placement market financing is the direct sale by a public limited
company or private limited company of private as well as public sector
of its securities to a limited number of sophisticated investors like UTI ,
LIC , GIC state finance corporation and pension and insurance funds the
intermediaries are credit rating agencies and trustees and financial
advisors such as merchant bankers. And the maximum time – frame
required for private placement market is only 2 to 3 months. Private
placement can be made out of promoter quota but it cannot be made
with unrelated investors.

SECONDRY MARKET
The secondary market is that segment of the capital market where the
outstanding securities are traded from the investors point of view the
secondary market imparts liquidity to the long – term securities held by
them by providing an auction market for these securities.

The secondary market operates through the medium of stock exchange
which regulates the trading activity in this market and ensures a measure
of safety and fair dealing to the investors.



India has a long tradition of trading in securities going back to nearly
200 years. The first India stock exchange established at Mumbai in
1875 is the oldest exchange in Asia. The main objective was to protect
the character status and interest of the native share and stock broker.

BOMBAY STOCK EXCHANGE
Bombay Stock Exchange is the oldest stock exchange in Asia with a rich
heritage, now spanning three centuries in its 133 years of existence. What is
now popularly known as BSE was established as "The Native Share & Stock
Brokers' Association" in 1875.

BSE is the first stock exchange in the country which obtained permanent
recognition (in 1956) from the Government of India under the Securities
Contracts (Regulation) Act 1956. BSE's pivotal and pre-eminent role in the
development of the Indian capital market is widely recognized. It migrated
from the open outcry system to an online screen-based order driven trading
system in 1995. Earlier an Association of Persons (AOP), BSE is now a
corporatised and demutualised entity incorporated under the provisions of
the Companies Act, 1956, pursuant to the BSE (Corporatisation and
Demutualisation) Scheme, 2005 notified by the Securities and Exchange
Board of India (SEBI). With demutualisation, BSE has two of world's best
exchanges, Deutsche Börse and Singapore Exchange, as its strategic
partners.

Over the past 133 years, BSE has facilitated the growth of the Indian
corporate sector by providing it with an efficient access to resources. There



is perhaps no major corporate in India which has not sourced BSE's services
in raising resources from the capital market.

Today, BSE is the world's number 1 exchange in terms of the number of
listed companies and the world's 5th in transaction numbers. The market
capitalization as on December 31, 2007 stood at USD 1.79 trillion . An
investor can choose from more than 4,700 listed companies, which for easy
reference, are classified into A, B, S, T and Z groups.

The BSE Index, SENSEX, is India's first stock market index that enjoys an
iconic stature , and is tracked worldwide. It is an index of 30 stocks
representing 12 major sectors. The SENSEX is constructed on a 'free-float'
methodology, and is sensitive to market sentiments and market realities.
Apart from the SENSEX, BSE offers 21 indices, including 12 sectoral
indices. BSE has entered into an index cooperation agreement with
Deutsche Börse. This agreement has made SENSEX and other BSE indices
available to investors in Europe and America. Moreover, Barclays Global
Investors (BGI), the global leader in ETFs through its iShares® brand, has
created the 'iShares® BSE SENSEX India Tracker' which tracks the
SENSEX. The ETF enables investors in Hong Kong to take an exposure to
the Indian equity market.

BSE has tied up with U.S. Futures Exchange (USFE) for U.S. dollar-
denominated futures trading of SENSEX in the U.S. The tie-up enables
eligible U.S. investors to directly participate in India's equity markets for the



first time, without requiring American Depository Receipt (ADR)
authorization. The first Exchange Traded Fund (ETF) on SENSEX, called
"SPIcE" is listed on BSE. It brings to the investors a trading tool that can be
easily used for the purposes of investment, trading, hedging and arbitrage.
SPIcE allows small investors to take a long-term view of the market.

BSE provides an efficient and transparent market for trading in equity, debt
instruments and derivatives. It has a nation-wide reach with a presence in
more than 450 cities and towns of India. BSE has always been at par with
the international standards. The systems and processes are designed to
safeguard market integrity and enhance transparency in operations. BSE is
the first exchange in India and the second in the world to obtain an ISO
9001:2000 certification. It is also the first exchange in the country and
second in the world to receive Information Security Management System
Standard BS 7799-2-2002 certification for its BSE On-line Trading System
(BOLT).

