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CONTENTS PAGE

MODULE I FINANCIAL SYSTEM 5

MODULE II MONEY MARKET 18

MODULE III CAPITAL MARKET 38

MODULE IV FINANCIAL INSTITUTIONS 74

MODULE V REGULATORY INSTITUTIONS 94

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MODULE I

FINANCIAL SYSTEM
An introduction

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. There are areas or people with surplus funds and there are those
with a deficit. A financial system or financial sector functions as an intermediary
and facilitates the flow of funds from the areas of surplus to the areas of deficit. A
Financial System is a composition of various institutions, markets, regulations and
laws, practices, money manager, analysts, transactions and claims and liabilities.

Financial system comprises of set of subsystems of financial institutions,

financial markets, financial instruments and services which helps in the
formation of capital. It provides a mechanism by which savings are transformed to
investment.

Financial System;

The word "system", in the term "financial system", implies a set of complex
and closely connected or interlinked 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.

Meaning of Financial System

A financial system functions as an intermediary between savers and investors.
It facilitates the flow of funds from the areas of surplus to the areas of deficit. It is
concerned about the money, credit and finance. These three parts are very closely
interrelated with each other and depend on each other.
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A financial system may be defined as a set of institutions, instruments and

markets which promotes savings and channels them to their most efficient use. It
consists of individuals (savers), intermediaries, markets and users of savings
(investors).

In the worlds of Van Horne, “financial system allocates savings

efficiently in an economy to ultimate users either for investment in real
assets or for consumption”.

According to Prasanna Chandra, “financial system consists of a variety

of institutions, markets and instruments related in a systematic manner
and provide the principal means by which savings are transformed into
investments”.

Thus financial system is a set of complex and closely interlinked financial

institutions, financial markets, financial instruments and services which facilitate
the transfer of funds. Financial institutions mobilise funds from suppliers and
provide these funds to those who demand them. Similarly, the financial markets are
also required for movement of funds from savers to intermediaries and from
intermediaries to investors. In short, financial system is a mechanism by which
savings are transformed into investments.

Functions of Financial System

The financial system of a country performs certain valuable functions for the
economic growth of that country. The main functions of a financial system may be
briefly discussed as below:

1. Saving function: An important function of a financial system is to mobilise

savings and channelize them into productive activities. It is through financial
system the savings are transformed into investments.

2. Liquidity function: The most important function of a financial system is to provide

money and monetary assets for the production of goods and services. Monetary assets
are those assets which can be converted into cash or money easily without loss of
value. All activities in a financial system are related to liquidity-either provision of
liquidity or trading in liquidity.

3. Payment function: The financial system offers a very convenient mode of payment
for goods and services. The cheque system and credit card system arethe easiest
methods of payment in the economy. The cost and time of transactions are
considerably reduced.

4. Risk function: The financial markets provide protection against life, health and
income risks. These guarantees are accomplished through the sale of life, health
insurance and property insurance policies.
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5. Information function: A financial system makes available price-related

information. This is a valuable help to those who need to take economic and
financial decisions. Financial markets disseminate information for enabling
participants to develop an informed opinion about investment, disinvestment,
reinvestment or holding a particular asset.

6. Transfer function: A financial system provides a mechanism for the transfer

of the resources across geographic boundaries.

7. Reformatory functions: A financial system undertaking the functions of

developing, introducing innovative financial assets/instruments services and
practices and restructuring the existing assts, services etc, to cater the emerging
needs of borrowers and investors (financial engineering and re engineering).

8. Other functions: It assists in the selection of projects to be financed and also

reviews performance of such projects periodically. It also promotes the process of
capital formation by bringing together the supply of savings and the demand for
investible funds.

Role and Importance of Financial System in Economic Development

1. It links the savers and investors. It helps in mobilizing and allocating the
savings efficiently and effectively. It plays a crucial role in economic development
through saving-investment process. This savings – investment process is called
capital formation.
2. It helps to monitor corporate performance.
3. It provides a mechanism for managing uncertainty and controlling risk.
4. It provides a mechanism for the transfer of resources across geographical
boundaries.
5. It offers portfolio adjustment facilities (provided by financial markets and
financial intermediaries).
6. It helps in lowering the transaction costs and increase returns. This will
motivate people to save more.
7. It promotes the process of capital formation.
8. It helps in promoting the process of financial deepening and broadening.
Financial deepening means increasing financial assets as a percentage of GDP
and financial broadening means building an increasing number and variety of
participants and instruments.

In short, a financial system contributes to the acceleration of economic

development. It contributes to growth through technical progress.

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Structure of Indian Financial System

Financial structure refers to shape, components and their order in the financial
system. The Indian financial system can be broadly classified into formal
(organised) financial system and the informal (unorganised) financialsystem. The
formal financial system comprises of Ministry of Finance, RBI, SEBI and other
regulatory bodies. The informal financial system consists of individual money lenders,
groups of persons operating as funds or associations, partnership firms consisting of
local brokers, pawn brokers, and non-banking financial intermediaries such as
finance, investment and chit fund companies.

The formal financial system comprises financial institutions, financial

markets, financial instruments and financial services. These constituents or
components of Indian financial system may be briefly discussed as below:

I. Financial Institutions
Financial institutions are the participants in a financial market. They are
business organizations dealing in financial resources. They collect resources by
accepting deposits from individuals and institutions and lend them to trade,
industry and others. They buy and sell financial instruments. They generate
financial instruments as well. They deal in financial assets. They accept deposits,
grant loans and invest in securities.
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Financial institutions are the business organizations that act as mobilises

of savings and as purveyors of credit or finance. This means financial
institutions mobilise the savings of savers and give credit or finance to the
investors. They also provide various financial services to the community. They deal
in financial assets such as deposits, loans, securities and so on.

On the basis of the nature of activities, financial institutions may be classified

as: (a) Regulatory and promotional institutions, (b) Banking institutions, and (c)
Non-banking institutions.

1. Regulatory and Promotional Institutions:

Financial institutions, financial markets, financial instruments and

financial services are all regulated by regulators like Ministry of Finance, the
Company Law Board, RBI, SEBI, IRDA, Dept. of Economic Affairs, Department of
Company Affairs etc. The two major Regulatory and Promotional Institutions in
India are Reserve Bank of India (RBI) and Securities Exchange Board of India
(SEBI). Both RBI and SEBI administer, legislate, supervise, monitor, control and
discipline the entire financial system. RBI is the apex of all financial institutions
in India. All financial institutions are under the control of RBI. The financial
markets are under the control of SEBI. Both RBI and SEBI have laid down several
policies, procedures and guidelines. These policies, procedures and guidelines are
changed from time to time so as to set the financial system in the right direction.

2. Banking Institutions:

Banking institutions mobilise the savings of the people. They provide a

mechanism for the smooth exchange of goods and services. They extend creditwhile
lending money. They not only supply credit but also create credit. Thereare three
basic categories of banking institutions. They are commercial banks, co-operative
banks and developmental banks.

3. Non-banking Institutions:

The non-banking financial institutions also mobilize financial resources

directly or indirectly from the people. They lend the financial resources mobilized.
They lend funds but do not create credit. Companies like LIC, GIC, UTI,
Development Financial Institutions, Organisation of Pension and Provident Funds
etc. fall in this category. Non-banking financial institutions can be categorized as
investment companies, housing companies, leasing companies, hire purchase
companies, specialized financial institutions (EXIM Bank etc.) investment
institutions, state level institutions etc.

Financial institutions are financial intermediaries. They intermediate

between savers and investors. They lend money. They also mobilise savings.

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II. Financial Markets

Financial markets are another part or component of financial system. Efficient

financial markets are essential for speedy economic development. The vibrant
financial market enhances the efficiency of capital formation. It facilitates the flow
of savings into investment. Financial markets bridge one set of financial
intermediaries with another set of players. Financial markets are the backbone of the
economy. This is because they provide monetary support for the growth of the
economy. The growth of the financial markets is the barometer ofthe growth of a
country’s economy.

Financial market deals in financial securities (or financial instruments) and

financial services. Financial markets are the centres or arrangements that provide
facilities for buying and selling of financial claims and services. These are the
markets in which money as well as monetary claims is traded in. Financial
markets exist wherever financial transactions take place. Financial transactions
include issue of equity stock by a company, purchase of bonds inthe secondary
market, deposit of money in a bank account, transfer of funds from a current
account to a savings account etc.

The participants in the financial markets are corporations, financial institutions,

individuals and the government. These participants trade in financial products in
these markets. They trade either directly or through brokers and dealers.

In short, financial markets are markets that deal in financial assets and credit
instruments.

Functions of Financial Markets:

The main functions of financial markets are outlined as below:

1. To facilitate creation and allocation of credit and liquidity.

2. To serve as intermediaries for mobilisation of savings.

3. To help in the process of balanced economic growth.

4. To provide financial convenience.

5. To provide information and facilitate transactions at low cost.

6. To cater to the various credits needs of the business organisations.

Classification of Financial Markets:

There are different ways of classifying financial markets. There are mainly fiveways
of classifying financial markets.

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1. Classification on the basis of the type of financial claim: On this basis,

financial markets may be classified into debt market and equity market.

Debt market: This is the financial market for fixed claims like debt
instruments.

Equity market: This is the financial market for residual claims, i.e., equity
instruments.

2. Classification on the basis of maturity of claims: On this basis, financial

markets may be classified into money market and capital market.

Money market: A market where short term funds are borrowed and lend is
called money market. It deals in short term monetary assets with a maturity
period of one year or less. Liquid funds as well as highly liquid securities are
traded in the money market. Examples of money market are Treasury bill market,
call money market, commercial bill market etc. The main participants in this
market are banks, financial institutions and government. In short, money market
is a place where the demand for and supply of short term funds are met.

Capital market: Capital market is the market for long term funds. This market
deals in the long term claims, securities and stocks with a maturity period of more
than one year. It is the market from where productive capital is raised and made
available for industrial purposes. The stock market, the government bond market
and derivatives market are examples of capital market. In short, the capital market
deals with long term debt and stock.

3. Classification on the basis of seasoning of claim: On this basis, financial

markets are classified into primary market and secondary market.

Primary market: Primary markets are those markets which deal in the new
securities. Therefore, they are also known as new issue markets. These are markets
where securities are issued for the first time. In other words, these are the markets
for the securities issued directly by the companies. The primary markets mobilise
savings and supply fresh or additional capital to business units. In short, primary
market is a market for raising fresh capital in the formof shares and debentures.

Secondary market: Secondary markets are those markets which deal in

existing securities. Existing securities are those securities that have already been
issued and are already outstanding. Secondary market consists of stock exchanges.
Stock exchanges are self regulatory bodies under the overall regulatory purview
of the Govt. /SEBI.

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4. Classification on the basis of structure or arrangements: On this basis, financial

markets can be classified into organised markets and unorganized markets.

Organised markets: These are financial markets in which financial

transactions take place within the well established exchanges or in the
systematic and orderly structure.

Unorganised markets: These are financial markets in which financial

transactions take place outside the well established exchange or without
systematic and orderly structure or arrangements.

5. Classification on the basis of timing of delivery: On this basis, financial markets

may be classified into cash/spot market and forward / future market.

Cash / Spot market: This is the market where the buying and selling of
commodities happens or stocks are sold for cash and delivered immediately after
the purchase or sale of commodities or securities.

Forward/Future market: This is the market where participants buy and sell
stocks/commodities, contracts and the delivery of commodities or securities
occurs at a pre-determined time in future.

6. Other types of financial market: Apart from the above, there are some other types
of financial markets. They are foreign exchange market and derivatives market.

Foreign exchange market: Foreign exchange market is simply defined as a

market in which one country’s currency is traded for another country’s currency.
It is a market for the purchase and sale of foreign currencies.

Derivatives market: The derivatives are most modern financial instruments

in hedging risk. The individuals and firms who wish to avoid or reduce risk can
deal with the others who are willing to accept the risk for a price. A common place
where such transactions take place is called the derivative market. It is a market in
which derivatives are traded. In short, it is a market for derivatives. The important
types of derivatives are forwards, futures, options, swaps, etc.

III. Financial Instruments (Securities)

Financial instruments are the financial assets, securities and claims. They
may be viewed as financial assets and financial liabilities. Financial assets represent
claims for the payment of a sum of money sometime in the future (repayment of
principal) and/or a periodic payment in the form of interest or dividend. Financial
liabilities are the counterparts of financial assets. They represent promise to pay
some portion of prospective income and wealth to

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others. Financial assets and liabilities arise from the basic process of financing.
Some of the financial instruments are tradable/ transferable. Others are non
tradable/non-transferable. Financial assets like deposits with banks, companies
and post offices, insurance policies, NSCs, provident funds and pension funds are
not tradable. Securities (included in financial assets) like equity shares and
debentures, or government securities and bonds are tradable. Hence they are
transferable. In short, financial instruments are instruments through which a
company raises finance.

The financial instruments may be capital market instruments or money

market instruments or hybrid instruments. The financial instruments that are
used for raising capital through the capital market are known as capital market
instruments. These include equity shares, preference shares, warrants,
debentures and bonds. These securities have a maturity period of more than one
year.

The financial instruments that are used for raising and supplying money in
a short period not exceeding one year through money market are called money
market instruments. Examples are treasury bills, commercial paper, call money,
short notice money, certificates of deposits, commercial bills, money market
mutual funds.

Hybrid instruments are those instruments which have both the features of
equity and debenture. Examples are convertible debentures, warrants etc.

Financial instruments may also be classified as cash instruments and

derivative instruments. Cash instruments are financial instruments whose value is
determined directly by markets. Derivative instruments are financial
instruments which derive their value from some other financial instrument or
variable.

Financial instruments can also be classified into primary instruments and

secondary instruments. Primary instruments are instruments that are directly issued
by the ultimate investors to the ultimate savers. For example, shares and debentures
directly issued to the public. Secondary instruments are issued by the financial
intermediaries to the ultimate savers. For example, UTI and mutual funds issue
securities in the form of units to the public.

Characteristics of Financial Instruments

The important characteristics of financial instruments may be outlined as below:

1. Liquidity: Financial instruments provide liquidity. These can be easily and

quickly converted into cash.

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2. Marketing: Financial instruments facilitate easy trading on the market. They

have a ready market.
3. Collateral value: Financial instruments can be pledged for getting loans.
4. Transferability: Financial instruments can be easily transferred from person
to person.
5. Maturity period: The maturity period of financial instruments may be short
term, medium term or long term.
6. Transaction cost: Financial instruments involve buying and selling cost. The
buying and selling costs are called transaction costs. These are lower.
7. Risk: Financial instruments carry risk. This is because there is uncertainty
with regard to payment of principal or interest or dividend as the case may be.
8. Future trading: Financial instruments facilitate future trading so as to cover
risks due to price fluctuations, interest rate fluctuations etc.
IV. Financial Services
The development of a sophisticated and matured financial system in the
country, especially after the early nineties, led to the emergence of a new sector.
This new sector is known as financial services sector. Its objective is to
intermediate and facilitate financial transactions of individuals and institutional
investors. The financial institutions and financial markets help the financial system
through financial instruments. The financial services include all activities
connected with the transformation of savings into investment. Important financial
services include lease financing, hire purchase, instalment payment systems,
merchant banking, factoring, forfaiting etc.
Growth and Development of Indian Financial System
At the time of independence in 1947, there was no strong financial
institutional mechanism in the country. The industrial sector had no access to the
savings of the community. The capital market was primitive and shy. The private
and unorganised sector played an important role in the provision ofliquidity. On
the whole, there were chaos and confusions in the financial system.
After independence, the government adopted mixed economic system. A
scheme of planned economic development was evolved in 1951 with a view to
achieve the broad economic and social objective. The government started creating
new financial institutions to supply finance both for agricultural and industrial
development. It also progressively started nationalizing some important
financial institutions so that the flow of finance might be in the right direction. The
following developments took place in the Indian financial system:

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1. Nationalisation of financial institutions: RBI, the leader of the financial system,

was established as a private institution in 1935. It was nationalized in 1949. This
was followed by the nationalisation of the Imperial bank of India. One of the
important mile stone in the economic growth of India was the nationalisation of 245
life insurance Corporation in 1956. As a result, Life
Insurance Corporation of India came into existence on 1st September, 1956.
Another important development was the nationalisation of 14 major commercial
banks in 1969. In 1980, 6 more banks were nationalized. Another landmark
was the nationalisation of general insurance business and setting up of General
Insurance Corporation in 1972.

2. Establishment of Development Banks: Another landmark in the history of

development of Indian financial system is the establishment of new financial
institutions to supply institutional credit to industries. In 1949, RBI undertook a
detailed study to find out the need for specialized institutions. The first
development bank was established in 1948. That was Industrial Finance
Corporation of India (IFCI). In 1951, Parliament passed State Financial
Corporation Act. Under this Act, State Governments could establish financial
corporation’s for their respective regions. The Industrial Credit and Investment
Corporation of India (ICICI) were set up in 1955. It was supported by Government
of India, World Bank etc. The UTI was established in 1964 as a public sector
institution to collect the savings of the people and make them available for
productive ventures. The Industrial Development Bank of India (IDBI) was
established on 1st July 1964 as a wholly owned subsidiary of the RBI. On February
16, 1976, the IDBI was delinked from RBI. It became an independent financial
institution. It co-ordinates the activities of all other financial institutions. In 1971,
the IDBI and LIC jointly set up the Industrial Reconstruction Corporation of India
with the main objective of reconstruction and rehabilitation of sick industrial
undertakings. The IRCI was converted into a statutory corporation in March 1985
and renamed as Industrial Reconstruction Bank of India. Now its new name is
Industrial Investment Bank of India (IIBI). In 1982, the Export-Import Bank of
India (EXIM Bank) was set up to provide financial assistance to exporters and
importers. On April 2, 1990 the Small Industries Development Bank of India
(SIDBI) was set up as a wholly owned subsidiary of IDBI. The SIDBI has taken over
the responsibility of administrating the Small Industries Development Fund and
the National Equity Fund.

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3. Establishment of Institution for Agricultural Development: In 1963, the

RBI set up the Agricultural Refinance and Development Corporation (ARDC) to
provide refinance support to banks to finance major development projects, minor
irrigation, farm mechanization, land development etc. In order to meet credit
needs of agriculture and rural sector, National Bank for Agriculture and Rural
Development (NABARD) was set up in 1982. The main objective of the
establishment of NABARD is to extend short term, medium term and long term
finance to agriculture and allied activities.
4. Establishment of institution for housing finance: The National Housing
Bank (NHB) has been set up in July 1988 as an apex institution to mobilise
resources for the housing sector and to promote housing finance institutions.
5. Establishment of Stock Holding Corporation of India (SHCIL): In 1987,
another institution, namely, Stock Holding Corporation of India Ltd. was set up
to strengthen the stock and capital markets in India. Its main objective is to
provide quick share transfer facilities, clearing services, support services etc. to
investors.
6. Establishment of mutual funds and venture capital institutions: Mutual
funds refer to the funds raised by financial service companies by pooling the
savings of the public and investing them in a diversified portfolio. They provide
investment avenues for small investors who cannot participate in the equities of
big companies.
Venture capital is a long term risk capital to finance high technology projects.
The IDBI venture capital fund was set up in 1986. The ICICI and theUTI have
jointly set up the Technology Development and Information Company of India Ltd. in
1988 to provide venture capital.
7. New Economic Policy of 1991: Indian financial system has undergone
massive changes since the announcement of new economic policy in 1991.
Liberalisation, Privatisation and Globalisation has transformed Indian economy
from closed to open economy. The corporate industrial sector also has undergone
changes due to delicensing of industries, financial sector reforms,capital markets
reforms, disinvestment in public sector undertakings etc.
Since 1990s, Government control over financial institutions has diluted in
a phased manner. Public or development financial institutions have been
converted into companies, allowing them to issue equity/bonds to the public.
Government has allowed private sector to enter into banking and insurance sector.
Foreign companies were also allowed to enter into insurance sector in India.
Weaknesses of Indian Financial System
Even though Indian financial system is more developed today, it suffers from
certain weaknesses. These may be briefly stated below:

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1. Lack of co-ordination among financial institutions: There are a large

number of financial intermediaries. Most of the financial institutions are owned by
the government. At the same time, the government is also the controlling authority
of these institutions. As there is multiplicity of institutions in the Indian financial
system, there is lack of co-ordination in the working of these institutions.
2. Dominance of development banks in industrial finance: The industrial
financing in India today is largely through the financial institutions set up by the
government. They get most of their funds from their sponsors. They act as distributive
agencies only. Hence, they fail to mobilise the savings of the public. This stands in
the way of growth of an efficient financial system in the country.
3. Inactive and erratic capital market: In India, the corporate customers are
able to raise finance through development banks. So, they need not go to capital
market. Moreover, they do not resort to capital market because it is erratic and
inactive. Investors too prefer investments in physical assets to investments in
financial assets.
4. Unhealthy financial practices: The dominance of development banks has
developed unhealthy financial practices among corporate customers. The
development banks provide most of the funds in the form of term loans. So there
is a predominance of debt in the financial structure of corporate enterprises. This
predominance of debt capital has made the capital structure of the borrowing
enterprises uneven and lopsided. When these enterprises face financial crisis, the
financial institutions permit a greater use of debt than is warranted. This will make
matters worse.
5. Monopolistic market structures: In India some financial institutions are so
large that they have created a monopolistic market structures in the financial
system. For instance, the entire life insurance business is in the hands of LIC.
The weakness of this large structure is that it could lead to inefficiency in their
working or mismanagement. Ultimately, it would retard the development of the
financial system of the country itself.
6. Other factors: Apart from the above, there are some other factors which put
obstacles to the growth of Indian financial system. Examples are:
a. Banks and Financial Institutions have high level of NPA.
b. Government burdened with high level of domestic debt.
c. Cooperative banks are labelled with scams.
d. Investors confidence reduced in the public sector undertaking etc.,
e. Financial illiteracy.