BSE continues to innovate. In recent times, it has become the first national
level stock exchange to launch its website in Gujarati and Hindi to reach out
to a larger number of investors. It has successfully launched a reporting
platform for corporate bonds in India christened the ICDM or Indian
Corporate Debt Market and a unique ticker-cum-screen aptly named 'BSE
Broadcast' which enables information dissemination to the common man on
the street.



In 2006, BSE launched the Directors Database and ICERS (Indian
Corporate Electronic Reporting System) to facilitate information flow and
increase transparency in the Indian capital market. While the Directors
Database provides a single-point access to information on the boards of
directors of listed companies, the ICERS facilitates the corporates in sharing
with BSE their corporate announcements.

BSE also has a wide range of services to empower investors and facilitate
smooth transactions:

Investor Services: The Department of Investor Services redresses grievances
of investors. BSE was the first exchange in the country to provide an amount
of Rs.1 million towards the investor protection fund; it is an amount higher
than that of any exchange in the country. BSE launched a nationwide
investor awareness programme- 'Safe Investing in the Stock Market' under
which 264 programmes were held in more than 200 cities.

The BSE On-line Trading (BOLT): BSE On-line Trading (BOLT) facilitates
on-line screen based trading in securities. BOLT is currently operating in
25,000 Trader Workstations located across over 450 cities in India.

BSEWEBX.com: In February 2001, BSE introduced the world's first
centralized exchange-based Internet trading system, BSEWEBX.com. This



initiative enables investors anywhere in the world to trade on the BSE
platform.

Surveillance: BSE's On-Line Surveillance System (BOSS) monitors on a
real-time basis the price movements, volume positions and members'
positions and real-time measurement of default risk, market reconstruction
and generation of cross market alerts.

BSE Training Institute: BTI imparts capital market training and certification,
in collaboration with reputed management institutes and universities. It
offers over 40 courses on various aspects of the capital market and financial
sector. More than 20,000 people have attended the BTI programmes

Awards

• The World Council of Corporate Governance has awarded the Golden
Peacock Global CSR Award for BSE's initiatives in Corporate Social
Responsibility (CSR).
• The Annual Reports and Accounts of BSE for the year ended March
31, 2006 and March 31 2007 have been awarded the ICAI awards for
excellence in financial reporting.
• The Human Resource Management at BSE has won the Asia - Pacific
HRM awards for its efforts in employer branding through talent
management at work, health management at work and excellence in
HR through technology

Drawing from its rich past and its equally robust performance in the recent
times, BSE will continue to remain an icon in the Indian capital market.



NATIONAL STOCK EXCHANGE

The National Stock Exchange of India Limited has genesis in the report of
the High Powered Study Group on Establishment of New Stock Exchanges,
which recommended promotion of a National Stock Exchange by financial
institutions (FIs) to provide access to investors from all across the country
on an equal footing. Based on the recommendations, NSE was promoted by
leading Financial Institutions at the behest of the Government of India and
was incorporated in November 1992 as a tax-paying company unlike other
stock exchanges in the country.

On its recognition as a stock exchange under the Securities Contracts
(Regulation) Act, 1956 in April 1993, NSE commenced operations in the
Wholesale Debt Market (WDM) segment in June 1994. The Capital Market
(Equities) segment commenced operations in November 1994 and
operations in Derivatives segment commenced in June 2000.

NSE's mission is setting the agenda for change in the securities markets in
India. The NSE was set-up with the main objectives of:

• establishing a nation-wide trading facility for equities, debt
instruments and hybrids,



• ensuring equal access to investors all over the country through an
appropriate communication network,
• providing a fair, efficient and transparent securities market to
investors using electronic trading systems,
• enabling shorter settlement cycles and book entry settlements
systems, and
• Meeting the current international standards of securities markets.

The standards set by NSE in terms of market practices and technology have
become industry benchmarks and are being emulated by other market
participants. NSE is more than a mere market facilitator. It's that force
which is guiding the industry towards new horizons and greater
opportunities.

The logo of the NSE symbolises a single nationwide securities trading
facility ensuring equal and fair access to investors, trading members and
issuers all over the country. The initials of the Exchange viz., N, S and E
have been etched on the logo and are distinctly visible. The logo symbolises
use of state of the art information technology and satellite connectivity to
bring about the change within the securities industry. The logo symbolises



vibrancy and unleashing of creative energy to constantly bring about change
through innovation.

CORPORATE STRUCTURE

NSE is one of the first de-mutualised stock exchanges in the country, where
the ownership and management of the Exchange is completely divorced
from the right to trade on it. Though the impetus for its establishment came
from policy makers in the country, it has been set up as a public limited
company, owned by the leading institutional investors in the country.

From day one, NSE has adopted the form of a demutualised exchange - the
ownership, management and trading is in the hands of three different sets of
people. NSE is owned by a set of leading financial institutions, banks,
insurance companies and other financial intermediaries and is managed by
professionals, who do not directly or indirectly trade on the Exchange. This
has completely eliminated any conflict of interest and helped NSE in
aggressively pursuing policies and practices within a public interest
framework.

The NSE model however, does not preclude, but in fact accommodates
involvement, support and contribution of trading members in a variety of
ways. Its Board comprises of senior executives from promoter institutions,
eminent professionals in the fields of law, economics, accountancy, finance,
taxation, and etc, public representatives, nominees of SEBI and one full time
executive of the Exchange.



While the Board deals with broad policy issues, decisions relating to market
operations are delegated by the Board to various committees constituted by
it. Such committees includes representatives from trading members,
professionals, the public and the management. The day-to-day management
of the Exchange is delegated to the Managing Director who is supported by
a team of professional staff.

STRUCTURE OF INTERNATIONAL CAPITAL MARKET



INTERNATIONAL
CAPITAL MARKETS

INTERNATIONAL INTERNATIONAL
BOND MARKET EQUITY MARKET

FOREIGN EURO FOREIGN EURO
BONDS BOND EQUITY EQUITY

AMERICAN GLOBAL
YANKEE EURO/
DEPOSITORY DEPOSITORY
BONDS DOLLAR RECIEPTS RECIEPTS

SAMURAI EURO/ IDR/
BONDS YEN EDR

BULLDOG EURO/
BONDS POUNDS

INTERNATIONAL CAPITAL MARKETS

ORIGIN



The genesis of the present international markets can be teased to 1960s,
when there was a real demand for high quality dollar-denominated bonds
form wealthy Europeans (and others) who wished to hold their assets their
home countries or in currencies other then their own. These investors were
driven by the twin concerns of avoiding taxes in their home country and
protecting themselves against the falling value of domestic currencies. The
bonds which were then available for investment were subjected to
withholding tax. Further it is was also necessary to register to address these
concerns. These were issued in bearer forms and so, there was no of
ownership and tax was withheld.

Also, until 1970, the International Capital Market focused on debt financing
and the equity finances were raised by the corporate entities primarily in the
domestic markets. This was due to the restrictions on cross-border equity
investments prevailing unit then in many countries. Investors too preferred
to invest in domestic equity issued due to perceived risks implied in foreign
equity issues either related to foreign currency exposure or related to
apprehensions of restrictions on such investments by the regulator.

Major changes have occurred since the ‘70s which have witnessed
expanding and fluctuating trade volumes and patterns with various blocks
experiencing extremes in fortunes in their exports/imports. This was the was
the period which saw the removal of exchange controls by countries like the
UK, franc and Japan which gave a further technology of markets have
played an important role in channelizing the funds from surplus unit to
deficit units across the globe. The international capital markets also become
a major source of external finance for nations with low internal saving. The



markets were classified into euro markets, American Markets and Other
Foreign Markets.

THE PLAYERS
Borrowers/Issuers, Lenders/ Investors and Intermediaries are the major
players of the international market. The role of these players is discussed
below.

BORROWERS/ISSUERS
These primarily are corporates, banks, financial institutions, government and
quasi government bodies and supranational organizations, which need forex
funds for various reasons. The important reasons for corporate borrowings
are, need for foreign currencies for operation in markets abroad,
dull/saturated domestic market and expansion of operations into other
countries.