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MODULE II
MONEY MARKET

Financial Market deals in financial instruments (securities) and financial

services. Financial markets are classified into two, namely, money market and
capital market. Meaning of Money Market

Money market is a segment of financial market. It is a market for short

term funds. It deals with all transactions in short term securities. These
transactions have a maturity period of one year or less. Examples are bills of
exchange, treasury bills etc. These short term instruments can be converted into
money at low transaction cost and without much loss. Thus, money market is a
market for short term financial securities that are equal to money.

According to Crowther, “Money market is a collective name given to various firms

and institutions that deal in the various grades of near money”.

Money market is not a place. It is an activity. It includes all organizations and

institutions that deal in short term financial instruments. However, sometimes
geographical names are given to the money market according to the location, e.g.
Mumbai Money Market.

Characteristics of Money Market

The following are the characteristics of money market:

1. It is a market for short term financial assets that are close substitutes of
money.

2. It is basically an over the phone market.

3. It is a wholesale market for short term debt instruments.

4. It is not a single market but a collection of markets for several instruments.

5. It facilitates effective implementation of monetary policy of a central bank of a

country.

6. Transactions are made without the help of brokers.

7. It establishes the link between the RBI and banks.

8. The players in the money market are RBI, commercial banks, and companies.

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Functions of Money Market

Money market performs the following functions:

1. Facilitating adjustment of liquidity position of commercial banks, business

undertakings and other non-banking financial institutions.

2. Enabling the central bank to influence and regulate liquidity in the economy
through its intervention in the market.

3. Providing a reasonable access to users of short term funds to meet their

requirements quickly at reasonable costs.

4. Providing short term funds to govt. institutions.

5. Enabling businessmen to invest their temporary surplus funds for short period.

6. Facilitating flow of funds to the most important uses.

7. Serving as a coordinator between borrowers and lender of short term funds.

8. Helping in promoting liquidity and safety of financial assets.

Importance of Money Market

A well developed money market is essential for the development of a

country. It supplies short term funds adequately and quickly to trade and industry.
A developed money market helps the smooth functioning of the financial system
in any economy in the following ways:

1. Development of trade and industry: Money market is an important source of

finance to trade and industry. Money market finances the working capital
requirements of trade and industry through bills, commercial papers etc. It
influences the availability of finance both in the national and international trade.

2. Development of capital market: Availability funds in the money market and

interest rates in the money market will influence the resource mobilisation and
interest rate in the capital market. Hence, the development of capital market depends
upon the existence of a developed money market. Money market is also necessary for
the development of foreign exchange market and derivatives market.

3. Helpful to commercial banks: Money market helps commercial banks for

investing their surplus funds in easily realisable assets. The banks get back the funds
quickly in times of need. This facility is provided by money market. Further, the
money market enables commercial banks to meet the statutory

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requirements of CRR and SLR. In short, money market provides a stable source
of funds in addition to deposits.

4. Helpful to central bank: Money market helps the central bank of a country to
effectively implement its monetary policy. Money market helps the central bankin
making the monetary control effective through indirect methods (repos and open
market operations). In short, a well developed money market helps in the effective
functioning of a central bank.

5. Formulation of suitable monetary policy: Conditions prevailing in a money

market serve as a true indicator of the monetary state of an economy. Hence it
serves as a guide to the Govt. in formulating and revising the monetary policy. In
short, the Govt. can formulate the monetary policy after taking into consideration
the conditions in the money market.

6. Helpful to Government: A developed money market helps the Govt. to raise

short term funds through the Treasury bill floated in the market. In the absence of
a developed money market, the Govt. would be forced to issue more currency notes
or borrow from the central bank. This will raise the money supply over and above
the needs of the economy. Hence the general price level will go up (inflationary
trend in the economy). In short, money market is a device to the Govt. to balance
its cash inflows and outflows.

Thus, a well developed money market is essential for economic growth and
stability.

Characteristics of a Developed Money Market

In every country some types of money market exists. Some of them are highly
developed while others are not well developed. A well developed and efficient money
market is necessary for the development of any economy. The following are the
characteristics or prerequisites of a developed and efficient money market:

1. Highly developed commercial banking system: Commercial banks are the nerve
centre of the whole short term funds. They serve as a vital link between the central
bank and the various segments of the money market. When the commercial banking
system is developed or organized, the money market will be developed.

2. Presence of a central bank: In a developed money market, there is always a

central bank. The central bank is necessary for direction and control of money
market. Central bank absorbs surplus cash during off-seasons and provides
additional funds in busy seasons. This is done through open market operations.
Being the bankers’ bank, central bank keeps the reserves of commercial banks

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and provides them financial accommodation in times of need. If the central bank
cannot influence the money market it means the money market is not developed.
In short, without the support of a central bank a money market cannot function.

3. Existence of sub markets: Money market is a group of various sub markets. Each
sub market deals in instruments of varied maturities. There should be large number
of submarkets. The larger the number of sub markets, the broader and more
developed will be the structure of money market. Besides, the sub market must be
interrelated and integrated with each other. If there is no co-ordination and
integration among them, different interest rates will prevail in the sub markets.

4. Availability of credit instruments: The continuous availability of readily

acceptable negotiable securities (near money assets) is necessary for the existence
of a developed money market. In addition to variety of instruments or securities, there
should be a number of dealers (participants) in the money market to transact in
these securities. It is the dealers in securities who actually infuse life into the money
market.

5. Existence of secondary market: There should be active secondary market in

these credit instruments. The success of money market always depends on the
secondary market. If the secondary market develops, then there will be active
trading of the instruments.

6. Availability of ample resources: There must be availability of sufficient funds to

finance transactions in the sub markets. These funds may come from within the
country and outside the country. Under developed money markets do not have
ample funds. Thus availability of sufficient funds is essential for the smoothand
efficient functioning of the money market.

7. Demand and supply of funds: Money market should have a large demand and
supply of funds. This depends upon the number of participants and also the Govt.
policies in encouraging the investments in various sectors and monetary policy of
RBI.

8. Other factors: There are some other factors that also contribute to the
development of a money market. These factors include industrial development,
volume of international trade, political stability, trade cycles, foreign investment,
price stabilisation etc.

Components / Constituents / Composition of Money Market (Structure of

Money Market)

Money market consists of a number of sub markets. All submarkets

collectively constitute the money market. Each sub market deals in a particular

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financial instrument. The main components or constituents or sub markets of

money markets are as follows:

1. Call money market

2. Commercial bill market

3. Treasury bill markets

4. Certificates of deposits market

5. Commercial paper market

6. Acceptance market

7. Collateral loan market

I. Call Money Market

Call money is required mostly by banks. Commercial banks borrow money

without collateral from other banks to maintain a minimum cash balance known
as cash reserve ratio (CRR). This interbank borrowing has led to the development
of the call money market.

Call money market is the market for very short period loans. If money is lent
for a day, it is called call money. If money is lent for a period of more thanone
day and upto 14 days is called short notice money. Thus call money market refers
to a market where the maturity of loans varies between 1 day to 14 days.In the
call money market, surplus funds of financial institutions, and banks are traded.
There is no demand for collateral security against call money.

In India call money markets are mainly located in big industrial and
commercial centres like Mumbai, Kolkata, Chennai, Delhi and Ahmadabad.

Participants or Players in the Call Money Market

1. Scheduled commercial banks and RBI

2. Non-Scheduled commercial banks

3. Co-operative banks

4. Foreign banks

5. Discount and Finance House of India

6. Primary dealers

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The above players are permitted to operate both as lenders and borrowers.

(1) LIC (2) UTI (3) GIC (4) IDBI (5) NABARD (6) Specific mutual funds, etc.

The above participants are permitted to operate as lenders

2. Commercial Bill Market

Commercial bill market is another segment of money market. It is a market

in which commercial bills (short term) are bought and sold. Commercial bills are
important instruments. They are widely used in both domestic and foreign trade
to discharge the business obligations (or to settle business obligations).
Discounting is the main process in this market. Hence commercial bill market is
also known as discount market.

There are specialized institutions known as discount houses for

discounting commercial bills accepted by reputed acceptance houses. RBI has
permitted the financial institutions, mutual funds, commercial banks and co-
operative banks to enter in the commercial bill market.

3. Treasury Bills Market

Treasury bill market is a market which deals in treasury bills. In this market,
treasury bills are bought and sold. Treasury bill is an important instrument of short
term borrowing by the Govt. These are the promissory notes or a kind of finance
bill issued by the Govt. for a fixed period not extending beyond one year. Treasury
bill is used by the Govt. to raise short term funds for meeting temporary Govt. deficits.
Thus it represents short term borrowings of the Govt.

Advantages or Importance of Treasure Bill Market

Advantages to the Issuer / Govt.

1. The Govt. can raise short term funds for meeting temporary budget deficit.

2. The Govt. can absorb excess liquidity in the economy through the issue of T-
bills in the market.

3. It does not lead to inflationary pressure.

Advantages for the Purchaser/ Investor

1. It is a ready market for purchasers or investors.

2. It is a safety instrument to invest.

3. Treasury bills are eligible securities for SLR requirement.

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4. The market provides hedging facility.

4. Certificates of Deposits Market

CD market is a market which deals in CDs. CDs are short term deposit
instruments to raise large sums of money. These are short term deposits which are
transferable from one party to another. Banks and financial institutions are major
issuers of CD. These are short term negotiable instruments.

Advantages of CD Market

1. It enables the depositors to earn higher return on their short term surplus.

2. The market provides maximum liquidity.

3. The bank can raise money in times of need. This will improve their lending
capacity.

4. The market provides an opportunity for banks to invest surplus funds.

5. The transaction cost of CDs is lower.

5. Commercial Paper Market

Commercial Paper Market is another segment of money market. It is a

market which deals in commercial papers. Commercial papers are unsecured short
term promissory notes issued by reputed, well established and big companies
having high credit rating. These are issued at a discount. Commercial papers can
now be issued by primary dealers and all India financial institutions. They can be
issued to (or purchased by) individuals, banks, companies and other registered
Indian corporate bodies. (Investors in CP)

Role of RBI in the Commercial Paper Market

The Working Group on Money Market (Vaghul Committee) in 1987 suggested

the introduction of the commercial Paper (CP) in India. As per the recommendation of
the committee, the RBI introduced commercial papers in January 1990. The
Committee suggested the following:
(a) CP should be issued to investors directly or through bankers.
(b) The CP issuing company must have a net worth of not less then Rs. 5
crores.
(c) The issuing company’s shares must be listed in the stock exchange.