Governments borrow in the global financial market to adjust the balance of
payments mismatches, to gain net capital investments abroad and to keep a
sufficient inventory of foreign currency reserves for contingencies like
supporting the domestic currency against speculative pressures.

LENDERS/INVESTORS
In case of Euro-loans, the lenders are mainly banks who possess inherent
confidence in the credibility of the borrowing corporate or any other entity
mention above in case of GDR it is the institutional investor and high net



worth individuals (referred as Belgian Dentists) who subscribe to the equity
of the corporates. For an ADR it is the institutional investor or the individual
investor through the Qualified Intuitional Buyer who put in the money in the
instrument depending on the statutory status attributed to the ADR as per
statutory requirements of the land.

INTERMEDIARIES
LEAD MANGERS
They undertake due diligence and preparation of offer circular, marketing
the issues and arranger for road shows.

UNDERWRITERS
Underwriters of the issue bear interest rate/market risks moving against
them before they place bonds or Depository Receipts. Usually, the lend
managers and co-managers act as underwriters for the issue.

CUSTODIAN
On behalf of DRs, the custodian holds the underlying shares, and collects
rupee dividends on the underlying shares and repatriates the same to the
depository in US dollars/foreign equity.

Apart from the above, Agents and Trustees, Listing Agents and Depository
Banks also play a role in issuing the securities.

THE INSTRUMENTS



The early eighties witnessed liberalization of many domestic economies and
globalization of the same. Issuers form developing countries, where issue of
dollar/foreign currency denominated equity shares were not permitted, could
access international equity markets through the issue of an intermediate
instrument called ‘Depository Receipt’.

A Depository Receipt (DR) is a negotiable certificate issued by a depository
bank which represents the beneficial interest in shares issued by a company.
These shares are deposited with the local ‘custodian’ appointed by the
depository, which issues receipts against the deposit of shares.

The various instruments used to raise funds abroad include: equity, straight
debt or hybrid instruments. The following figure shows the classification of
international capital markets based on instruments used and market(s)
accessed.

EURO EQUITY

GLOBAL DEPOSITORY RECEIPTS (GDR):
A GDR is a negotiable instrument which represents publicly traded local-
currency equity share. GDR is any instrument in the from of a depository
receipt or certificate created by the Overseas Depository Bank outside India
and issued to non-resident investors against the issue of ordinary shares or
foreign currency convertible bonds of the issuing company. Usually, a
typical GDR is denominated in US dollars whereas the underlying shares
would be denominated in the local currency of the Issuer. GDRs may be – at



the request of the investor – converted into equity shares by cancellation of
GDRs through the intermediation of the depository and the sale of
underlying shares in the domestic market through the local custodian.

GDRs, per se, are considered as common equity of the issuing company and
are entitled to dividends and voting rights since the date of its issuance. The
company transactions. The voting rights of the shares are exercised by the
Depository as per the understanding between the issuing Company and the
GDR holders.

FOREIGN EQUTIY

AMERICAN DEPOSITORY RECEIPTS (ADR):
ADR is a dollar denominated negotiable certificate, it represents a non-US
company’s publicly traded equity. It was devised in the last 1920s to help
Americans invest in overseas securities and assist non-US companies
wishing to have their stock traded in the American Markets. ADRs are
divided into 3 levels based on the regulation and privilege of each
company’s issue.

I. ADR LEVEL – I:
It is often step of an issuer into the US public equity market. The
issuer can enlarge the market for existing shares and thus
diversify to the investor base. In this instrument only minimum
disclosure is required to the sec and issuer need not comply with



the US GAAP (Generally Accepted Accounting Principles). This
type of instrument is traded in the US OTC Market.

The issuer is not allowed to raise fresh capital or list on any one
of the national stock exchanges.

II. ADR LEVEL – II:
Through this level of ADR, the company can enlarge the investor
base for existing shares to a greater extent. However, significant
disclosures have to be made to the SEC. The company is allowed
to List on the American Stock Exchange (AMEX) or New York
Stock Exchange (NYSE) which implies that company must meet
the listing requirements of the particular exchange.

III. ADR LEVEL – III:
This level of ADR is used for raising fresh capital through Public
offering in the US Capital with the EC and comply with the
listing requirements of AMEX/NYSE while following the US-
GAAP.

DEBT INSTRUMENTS



EUROBONDS
The process of lending money by investing in bonds originated during the
19th century when the merchant bankers began their operations in the
international markets. Issuance of Eurobonds became easier with no
exchange controls and no government restrictions on the transfer of funds
in international markets.

THE INSTRUMENTS

EUROBONDS
All Eurobonds, through their features can appeal to any class of issuer or
investor.
The characteristics which make them unique and flexible are:
a) No withholding of taxes of any kind on interests payments
b) They are in bearer form with interest coupon attached
c) They are listed on one or more stock exchanges but issues are
generally traded in the over the counter market.

Typically, a Eurobond is issued outside the country of the currency in
which it is denominated. It is like any other Euro instrument and through
international syndication and underwriting, the paper is sold without any
limit of geographical boundaries. Eurobonds are generally listed on the
world's stock exchanges, usually on the Luxembourg Stock Exchange.

a) FIXED-RATE BONDS/STRAIGHT DEBT BONDS:



Straight debt bonds are fixed interest bearing securities which are
redeemable at face value. The bonds issued in the Euro-market
referred to as Euro-bonds, have interest rates fixed with reference
to the creditworthiness of the issuer. The interest rates on dollar
denominated bonds are set at a margin over the US treasury yields.
The redemption of straights is done by bullet payment, where the
repayment of debt will be in one lump sum at the end of the
maturity period, and annual servicing.

b) FLOATING RATE NOTES (FRNs):
FRNs can be described as a bond issue with a maturity period
varying from 5-7 years having varying coupon rates - either
pegged to another security or re-fixed at periodic intervals.
Conventionally, the paper is referred to as notes and not as bonds.
The spreads or margin on these notes will be above 6 months
USOR for Eurodollar deposits.

FOREIGN BONDS



These are relatively lesser known bonds issued by foreign entities for
raising medium to long-term financing from domestic money centers in
their domestic currencies. A brief note on the various instruments in this
category is given below:

a) YANKEE BONDS:
These are US dollar denominated issues by foreign borrowers
(usually foreign governments or entities, supranational and highly
rated corporate borrowers) in the US bond markets.

A bond denominated in U.S. dollars and is publicly issued in the
U.S. by foreign banks and corporations. According to the
Securities Act of 1933, these bonds must first be registered with
the Securities and Exchange Commission (SEC) before they can
be sold. Yankee bonds are often issued in trenches and each
offering can be as large as $1 billion.

Due to the high level of stringent regulations and standards that
must be adhered to, it may take up to 14 weeks (or 3.5 months) for
a Yankee bond to be offered to the public. Part of the process
involves having debt-rating agencies evaluate the creditworthiness
of the Yankee bond's underlying issuer.

Foreign issuers tend to prefer issuing Yankee bonds during times
when the U.S. interest rates are low, because this enables the
foreign issuer to pay out less money in interest payments.



b) SAMURAI BONDS:
A yen-denominated bond issued in Tokyo by a non-Japanese
company and subject to Japanese regulations. Other types of yen-
denominated bonds are Euro/yens issued in countries other than
Japan.

Samurai bonds give issuers the ability to access investment capital
available in Japan. The proceeds from the issuance of samurai
bonds can be used by non-Japanese companies to break into the
Japanese market, or it can be converted into the issuing company's
local currency to be used on existing operations. Samurai bonds
can also be used to hedge foreign exchange rate risks.

These are bonds issued by non-Japanese borrowers in the domestic
Japanese markets.

c) BULLDOG BONDS:
These are sterling denominated foreign bond which are raised in
the UK domestic securities market.

A sterling denominated bond that is issued in London by a
company that is not British.

These sterling bonds are referred to as bulldog bonds as the
bulldog is a national symbol of England.

d) SHIBOSAI BONDS:



These are the privately placed bonds issued in the Japanese
markets.