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(d) The minimum amount of issue should be Rs. 1 crore and the minimum
denomination of Rs. 5 lakhs
(e) The CPs issuing cost should not exceed 1% of the amount raised.
(f) RBI is the sole authority to decide the size of issue and timing of issue.
(g) The instrument should not be subject to stamp duty at the time of issue
and there should not be any tax deduction at source.
(h) The interest on CP shall be a market determined.
(i) The issuing companies should get certification of credit rating for every six
months and ‘A’ grading enterprises may be permitted to enter the market.

6. Acceptance Market

Acceptance Market is another component of money market. It is a market for

banker’s acceptance. The acceptance arises on account of both home and foreign
trade. Bankers acceptance is a draft drawn by a business firm upon abank and
accepted by that bank. It is required to pay to the order of a particular party or to
the bearer, a certain specific amount at a specific date in future. It is commonly
used to settle payments in international trade. Thus acceptance market is a
market where the bankers’ acceptances are easily sold anddiscounted.

7. Collateral Loan Market

Collateral loan market is another important sector of the money market. The
collateral loan market is a market which deals with collateral loans. Collateral
means anything pledged as security for repayment of a loan. Thuscollateral loans
are loans backed by collateral securities such as stock, bonds etc. The collateral
loans are given for a few months. The collateral security is returned to the
borrower when the loan is repaid. When the borrower is not able to repay the loan,
the collateral becomes the property of the lender. The borrowers are generally the
dealers in stocks and shares.

Money Market Instruments

Money market is involved in buying and selling of short term instruments. It

is through these instruments, the players or participants borrow and lendmoney
in the money market. There are various instruments available in the money
market. The important money market instruments are:-
1. Call and short notice money
2. Commercial bills
3. Treasury bills
4. Certificate of deposits

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5. Commercial papers
6. Repurchase agreements
7. Money market mutual funds.
8. ADR/GDR

These instruments are issued for short period. These are interest bearing
securities. These instruments may be discussed in detail in the following pages.

1. Call and Short Notice Money

These are short term loans. Their maturity varies between one day to fourteen
days. If money is borrowed or lent for a day it is called call money or overnight money.
When money is borrowed or lent for more than a day and up to fourteen days, it is
called short notice money.

Surplus funds of the commercial banks and other institutions are usually
given as call money. Banks are the borrowers as well as the lenders for the call
money. Banks borrow call funds for a short period to meet the cash reserve ratio
(CRR) requirements. Banks repay the call fund back once the requirements have
been met. The interest rate paid on call loans is known as the call rate. It is a highly
volatile rate. It varies from day to day, hour to hour, and sometimes even minute
to minute. Features of Call and Short Notice Money
1. These are highly liquid.
2. The interest (call rate) is highly volatile.
3. These are repayable on demand.
4. Money is borrowed or lent for a very short period.
5. There is no collateral security demanded against these loans. This means they
are unsecured.
6. The risk involved is high.

2. Commercial Bills

When goods are sold on credit, the seller draws a bill of exchange on the
buyer for the amount due. The buyer accepts it immediately. This means heagrees
to pay the amount mentioned therein after a certain specified date. After accepting
the bill, the buyer returns it to the seller. This bill is called trade bill. The seller
may either retain the bill till maturity or due date or get it discounted from some
banker and get immediate cash. When trade bills are accepted by commercial
banks, they are called commercial bills. The bank discounts this bill by deducting
a certain amount (discount) and balance is paid.

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A bill of exchange contains a written order from the creditor (seller) to the
debtor (buyer) to pay a certain sum, to a certain person after a certain period.

According to Negotiable instruments Act, 1881, a bill of exchange is ‘an

instrument in writing containing an unconditional order, signed by the maker,
directing a certain person to pay a certain sum of money only to, or to the order
of a certain person or to the bearer of the instrument’.

Features of Commercial Bills

1. These are negotiable instruments.

2. These are generally issued for 30 days to 120 days. Thus these are short term
credit instruments.

3. These are self liquidating instruments with low risk.

4. These can be discounted with a bank. When a bill is discounted with a bank,
the holder gets immediate cash. This means bank provides credit to the customers.
The credit is repayable on maturity of the bill. In case of need for funds, the bank
can rediscount the bill in the money market and get ready money.

5. These are used for settling payments in the domestic as well as foreign trade.

6. The creditor who draws the bill is called drawer and the debtor who accepts
the bill is called drawee.

Types of Bills

Many types of bills are in circulation in a bill market. They may be broadly
classified as follows:
1. Demand Bills and Time Bills :- Demand bill is payable on demand. It is payable
immediately on presentation or at sight to the drawing. Demand bill is also
known as sight bill. Time bill is payable at a specified future date. Timebill is
also known as usance bill.
2. Clean Bills and Documentary Bills: When bills have to be accompanied by
documents of title to goods such as railway receipts, bill of lading etc. the bills
are called documentary bills. When bills are drawn without accompanying any
document, they are called clean bills. In such a case, documents will be directly
sent to the drawee.
3. Inland and Foreign Bills :- Inland bills are bills drawn upon a person resident in
India and are payable in India. Foreign bills are bills drawn outside India and
they may be payable either in India or outside India.

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4. Accommodation Bills and Supply Bills :- In case of accommodation bills, two

parties draw bills on each other purely for the purpose of mutual financial
accommodation. These bills are then discounted with the bankers and the
proceeds are shared among themselves. On the due dates, the parties make
payment to the bank. Accommodation bills are also known as ‘wind bills’ or
‘kite bills’. Supply bills are those drawn by suppliers or contactors on the Govt.
departments for the goods supplied to them. These bills are not considered as
negotiable instruments.

3. Treasury Bills

Treasury bills are short term instruments issued by RBI on behalf of Govt.
These are short term credit instruments for a period ranging from 91 to 364. These
are negotiable instruments. Hence, these are freely transferable. These are issued
at a discount. These are repaid at par on maturity. These are consideredas safe
investment.

Thus treasury bills are credit instruments used by the Govt. to raise short
term funds to meet the budgetary deficit. Treasury bills are popularly called T-
bills.

The difference between the amount paid by the tenderer at the time of purchase
(which is less than the face value), and the amount received on maturity
represents the interest amount on T-bills and is known as the discount.

Features of T-Bills

1. They are negotiable securities.

2. They are highly liquid.

3. There is no default risk (risk free). This is because they are issued by the
Govt.

4. They have an assured yield.

5. The cost of issue is very low. It does not involve stamp fee.

6. These are available for a minimum amount of Rs. 25000 and in multiples
thereof.

Types of T-Bills

There are two categories of T-Bills. They are:

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1. Ordinary or Regular T-Bills: These are issued to the public, banks and other
institutions to raise money for meeting the short term financial needs of the Govt.
These are freely marketable. These can be bought and sold at any time.

2. Ad hoc T-Bills: These are issued in favour of the RBI only. They are not sold
through tender or auction. They are purchased by the RBI on tap. The RBI is
authorised to issue currency notes against there.

On the basis of periodicity T-bills may be classified into four. They are as
follows :

1. 91-Day T-Bills
2. 14-Day T-Bills
3. 182-Day T-Bills: - These were introduced in November 1986 to provide short
term investment opportunities to financial institutions and others.
4. 364-Day T-Bills

4. Certificate of Deposits (CDs)

With a view to give investor’s greater flexibility in the development of their

short term surplus funds, RBI permitted banks to issue Certificate of Deposit.
CDs were introduced in June 1989. CD is a certificate in the form of promissory
note issued by banks against the short term deposits of companies and institutions,
received by the bank. Simply stated, it is a time deposit of specific maturity and is
easily transferable. It is a document of title to a time deposit. It is issued as a bearer
instrument and is negotiable in the market. It is payable on a fixed date. It has a
maturity period ranging from three to twelve months. It is issued at a discount rate
varying between 13% to 18%. The discount rate is determined by the issuing bank
and the market. All scheduled banks except Regional Rural Banks and scheduled
co-operative banks are eligible to issue CDs to the extent of 7% of deposits. It can
be issued to individuals, corporations, companies, trusts, funds and associations.

CDs are issued by banks during period of tight liquidity, at relatively high
interest rate. Banks rely on this source when the deposit growth is low but credit
demand is high. They can be issued to individuals, companies, trusts, funds,
associates, and others.

The main difference between fixed deposit and CD is that CDs are easily
transferable from one party to another, whereas FDs are non-transferable.

Features of CDs

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1. These are unsecured promissory notes issued by banks or financial

institutions.
2. These are short term deposits of specific maturity similar to fixed deposits.
3. These are negotiable (freely transferable by endorsement and delivery)
4. These are generally risk free.
5. The rate of interest is higher than that on T-bill or time deposits
6. These are issued at discount
7. These are repayable on fixed date.
8. These require stamp duty.

Guidelines for Issue of CDs

CDs are negotiable money market instruments. These are issued against
deposits in banks or financial institutions for a specified time period. RBI has
issued several guidelines regarding the issue of CDs. The following are the RBI
guidelines:

1. CDs can be issued by scheduled commercial banks (excluding RRBs and Local
Area Banks) and select all-India financial institutions.

2. Minimum of a CD should be Rs. 1 lakh i.e., the minimum deposit that could
be accepted from a single subscriber should not be less than Rs. 1 lakh and in
the multiples of Rs. 1 lakh thereafter.

3. CDs can be issued to individuals, corporations, companies, trusts, funds, and

associations. NRIs may also subscribe to CDs, but only on a repatriable basis.

4. The maturity period of CDs issued by banks should not be less than 7 days
and not more than one year. Financial institutions can issue CDs for a period not
less than one year and not exceeding 3 years from the date of issue.

5. CDs may be issued at a discount on face value. Bankers/Fls are also allowed
to issue CDs on a floating rate basis provided that the rate is objective, transparent
and market based.

6. Banks have to maintain the appropriate CRR and SLR requirements, on the issue
price of CDs.

7. Physical CDs are freely transferable by endorsement and delivery. Dematted CDs
can be transferred as per the procedure applicable to other demat securities. There is
no lock in period for CDs.

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8. Bank/Fls cannot grant loans against CDs. They cannot buy back their own CDs
before maturity.

9. Bankers/Fls should issue CDs only in the dematerialised form. However,according

to the depositories Act, 1996 investors have the option to seek a certificate in physical
form.

10. Since CDs are transferable, the physical certificate may be presented for
payment by the last holder.

5. Commercial Papers (CPs)

Commercial paper was introduced into the market in 1989-90. It is a finance

paper like Treasury bill. It is an unsecured, negotiable promissory note. It has a
fixed maturity period ranging from three to six months. It is generallyissued
by leading, nationally reputed credit worthy and highly rated corporations. It is
quite safe and highly liquid. It is issued in bearer form and on discount. It is also
known as industrial paper or corporate paper. CPs can be issued in multiples of Rs.
5 lakhs subject to the minimum issue size of Rs. 50 lakhs.

Thus a CP is an unsecured short term promissory note issued by leading,

creditworthy and highly rated corporates to meet their working capital
requirements. In short, a CP is a short term unsecured promissory note issued
by financially strong companies.

Advantages of Commercial Paper

1. These are simple to issue.

2. The issuers can issue CPs with maturities according to their cash flow.

3. The image of the issuing company in the capital market will improve. This
makes easy to raise long term capital

4. The investors get higher returns

5. These facilitate securitisation of loans. This will create a secondary market

for CP.

Disadvantages of Commercial Papers

1. It cannot be repaid before maturity.

2. It can be issued only by large, financially strong firms.

6. Repurchase Agreements (REPO)

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REPO is basically a contract entered into by two parties (parties include RBI,
a bank or NBFC. In this contract, a holder of Govt. securities sells the securities to
a lender and agrees to repurchase them at an agreed future date at an agreed
price. At the end of the period the borrower repurchases the securities at the
predetermined price. The difference between the purchase price and the original price
is the cost for the borrower. This cost of borrowing is called repo rate.

A transaction is called a Repo when viewed from the perspective of the seller
of the securities and reverse when described from the point of view of the suppliers of
funds. Thus whether a given agreement is termed Repo or Reverse Repo depends
largely on which party initiated the transaction.

Thus Repo is a transaction in which a participant (borrower) acquires

immediate funds by selling securities and simultaneously agrees to repurchase the
same or similar securities after a specified period at a specified price. It isalso
called ready forward contract.

7. Money Market Mutual Funds (MMMFs)

Money Market Mutual Funds mobilise money from the general public. The
money collected will be invested in money market instruments. The investors get
a higher return. They are more liquid as compared to other investment
alternatives.

The MMMFs were originated in the US in 1972. In India the first MMMF was
set up by Kothari Pioneer in 1997. But this did not succeed.

Advantages of MMMFs

1. These enable small investors to participate in the money market.

2. The investors get higher return.

3. These are highly liquid.

4. These facilitate the development of money market.

Disadvantage of MMMFs

1. Heavy stamp duty.

2. Higher flotation cost.

3. Lack of investors education.

8. American Depository Receipt and Global Depository Receipt

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ADRs are instruments in the nature of depository receipt and certificate.

These instruments are negotiable and represent publicly traded, local currency
equity shares issued by non - American company. For example, an NRI can invest
in Indian Company’s shares without bothering dollar conversion and other
exchange formalities.

If the facilities extended globally, these instruments are called GDR. ADR are
listed in American Stock exchanges and GDR are listed in other than American
Stock exchanges, say Landon, Luxembourg, Tokyo etc.,

Structure of the Indian Money Market

In the Indian money market RBI occupies a key role. It is the nerve centre of
the monetary system of our country. It is the leader of the Indian money market.
The Indian money market is highly disintegrated and unorganized. The Indian money
market can be divided into two sectors - unorganized and organised. In between
these two, there exists the co-operative sector. It can be included in the organised
sector.

The organised sector comprises of RBI, SBI group of banks, public sector banks,
private sector banks, development banks and other financial institutions. The
unorganised sector comprises of indigenous bankers, money lenders, chit funds etc.
These are outside the control of RBI. This is the reason why Indian money market
remains underdeveloped.

Features or Defects of the Indian Money Market

The features or defects of the Indian money market are as follows:

1. Existence of unorganised segment: The most important defect of the Indian

money market is the existence of unorganised segment. The unorganised segment
comprises of indigenous bankers, moneylenders etc. This unorganised sector does not
follow the rules and regulations of the RBI. Besides, a higher rate of interest prevails
in the unorganised market.

2. Lack of integration: Another important drawback of the Indian money market

is that the money market is divided into different sections. Unfortunately these
sections are loosely connected to each other. There is no co-ordination between
the organised and unorganised sectors. With the setting up of the RBI and the
passing of the Banking Regulations Act, the conditions have improved.

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3. Disparities in interest rates: Interest rates in different money markets and in

different segments of money market still differ. Too many interest rates are prevailing
in the market. For example, borrowing rates of Govt. lending rate of commercial banks,
the rates of co-operative banks and rates of financial institutions. This disparity in
interest rates is due to lack of mobility of funds from one segment to another.

4. Seasonal diversity of money market: The demand for money in Indian money
market is of seasonal in nature. During the busy season from Novemberto June,
money is needed for financing the marketing of agricultural products, seasonal
industries such as sugar, jaguar, etc. From July to October the demand for money
is low. As a result, the money rates fluctuate from one period toanother.

5. Absence of bill market: The bill market in India is not well developed. There
is a great paucity of sound commercial bills of exchange in our country. As a matter
of habit, Indian traders resort to hundies rather than properly drawn bill of
exchange.

6. Limited instruments: The supply of short term instruments like commercial

bills, treasury bills etc. are very limited and inadequate.

7. Limited number of participants: The participants in the Indian money

market are limited. Entry in the money market is tightly regulated.

8. Restricted secondary market: Secondary market for money market

instruments is mainly restricted to rediscounting of commercial bills and treasury
bills.

9. No contact with foreign money markets: Indian money market has little
contract with money markets in other countries.

In totality it can be concluded that Indian money market is relatively

underdeveloped.

Players or Participants in the Indian Money Market

The following are the players in the Indian money market:

1. Govt.

2. RBI

3. Commercial banks

4. Financial institutions like IFCI, IDBI, ICICI, SIDBI, UTI, LIC etc.

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5. Discount and Finance House of India.

6. Brokers

7. Mutual funds

8. Public sector undertakings

9. Corporate units

Recent Developments in the Indians Money Market

The recent developments in the Indian money market may be briefly

explained as below:
1. Integration of unorganised sector with the organised sector : RBI has taken
many steps to bring the institutions in the unorganised sector within its control
and regulation. These institutions are now slowly coming under the organised
sector. They started availing of the rediscounting facilities from the RBI.
2. Widening of call money market: In recent years, many steps have been taken
to widen the call money market. The number of participants in the call money
market is increasing. LIC, GIC, IDBI, UTI and specialised mutual funds have been
permitted to enter into this market as lenders only. The DFHI and STCIhave
been permitted to operate both as lenders and borrowers.
3. Introduction of innovative instruments: New financial instruments have been
introduced in the money market. On the recommendation of the Chakkraborty
Committee, the RBI introduced 192 days T-bills since 1986. A new instrument in
the form of 364 days T-bills was introduced at the end of April 1992. Again, new
instruments such as CDs, CPs, and interbank participation certificates have been
introduced. Necessary guidelines also have been issued for the operation of these
instruments.
4. Introduction of negotiable dealing system : As negotiable dealing system has
been introduced with a view to facilitating electronic bidding in auctions and
secondary market transactions in Govt. securities and dissemination of
information.
5. Offering of market rates of interest: In order to popularise money market
instruments, the ceiling on interest rate has been abolished. Call money rate, bill
discounting rate, inter bank rate etc. have been freed from May 1, 1989. Thus, today
Indian money market offers full scope for the play of market forces in determining the
rates of interest.
6. Satellite system dealership: The satellite system dealership was launched in
1996 to serve as a second tier to primary dealers in retailing of Govt. securities.

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RBI has decided to allow players such as provident funds, trusts to participate in
government bond auctions, on a non-competitive basis.
7. Promotion of bill culture: All attempts are being taken to discourage cash credit
and overdraft system of financing and to popularise bill financing. Exemption from
stamp duty is given on rediscounting of derivative usance promissory notes arising
out of genuine trade bill transactions. This is done to promote bill culture in the
country.
8. Introduction of money market mutual funds: Recently certain private sector mutual
funds and subsidiaries of commercial banks have been permitted to deal in money
market instrument. This has been done with a view to expand the money market
and also to develop secondary market for money market instruments.

9. Setting up of credit rating agencies: Recently some credit rating agencies have been
established. The important agencies are the Credit Rating Information Services of
India Ltd (CRISIL), Investment Information and Credit Rating Agency of India
(IICRA) and, Credit Analysis and Research Ltd. (CARE). These have been set up to
provide credit information through financial analysis of leading companies and
industrial sectors.

10. Adoption of suitable monetary policy: In recent years the RBI is adopting a more
realistic and appropriate monetary and credit policies. The main objective is to
increase the availability of resources in the money market and make the money
market more active.

11. Establishment of DFHI: The DFHI was set up in 1988 to activate the money
market and to promote a secondary market for all money market instruments.

12. Setting up of Securities Trading Corporation of India Ltd. (STCI) : The RBI has
set p the STCI in May 1994. Its main objective is to provide a secondary market in
Govt. securities. It has enlarged the T-bill market and the call market and provided
an active secondary market for T-bills.

Because of these recent developments, the Indian money market is developing.

Discount and Finance House of India

The DFHI was set up in April 1988 as a specialised money market institution.
It was set up as for the recommendations of the Vaghal Committee. DFHI was given
the specific task of widening and deepening the money market. The DFHI was set
up jointly by the RBI, public sector banks and financial institutions.

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Main Objectives of DFHI

1. To provide liquidity to money market instruments.

2. To provide safe and risk free short term investment avenues to institutions.

3. To facilitate money market transactions of small and medium sized

institutions that are not regular participants in the market.

4. To integrate the various segments of the money market.

5. To develop a secondary market for money market instruments.

Functions and Role of DFHI

1. To discount, rediscount, purchase and sell treasury bills, trade bills

of exchange, commercial bills and commercial papers.

2. To play an important role as a lender, borrower or broker in the

interbank call money market.

3. To promote and support company funds, trusts and other

organisations for the development of short term money market.

4. To advise Government, banks, and financial institutions involving

schemes for growth and development of money market.

5. To undertake buy back arrangements in trade bills and treasury bills

as well as securities of local authorities, public sector institutions,
Govt. and commercial and non-commercial houses.

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MODULE III

CAPITAL MARKET

There are many persons or organizations that require capital. Similarly,

there are several persons or organizations that have surplus capital. They want to
dispose of (or invest) their surplus capital. Capital market is a meeting place of
these two broad categories of persons or organizations.

Meaning and Definition of Capital Market

Capital market simply refers to a market for long term funds. It is a market
for buying and selling of equity, debt and other securities. Generally, it deals with
long term securities that have a maturity period of above one year.

Capital market is a vehicle through which long term finance is channelized

for the various needs of industry, commerce, govt. and local authorities. According
to W.H. Husband and J.C. Dockerbay, “the capital market is used to designate
activities in long term credit, which is characterised mainly by securities of
investment type”.

Thus, capital market may be defined as an organized mechanism for the

effective and smooth transfer of money capital or financial resources from the
investors to the entrepreneurs.

Characteristics of Capital Market

1. It is a vehicle through which capital flows from the investors to borrowers.

2. It generally deals with long term securities.

3. All operations in the new issues and existing securities occur in the capital
market.

4. It deals in many types of financial instruments. These include equity shares,

preference shares, debentures, bonds, etc. These are known as securities. It is for
this reason that capital market is known as ‘Securities Market’.