EURONOTES

Euronotes as a concept is different from syndicated bank credit and is
different from Eurobonds in terms of its structure and maturity period.
Euronotes command the price of a short-term instrument usually a few
basic points over LIBOR and in many instances at sub – LIBOR levels.
The documentation formalities are minimal (unlike in the case of
syndicated credits or bond issues) and cost savings can be achieved on that
score too. The funding instruments in the form of Euronotes possess
flexibility and can be tailored to suit the specific requirements of different
types of borrowers. There are numerous applications of basic concepts of
Euronotes. These may be categorized under the following heads:

a) COMMERCIAL PAPER:
These are short-term unsecured promissory notes which repay a
fixed amount on a certain future date. These are normally issued at a
discount to face value.

b) NOTE ISSUANCE FACILITIES (NIFs):
The currency involved is mostly US dollars. A NIF is a medium-
term legally binding commitment under which a borrower can issue
short-term paper, of up to one year. The underlying currency is
mostly US dollar. Underwriting banks are committed either to



purchase any notes which the borrower b unable to sell or to provide
standing credit. These can be re-issued periodically.

c) MEDIUM-TERM NOTES (MTNs):
MTNs are defined as sequentially issued fixed interest securities
which have a maturity of over one year. A typical MTN program
enables an issuer to issue Euronotes for different maturities. From
over one year up to the desired level of maturity. These are
essentially fixed rate funding arrangements as the price of each
preferred maturity is determined and fixed up front at the time of
launching. These are conceived as non-underwritten facilities, even
though international markets have started offering underwriting
support in specific instances.

A Global MTN (G-MTN) is issued worldwide by tapping Euro as
well as the- US markets under the same program.

Under G-MTN programs, issuers of different credit ratings are able
to raise finance by accessing retail as well as institutional investors.
In view of flexible access, speed and efficiency, and enhanced
investor base G-MTN programs afford numerous benefits to the
issuers.

Spreads paid on MTNs depend on credit ratings, treasury yield
curve and the familiarity of the issuers among investors. Investors
include Private Banks, Pension Funds, Mutual Funds and Insurance
Companies.



FOREIGN EXCHANGE AND FOREIGN EXCHANGE
MARKETS –
OVERVIEW
In today’s world no country is self sufficient, so there is a need for exchange
of goods and services amongst the different countries. However, unlike in
the primitive age the exchange of goods and services is no longer carried out
on barter basis. Every sovereign country in the world has a currency which
is a legal tender in its territory and this currency does not act as money
outside its boundaries. So whenever a country buys or sells goods and
services from or to another country, the residents of two countries have to
exchange currencies. So we can imagine that if all countries have the same
currency then there is no need for foreign exchange.

FOREIGN EXCHANGE IN INDIA
In India, foreign exchange has been given a statutory definition. Section 2
(b) of Foreign Exchange Regulation Act, 1973 states:
‘Foreign exchange’ means foreign currency and includes:
• All deposits, credits and balances payable in any foreign currency and
any drafts, traveler’s cheques, letters of credit and bills of exchange ,
expressed or drawn in Indian currency but payable in any foreign
currency,
• Any instrument payable, at the option of drawee or holder thereof or
any other party thereto, either in Indian currency or in foreign
currency or partly in one and partly in the other.



For India we can conclude that foreign exchange refers to foreign money,
which includes notes, cheques, bills of exchange, bank balances and
deposits in foreign currencies.

ABOUT FOREIGN EXCHANGE MARKET
Particularly for foreign exchange market there is no market place called the
foreign exchange market. It is mechanism through which one country’s
currency can be exchange i.e. bought or sold for the currency of another
country. The foreign exchange market does not have any geographic
location. The market comprises of all foreign exchange traders who are
connected to each other through out the world. They deal with each other
through telephones, telexes and electronic systems. With the help of Reuters
Money 2000-2, it is possible to access any trader in any corner of the world
within a few seconds.

WHO ARE THE PARTICIPANTS IN FOREIGN
EXCHANGE MARKETS?
The main players in foreign exchange markets are as follows:
1. CUSTOMERS
The customers who are engaged in foreign trade participate in foreign
exchange markets by availing of the services of banks. Exporters
require converting the dollars in to rupee and importers require
converting rupee in to the dollars as they have to pay in dollars for the
goods/services they have imported.