5. It functions through a number of intermediaries such as banks, merchant bankers,

brokers, underwriters, mutual funds etc. They serve as links between investors and
borrowers.

6. The constituents (players) in the capital market include individuals and

institutions. They include individual investors, investment and trust companies,
banks, stock exchanges, specialized financial institutions etc.

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Functions of a Capital Market

The functions of an efficient capital market are as follows:

1. Mobilise long term savings for financing long term investments.

2. Provide risk capital in the form of equity or quasi-equity to entrepreneurs.

3. Provide liquidity with a mechanism enabling the investor to sell financial

assets.

4. Improve the efficiency of capital allocation through a competitive pricing

mechanism.

5. Disseminate information efficiently for enabling participants to develop an

informed opinion about investment, disinvestment, reinvestment etc.

6. Enable quick valuation of instruments – both equity and debt.

7. Provide insurance against market risk through derivative trading and default
risk through investment protection fund.

8. Provide operational efficiency through: (a) simplified transaction procedures,

(b) lowering settlement times, and (c) lowering transaction costs.

9. Develop integration among: (a) debt and financial sectors, (b) equity and debt
instruments, (c) long term and short term funds.

10. Direct the flow of funds into efficient channels through investment and
disinvestment and reinvestment.

Distinguish between Money Market and Capital Market

Money market Capital market

1. Short term funds 1. Long term funds

2. Operational/WC needs 2. FC/PC requirements

3. Instruments are: bills, CPs, 3. Shares, debentures, bonds etc., are

T-bills, CDs etc., main instruments in capital market

4. Huge face value for single instrument 4. Small face value of securities

5. Central and coml. banks are major 5. Development banks, investment

players institutions are major players

6. No formal place for transactions 6. Formal place, stock exchanges

7. Usually no role for brokers 7. Brokers playing a vital role

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Importance of Capital Market

The importance of capital market is outlined as below:

1. Mobilisation of savings: Capital market helps in mobilizing the savings of the

country. It gives an opportunity to the individual investors to employ their savings
in more productive channels.

2. Capital formation: Large amount is required to invest in infrastructural

foundation. Such a large amount cannot be collected from one individual or few
individuals. Capital market provides an opportunity to collect funds from a large
number of people who have investible surplus. In short, capital market plays a vital
role in capital formation at a higher rate.

3. Economic development: With the help of capital market, idle funds of thesavers
are channelized to the productive sectors. In this way, capital markethelps in the
rapid industrialization and economic development of a country.

4. Integrates different parts of the financial system: The different components of

the financial system includes new issue market, money market, stock exchange etc.
It is the capital market which helps to establish a close contact among different
parts of the financial system. This is essential for the growth of aneconomy.

5. Promotion of stock market: A sound capital market promotes an organized stock

market. Stock exchange provides for easy marketability to securities. A readymade
market is available to buyers and sellers of securities.

6. Foreign capital: Multinational Corporations and foreign investors will be ready

to invest in a country where there is a developed capital market. Thus capital
market not only helps in raising foreign capital but the foreign technology also
comes within the reach of the local people.

7. Economic welfare: Capital market facilitates increase in production and

productivity in the economy. It raises the national income of the country. In this way,
it helps to promote the economic welfare of the nation.

8. Innovation: Introduction of a new financial instrument, finding new sources of

funds, introduction of new process etc. are some of the innovations introduced in
capital market. Innovation ensures growth.

Components of Capital Market

There are four main components of capital market. They are: (a) Primary
market, (b) Government Securities Market, (c) Financial Institutions, and (d)
Secondary Market

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These components of capital market may be discussed in detail in the

following pages:
A. Primary Market /New Issue Market (NIM)

Every company needs funds. Funds may be required for short term or long term.
Short term requirements of funds can be met through banks, lenders, institutions etc.
When a company wishes to raise long term capital, it goes to the primary market.
Primary market is an important constituent of a capital market.In the primary
market the security is purchased directly from the issuer.

Meaning of Primary Market

The primary market is a market for new issues. It is also called new issue market.
It is a market for fresh capital. It deals with the new securities which were not
previously available to the investing public. Corporate enterprises and Govt. raises
long term funds from the primary market by issuing financial securities.

Both the new companies and the existing companies can issue new securities
on the primary market. It also covers raising of fresh capital by government or its
agencies.

The primary market comprises of all institutions dealing in fresh securities. These
securities may be in the form of equity shares, preference shares, debentures, right
issues, deposits etc.

Functions of Primary Market

The main function of a primary market can be divided into three

service functions. They are: origination, underwriting and distribution.

1. Origination: Origination refers to the work of investigation, analysis and

processing of new project proposals. Origination begins before an issue is
actually floated in the market. The function of origination is done by
merchant bankers who may be commercial banks, all India financial
institutions or private firms.

2. Underwriting: When a company issues shares to the public it is not sure that
the whole shares will be subscribed by the public. Therefore, in orderto
ensure the full subscription of shares (or at least 90%) the company may
underwrite its shares or debentures. The act of ensuring the sale of shares
or debentures of a company even before offering to the public is called
underwriting. It is a contract between a company and an underwriter
(individual or firm of individuals) by which he agrees to undertake that part
of shares or debentures which has not been subscribed by the public. The firms
or persons who are engaged in underwriting are called underwriters.

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3. Distribution: This is the function of sale of securities to ultimate investors.

This service is performed by brokers and agents. They maintain a direct and
regular contact with the ultimate investors.

Methods of Raising Fund in the Primary Market (Methods of Floating New

Issues)

A company can raise capital from the primary market through various
methods. The methods include public issues, offer for sale, private placement,
right issue, and tender method.

a. Public Issues

This is the most popular method of raising long term capital. It means raising
funds directly from the public. Under this method, the company invites subscription
from the public through the issue of prospectus (and issuing advertisements in news
papers). On the basis of offer in the prospectus, the investors apply for the number
of securities they are willing to take. In response to application for securities, the
company makes the allotment of shares, debentures etc.

Types of Public Issues: Public issue is of two types, namely, initial public offer and
follow-on public offer.

Initial Public Offering (IPO): This is an offering of either a fresh issue of securities
or an offer for sale of existing securities or both by an unlisted company for the
first time in its life to the public. In short, it is a method of raising securities in
which a company sells shares or stock to the general public for the first time.

Follow-on Public Offering (FPO): This is an offer of sale of securities by a listed

company. This is an offering of either a fresh issue of securities or an offer for sale
to the public by an already listed company through an offer document.

Methods of Determination of Prices of New Shares

Equity offerings by companies are offered to the investors in two forms – (a)
fixed price offer method, and (b) book building method.

Fixed Price Offer Method

In this case, the company fixes the issue price and then advertises the
number of shares to be issued. If the price is very high, the investors will apply
for fewer numbers of shares. On the other hand, if the issue is under-priced, the
investors will apply for more number of shares. This will lead to huge over
subscription.

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The main steps involved in issue of shares under fixed price offer method
are as follows:

1. Selection of merchant banker

2. Issue of a prospectus

3. Application for shares

4. Allotment of shares to applicants

5. Issue of Share Certificate

Book-building Method

It was introduced on the basis of recommendations of the committee constituted

under the chairmanship of Y.H. Malegam in October, 1995. Under this method, the
company does not price the securities in advance. Instead, it offers the investors an
opportunity to bid collectively. It then uses the bids to arrive at a consensus price.
All the applications received are arranged and a final offer price (known as cut off
price) is arrived at. Usually the cut off price is the weighted average price at which the
majority of investors are willing to buy the securities. In short, book building means
selling securities to investors at an acceptable price with the help of intermediaries
called Book-runners. It involves sale of securities to the public and institutional
bidders on the basis of predetermined price range or price band. The price band
cannot exceed 20% ofthe floor price. The floor price is the minimum price at which
bids can be made by the investors. It is fixed by the merchant banker in consultation
with the issuing company. Thus, book building refers to the process under which
pricingof the issue is left to the investors.

Today most IPOs in India use book-building method. As per SEBI’s guidelines
1997, the book building process may be applied to 100 per cent of the issue, if the
issue size is 100 crores or more.

b. Offer for Sale Method

Under this method, instead of offering shares directly to the public by the
company itself, it offers through the intermediary such as issue houses / merchant
banks / investment banks or firms of stock brokers.

Under this method, the sale of securities takes place in two stages. In the first
stage, the issuing company sells the shares to the intermediaries such as issue
houses and brokers at an agreed price. In the second stage, the intermediaries
resell the securities to the ultimate investors at a market related price. This price
will be higher. The difference between the purchase price and the issue price
represents profit for the intermediaries. The intermediaries are responsible for
meeting various expenses. Offer for sale method is also called bought out deal.
This method is not common in India.

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c. Private Placement of Securities

Private placement is the issue of securities of a company direct to one

investor or a small group of investors. Generally the investors are the financial
institutions or other existing companies or selected private persons such as friends
and relatives of promoters. A private company cannot issue a prospectus. Hence it
usually raises its capital by private placement. A public limited company can also
raise its capital by placing the shares privately and without inviting the public for
subscription of its shares. Company law defines a privately placedissue to be the
one seeking subscription from 50 members. In a private placement, no prospectus
is issued. In this case the elaborate procedure required in the case of public issue
is avoided. Therefore, the cost of issue is minimal. The process of raising funds is
also very simple. But the number of shares that can be issued in a private
placement is generally limited.

Thus, private placement refers to the direct sale of newly issued securities
by the issuer to a small number of investors through merchant bankers.

d. Right Issue

Right issue is a method of raising funds in the market by an existing

company. Under this method, the existing company issues shares to its existing
shareholders in proportion to the number of shares already held by them. Thusa
right issue is the issue of new shares in which existing shareholders are given pre-
emptive rights to subscribe to the new issue on a pro-rata basis.

According to Section 81 (1) of the Companies Act, when the company wants
to increase the subscribed capital by issue of further shares, such shares must
be issued first of all to existing shareholders in proportion of their existing
shareholding. The existing shareholders may accept or reject the right.
Shareholders who do not wish to take up the right shares can sell their rights to
another person. If the shareholders neither subscribe the shares nor transfer their
rights, then the company can offer the shares to public.

A company making right issue is required to send a circular to all existing

shareholders. The circular should provide information on how additional funds
would be used and their effect on the earning capacity of the company. The
company should normally give a time limit of at least one month to two months to
shareholders to exercise their rights before it is offered to the public. No new
company can make right issue.

Promoters offer right issue at attractive price often at a discount to the

market price due to a variety of reasons. The reasons are: (a) they want to get their
issues fully subscribed to, (b) to reward their shareholders, (c) it is possible that
the market price does not reflect a share’s true worth or that it is over- priced, (d)
to increase their stake in the companies so as to avoid preferential allotment.