2. COMMERCIAL BANKS
They are most active players in the forex market. Commercial banks
dealing with international transactions offer services for conversion of
one currency in to another. They have wide network of branches.
Typically banks buy foreign exchange from exporters and sells
foreign exchange to the importers of the goods. As every time the
foreign exchange bought and sold may not be equal banks are left
with the overbought or oversold position. The balance amount is sold
or bought from the market.

Nowadays, in international foreign exchange markets, the
international trade turnover accounts for a fraction of huge amounts
dealt, i.e. bought and sold. The balance amount is accounted for either
by financial transactions or speculation. Banks have enough financial
strength and wide experience to speculate the market and banks does
so. Which is popularly known as the trading in the forex market.

Commercial banks have following objectives for being active in the
foreign exchange markets.

• They render better service by offering competitive rates to their
customers engaged in international trade;
• They are in a better position to manage risks arising out of exchange
rate fluctuations;
• Foreign exchange business is a profitable activity and thus such banks
are in a position to generate more profits for themselves;



• They can manage their integrated treasury in a more efficient manner.
• In India Reserve Bank of India has given license to the commercial
banks to deal in foreign exchange under section 6 Foreign Exchange
Regulation Act, 1973, which are called the Authorized Dealers (ADs).

3. CENTRAL BANK
In all countries central banks have been charged with the
responsibility of maintaining the external value of the domestic
currency. Generally this is achieved by the intervention of the bank.
Apart from this central banks deal in the foreign exchange market for
the following purposes:
1) Exchange rate management: It is achieved by the intervention
though sometimes banks have to maintain external rate of the
domestic currency at a level or in a band so fixed.
2) Reserve management: Central bank of the country is mainly
concerned with the investment of countries foreign exchange reserve
in a stable proportions in range of currencies and in a range of assets
in each currency. For this bank has to involve certain amount of
switching between currencies.

4. EXCHANGE BROKERS
Forex brokers play a very important role in the foreign exchange
markets. However the extent to which services of forex brokers are
utilized depends on the tradition and practice prevailing at a particular
forex market center. In India as per FEDAI guidelines the A Ds are
free to deal directly among themselves without going through brokers.



The forex brokers are not allowed to deal on their own account all
over the world and also in India.

.

5. OVERSEAS FOREX MARKETS
Today the daily global turnover is guestimated to be more than US $
1.5 trillion a day. The international trade however constitutes hardly 5
to 7 % of this total turnover. The rest of trading in world forex
markets is constituted of financial transactions and speculation. As we
know that the forex market is 24-hour market, the day begins with
Tokyo and thereafter Singapore opens, thereafter India, followed by
Bahrain, Frankfurt, Paris, London, New York, Sydney, and back to
Tokyo.

FORWARD EXCHANGE CONTRACT

WHAT IS THE NEED FOR FORWARD EXCHANGE
CONTRACT?
The risk on account of exchange rate fluctuations, in international trade
transactions increases if the time period needed for completion of
transaction is longer. It is not uncommon in international trade, on account
of logistics, the time frame can not be foretold with clock precision.
Exporters and importers alike, can not be precise as to the time when the



shipment will be made as sometimes space on the ship is not available,
while at the other, there are delays on account of congestion of port etc.

In international trade there is considerable time lag between entering in to a
sales/purchase contract, shipment of goods, and payment. In the meantime,
if exchange rate moves against the party who has to exchange his home
currency in to foreign currency, he may end up in loss. Consequently,
buyers and sellers want to protect them against exchange rate risk. One of
the methods by which they can protect themselves is entering in to a foreign
exchange forward contract.

We can see from the daily report of the Vadilal Industries Limited (Forex
division) that the rupee fell down nearly 25 paise in a day.
The date of this fluctuation is 25th May 2000. Now let suppose that the
exporter has dealt

FORWARD EXCHANGE FORWARD CONTRACT
Forward exchange forward contract is a contract wherein two parties agree
to deliver certain amount of foreign exchange at an agreed rate either at a
fixed future date or during a fixed future period. If the merchants are sure
about the remittance or the payment of the foreign exchange then they can
choose the fix date forward exchange contract, in which they are bound by
the date on which they have to meet their part of liability in the agreement.
If the customers are not sure about the date of remittance or the payment of
the foreign exchange they can enter in to the option period forward
exchange contract. Both the types are explained below.


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