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e. Other Methods of Issuing Securities

Apart from the above methods, there are some other methods of issuing
securities. They are:

1. Tender method: Under tender method, the issue price is not predetermined.The
company announces the public issue without indicating the issue price. It invites bids
from various interested parties. The parties participating in the tender submit their
maximum offers indicating the maximum price they are willing to pay. They should
also specify the number of shares they are interested to buy. The company, after
receiving various offers, may decide about the pricein such a manner that the entire
issue is fairly subscribed or sold to the parties participating in the tender.

2. Issue of bonus shares: Where the accumulated reserves and surplus ofprofits
of a company are converted into paid up capital, it is called bonus issue.It simply
refers to capitalization of existing reserves and surpluses of a company.

3. Offer to the employees: Now a days companies issue shares on a preferential basis
to their employees (including whole time directors). This attracts, retains and
motivates the employees by creating a sense of belonging and loyalty.Generally
shares are issued at a discount. A company can issue shares to theiremployees under
the following two schemes: (a) Employee stock option scheme and (b) employee
stock purchase scheme.

4. Offer to the creditors: At the time of reorganization of capital, creditors may

be issued shares in full settlement of their loans.

5. Offer to the customers: Public utility undertakings offer shares to their

customers.

Procedure of Public Issue

Under public issue, the new shares/debentures may be offered either

directly to the public through a prospectus (offer document) or indirectly through
an offer for sale involving financial intermediaries or issue houses. The main steps
involved in public issue are as follows:

1. Draft prospectus: A draft prospectus has to be prepared giving all required

information. Any company or a listed company making a public issue or a right
issue of value more than Rs. 50 lakh has to file a draft offer document with SEBI for
its observation. The company can proceed further after getting observations from
the SEBI. The company can open its issue within 3 months from the date of SEBI’s
observation letter.

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2. Fulfilment of Entry Norms: The SEBI has laid down certain entry norms
(parameters) for accessing the primary market. A company can enter into the
primary market only if a company fulfils these entry norms.

3. Appointment of underwriters: Sometimes underwriters are appointed to ensure

full subscription.

4. Appointment of bankers: Generally, the company shall nominate its own banker
to act as collecting agent. The bankers along with their branch network process the
funds procured during the public issue.

5. Initiating allotment procedure: When the issue is subscribed to the minimum

level, the registrars initiate the allotment procedure.

6. Appointment of brokers to the issue: Recognised members of the stock exchange

are appointed as brokers to the issue.

7. Filing of documents: Documents such as draft prospectus, along with the copies
of the agreements entered into with the lead manager, underwriters, bankers,
Registrars, and brokers to the issue have to be filed with the Registrar of
Companies.

8. Printing of prospectus and application forms: After filing the above

documents, the prospectus and application forms are printed and dispatched to all
merchant bankers, underwriters and brokers to the issue.

9. Listing the issue: It is very essential to send a letter to the stock exchange concerned
where the issue is proposed to be listed.

10. Publication in news papers: The next step is to publish an abridged version of
the prospectus and the commencing and closing dates of issues in major English
dailies and vernacular newspapers.

11. Allotment of shares: After close of the issue, all application forms are
scrutinised tabulated and then the shares are allotted against those applications
received.

Players or Participants (or Intermediaries) in the Primary market/Capital

Market

There are many players (intermediaries) in the primary market (or capital
market). Important players are as follows:

1. Merchant bankers: In attracting public money to capital issues, merchant

bankers play a vital role. They act as issue managers, lead managers or co-
managers (functions in detail is given in following pages)

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2. Registrars to the issue: Registrars are intermediaries who undertake all activities
connected with new issue management. They are appointed by the company in
consultation with the merchant bankers to the issue.

3. Bankers: Some commercial banks act as collecting agents and some act as co-
ordinating bankers. Some bankers act as merchant bankers and some are brokers.
They play an important role in transfer, transmission and safe custody of funds.

4. Brokers: They act as intermediaries in purchase and sale of securities in the

primary and secondary markets. They have a network of sub brokers spread
throughout the length and breadth of the country.

5. Underwriters: Generally investment bankers act as underwriters. They agreed

to take a specified number of shares or debentures offered to the public, if the issue
is not fully subscribed by the public. Underwriters may be financial institutions, banks,
mutual funds, brokers etc.

Special Features of the Indian Capital Market

Indian capital market has the following special features:

1. Greater reliance on debt instruments as against equity and in particular,

borrowing from financial institutions.

2. Issue of debentures specifically, convertible debentures with automatic or

compulsory conversion into equity without the normal option given to investors.

3. Floatation of Mega issues for the purpose of take over, amalgamation etc. and
avoidance of borrowing from financial institutions for the fear of their discipline
and conversion clause by the bigger companies, and this has now become optional.

4. Avoidance of underwriting by some companies to reduce the costs and avoid

scrutiny by the FIs. It has become optional now.

5. Fast growth of mutual funds and subsidiaries of banks for financial services leading
to larger mobilisation of savings from the capital market.

Defects of the Indian Primary Market

The Indian primary market has the following defects:

1. The new issue market is not able to mobilise adequate savings from the public.
Only 10% of the savings of the household sector go to the primary market.

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2. The merchant bankers do not play adequate attention to the technical,

managerial and feasibility aspects while appraising the project proposal. In fact,
they do not seem to play a development role. As a result, the small investors are
duped by the companies.

3. There is inordinate delay in the allotment process. This will discourage the
small investors to approach the primary market for investing their funds.

4. Generally there is a tendency on the part of the investors to prefer fixed income
bearing securities like preference shares and debentures. They hesitate to invest
in equity shares. There is a risk aversion in the new issue market. This standsin
the way of a healthy primary market.

5. There is a functional and institutional gap in the new issue market. A wholesale
market is yet to develop for new issue or primary market.

6. In the case of investors from semi-urban and rural areas, they have to incur
more expenses for sending the application forms to centres where banks are
authorized to accept them. The expenses in connection with this include bank
charges, postal expenses and so on. All these will discourage the small investors in
rural areas.

Over the years, SEBI, and Central Government have come up with a series
of regulatory measures to give a boost to new issue market.

B. Government Securities Market

This is another constituent of the capital market. The govt. shall borrow funds
from banks, financial institutions and the public, to finance its expenditure in
excess of its revenues. One of the important sources of borrowing funds is issuing Govt.
securities. Govt. securities are the instruments issued by central government, state
governments, semi-government bodies, public sector corporations and financial
institutions such as IDBI, IFCI, SFCs, etc. in the form of marketable debt. They
comprise of dated securities issued by both central and state governments including
financial institutions owned by the government. These are the debt obligations of
the government. Govt. securities are also known as Gilt-edged securities. Gilt refers
to gold. Thus govt. securities or gilt-edged securities are as pure as gold. This implies
that these are completely risk free (norisk of default).

Govt. securities market is a market where govt. securities are traded. It is the
largest market in any economic system. Therefore, it is the benchmark for other
market. Government securities are issues by:

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 Central Government

 State Government

 Semi-Government authorities like local government authorities, e.g., city

corporations and municipalities

 Autonomous institutions, such as metropolitan authorities, port trusts,

development trusts, state electricity boards.

 Public Sector Corporations

 Other governmental agencies, such as SFCs, NABARD, LDBs, SIDCs,

housing boards etc.

Characteristics of Gilt-edged Securities Market

a. Gilt-edged securities market is one of the oldest markets in India. The market
in these securities is a significant part of Indian stock market. Main
characteristics of government securities market are as follows:

b. Supply of government securities in the market arises due to their issue by

the Central, State of Local governments and other semi-government and
autonomous institutions explained above.

c. Government securities are also held by Reserve Bank of India (RBI) for
purpose and sale of these securities and using as an important instrument of
monetary control.

d. The securities issued by government organisations are government

guaranteed securities and are completely safe as regards payment of
interest and repayment of principal.

e. Gilt-edged securities bear a fixed rate of interest which is generally lower

than interest rate on other securities.

f. These securities have a fixed maturity period.

g. Interest on government securities is payable half-yearly.

h. Subject to the limits under the Income Tax Act, interest on these securities
is exempt from income tax.

i. The gilt-edged market is an ‘over-the-counter’ market and each sale and

purpose has to be negotiated separately.

j. The gilt-edged market is basically limited to institutional investors.

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C. Financial Institutions

Financial institutions are the most active constituent of the Indian capital
market. There are special financial institutions which provide medium and long
term loans to big business houses. Such institutions help in promoting new
companies, expansion and development of existing companies etc. The main
special financial institutions of the Indian capital are IDBI, IFCI, ICICI, UTI, LIC,
NIDC, SFCs etc.

New Financial Instruments in the Capital Market

With the evolution of the capital market, new financial instruments are
being introduced to suit the requirements of the market. Some of the new financial
instruments introduced in recent years may be briefly explained as below:

1. Floating rate bonds: The interest rate on these bonds is not fixed. It is a
concept which has been introduced primarily to take care of the falling market or
to provide a cushion in times of falling interest rates in the economy. It helps the
issuer to hedge the loss arising due to interest rate fluctuations. Thus there is a
provision to reduce interest risk and assure minimum interest on the investment.
In India, SBI was the first to introduce FRB for retail investors.

2. Zero interest bonds: These carry no periodic interest payment. These are sold
at a huge discount. These can be converted into equity shares or non-convertible
debentures

3. Deep discount bonds: These bonds are sold at a large discount while issuing
them. These are zero coupon bonds whose maturity is very high (say, 15 years).
There is no interest payment. IDBI was the first financial institution to offerDDBs
in 1992.

4. Auction related debentures: These are a hybrid of CPs and debentures. These are
secured, redeemable, non-convertible instrument. The interest on them is determined
by the market. These are placed privately with bids. ANZ Grindlays designed this new
instrument for Ashok Leyland Finance.

5. Secured Premium Notes: These are issued along with a detachable warrant. This
warrant gives the holder the right to apply for, or seek allotment of one equity
share, provided the SPN is fully paid. The conversion of detachable warrant into
equity shares is done within the time limit notified by the company. There is a lock in
period during which no interest is paid for the invested amount. TISCO was the
first company to issue SPN (in 1992) to the public along with the right issue.

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6. Option bonds: Option bonds can be converted into equity or preference shares
at the option of the investor as per the condition stated in the prospectus. These
may be cumulative or non-cumulative. In case of cumulative bonds the interest is
accumulated and is payable at maturity. In case of non-cumulative bonds, interest
is payable at periodic intervals.

7. Warrants: A share warrant is an option to the investor to buy a specified

number of equity shares at a specified price over a specified period of time. The
warrant holder has to surrender the warrant and pay some cash known as
‘exercise price’ of the warrant to purchase the shares. On exercising the option
the warrant holder becomes a shareholder. Warrant is yet to gain popularity in
India, due to the complex nature of the instrument.

8. Preference shares with warrants: These carry a certain number of warrants.

These warrants give the holder the right to apply for equity shares at premium at
any time in one or more stages between the third and fifth year from the date of
allotment.

9. Non-convertible debentures with detachable equity warrants: In this

instrument, the holder is given an option to buy a specified number of shares from
the company at a predetermined price within a definite time frame.

10. Zero interest fully convertible debentures: On these instruments, no interest

will be paid to the holders till the lock in period. After a notified period, these
debentures will be automatically and compulsorily converted into shares.

11. Fully convertible debentures with interest: This instrument carries no interest
for a specified period. After this period, option is given to apply for equities at
premium for which no additional amount is payable. However, interest is payable
at a predetermined rate from the date of first conversion to second / final
conversion and equity will be issued in lieu of interest.

12. Non-voting shares: The Companies Bill, 1997 proposed to allow companies to
issue non-voting shares. These are quasi -equity instruments with differential rights.
These shares do not carry voting right. Their divided rate is also not predetermined
like preference shares.

13. Inverse float bonds: These bonds are the latest entrants in the Indian capital
market. These are bonds carrying a floating rate of interest that is inversely related
to short term interest rates.

14. Perpetual bonds: These are debt instruments having no maturity date. The
investors receive a stream of interest payment for perpetuity.

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D. Secondary Market
The investors want liquidity for their investments. When they need cash,
they should be able to sell the securities they hold. Similarly there are others who
want to invest in new securities. There should be a place where securities of
different companies can be bought and sold. Secondary market provides such a
place.

Meaning of Secondary Market

Secondary market is a market for old issues. It deals with the buying and
selling existing securities i.e. securities already issued. In other words, securities
already issued in the primary market are traded in the secondary market.
Secondary market is also known as stock market. The secondary market operates
through ‘stock exchanges’.

In the secondary market, the existing owner sells securities to anotherparty.

The secondary markets support the primary markets. The secondary market
provides liquidity to the individuals who acquired these securities. The primary
market gets benefits greatly from the liquidity provided by the secondarymarket.
This is because investors would hesitate to buy the securities in the primary
market if they thought they could not sell them in the secondary market later.

In India, stock market consists of recognised stock exchanges. In the stock

exchanges, securities issued by the central and state governments, public bodies,
and joint stock companies are traded.

Stock Exchange

In India the first organized stock exchange was Bombay Stock Exchange.
It was started in 1877. Later on, the Ahmadabad Stock Exchange and Calcutta Stock
Exchange were started in 1894 and 1908 respectively. At present there are 24 stock
exchanges in India. In Europe, stock exchanges are often called bourses.

Meaning and Definition of Stock Exchange/ Security Exchange

It is an organized market for the purchase and sale of securities of joint stock
companies, government and semi- govt. bodies. It is the centre where shares,
debentures and govt. securities are bought and sold.

According to Pyle, “Security exchanges are market places where securities

that have been listed thereon may be bought and sold for either investment or
speculation”.

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The Securities Contract (Regulation) Act 1956, defines a stock exchange as “an
association, organisation or body of individuals whether incorporated or not, established
for the purpose of assisting, regulating and controlling of business in buying, selling and
dealing in securities”.

According to Hartley Withers, “a stock exchange is something like a vast

warehouse where securities are taken away from the shelves and sold across the
countries at a price fixed in a catalogue which is called the official list”.

In short, stock exchange is a place or market where the listed securities are
bought and sold.

Characteristics of a Stock Exchange

1. It is an organized capital market.

2. It may be incorporated or non-incorporated body (association or body of

individuals).

3. It is an open market for the purchase and sale of securities.

4. Only listed securities can be dealt on a stock exchange.

5. It works under established rules and regulations.

6. The securities are bought and sold either for investment or for speculative
purpose.

Economic Functions of Stock Exchange

The stock exchange performs the following essential economic functions:

1. Ensures liquidity to capital: The stock exchange provides a place where shares
and stocks are converted into cash. People with surplus cash can invest in
securities (by buying securities) and people with deficit cash can sell their
securities to convert them into cash.

2. Continuous market for securities: It provides a continuous and ready market for
buying and selling securities. It provides a ready market for those who wish tobuy
and sell securities

3. Mobilisation of savings: It helps in mobilizing savings and surplus funds of

individuals, firms and other institutions. It directs the flow of capital in the most
profitable channel.

4. Capital formation: The stock exchange publishes the correct prices of various
securities. Thus the people will invest in those securities which yield higher
returns. It promotes the habit of saving and investment among the public. In this
way the stock exchange facilitates the capital formation in the country.

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5. Evaluation of securities: The prices at which transactions take place are

recorded and made public in the forms of market quotations. From the price
quotations, the investors can evaluate the worth of their holdings.

6. Economic developments: It promotes industrial growth and economic

development of the country by encouraging industrial investments. New and existing
concerns raise their capital through stock exchanges.

7. Safeguards for investors: Investors’ interests are very much protected by the stock
exchange. The brokers have to transact their business strictly according to the
rules prescribed by the stock exchange. Hence they cannot overcharge the investors.

8. Barometer of economic conditions: Stock exchange reflects the changes taking

place in the country’s economy. Just as the weather clock tells us which way the
wind is blowing, in the same way stock exchange serves as an indicator of the
phases in business cycle-boom, depression, recessions and recovery.

9. Platform for public debt: The govt. has to raise huge funds for the development
activities. Stock exchange acts as markets of govt. securities. Thus, stock exchange
provides a platform for raising public debt.

10. Helps to banks: Stock exchange helps the banks to maintain liquidity by
increasing the volume of easily marketable securities.

11. Pricing of securities: New issues of outstanding securities in the primary

market are based on the prices in the stock exchange. Thus, it helps in pricing of
securities.

Thus stock exchange is of great importance to a country. It provides

necessary mobility to capital. It directs the flow of capital into profitable and
successful enterprises. It is indispensable for the proper functioning of corporate
enterprises. Without stock exchange, even govt. would find it difficult to borrow
for its various schemes. It helps the traders, investors, industrialists and the
banker. Hence, it is described as the business of business.

Benefits of Stock Exchange

A. Benefits to Investors

1. The stock exchange plays the role of a friend, philosopher and guide to investors
by providing information about the prices of various securities.

2. It offers a ready market for buying and selling securities.

3. It increases the liquidity of the investors.

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4. It safeguards the interests of investors through strict rules and regulations.

5. It enables the investors to know the present worth of their securities.

6. It helps investors in making wise investment decisions by providing useful

information about the financial position of the companies.

7. The holder of a listed security can easily raise loan by pledging it as a collateral
security.

B. Benefits to Companies

1. A company enjoys greater reputation and credit in the market. Image of the
company goes up.

2. A company can raise large amount of capital from different types of securities.

3. It enjoys market for its shares.

4. The market price for shares and debentures will be higher. Due to this the
bargaining power of the company increases in the events of merger or
amalgamation.

C. Benefits to Community and Nation

1. Stock exchange encourages people to sell and invest their savings in shares
and debentures.

2. Through capital formation, stock exchange enables companies to undertake

expansion and modernization. Stock exchange is an ‘Alibaba Cave’ from which
business community draw unlimited money.

3. It helps the government in raising funds through sale of government securities. This
enables the government to undertake projects of national importance and social
value.

4. It diverts the savings towards productive channels.

5. It helps in better utilisation of the country’s financial resources.

6. It is an effective indicator of general economic conditions of a country.

Listing of Securities

A stock exchange does not deal in the securities of all companies. Only those
securities that are listed are dealt with the stock exchange. For the purpose of
listing of securities, a company has to apply to the stock exchange. The stock exchange
will decide whether to list the securities of the company or not. If permission is
granted by the stock exchange to deal with the securities therein,
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then such a company is included in the official trade list of the stock exchange. This
is technically known as listing of securities. Thus listing of securities means
permission to quote shares and debentures officially on the trading floor of the
stock exchange. Listing of securities refers to the sanction of the right to trade
the securities on the stock exchange. In short, listing means admission of securities
to be traded on the stock exchange. If the securities are not listed, they are not
allowed to be traded on the stock exchange.

Objectives of Listing
The main objectives of listing are:
1. To ensure proper supervision and control of dealings in securities.
2. To protect the interests of shareholders and the investors.
3. To avoid concentration of economic power.
4. To assure marketing facilities for the securities.
5. To ensure liquidity of securities.
6. To regulate dealings in securities.
Advantages of Listing

A. Advantages to Company:-

1. It provides continuous market for securities (securities include shares,

debentures, bonds etc.)

2. It enhances liquidity of securities.

3. It enhances prestige of the company.

4. It ensures wide publicity.

5. Raising of capital becomes easy.

6. It gives some tax advantage to the company.

B. Advantages to Investors:-

1. It provides safety of dealings.

2. It facilitates quick disposal of securities in times of need. This means that

listing enhances the liquidity of securities.

3. It gives some tax advantage to the security holder.

4. Listed securities command higher collateral value for the purpose of bank
loans.

5. It provides an indirect check against manipulation by the management.

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Disadvantages of Listing

1. It leads to speculation

2. Sometimes listed securities are subjected to wide fluctuations in their value.

This may degrade the company’s reputation.

3. It discloses vital information such as dividends and bonus declared etc. to

competitors.

4. Company has to spend heavily in the process of placing the securities with
public

Classification of Listed Securities

The listed shares are generally divided into two categories - Group A shares
(cleared securities) and Group B shares (non-cleared securities). Group A shares
represent large and well established companies having a broad investor base.
These shares are actively traded. Forward trading is allowed in Group A shares.
These facilities are not available to Group B shares. These are not actively traded.
Carry forward facility is not available in case of these securities.

Requirements of Listing (Procedure of Listing)

Any company intending to get its securities listed at an exchange has to fulfil
certain requirements. The application for listing is to be made in the prescribed
form. It should be supported by the following documents:

a) Memorandum and Articles.

b) Copies of all prospectuses or statements in lieu of prospectuses.

c) Copies of balance sheets, audited accounts, agreements with promoters,

underwriters, brokers etc.

d) Letters of consent from SEBI.

e) Details of shares and debentures issued and shares forfeited.

f) Details of bonus issues and dividends declared.

g) History of the company in brief.

h) Agreement with managing director etc.

i) An undertaking regarding compliance with the provisions of the Companies Act

and Securities Contracts (Regulation) Act as well as rules made therein.

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After the application is made to the stock exchange the listing committee of
the stock exchange will go into the details of the application. It has to ensure that
the company fulfils the conditions or criteria necessary for listing

Procedure for Dealing at Stock Exchange (Trading Mechanism or Method of

Trading on a Stock Exchange)

Outsiders are not allowed to buy or sell securities at a stock exchange. They
have to approach brokers. Dealings can be done only through brokers. They are
the members of the stock exchange. The following procedure is followed for
dealing at exchanges:

1. Selection of a broker: An individual cannot buy or sell securities directly at

stock exchange. He can do so only through a broker. So he has to select a broker
through whom the purchase or sale is to be made. The intending investor or
seller may appoint his bank for this purpose. The bank may help to choose the
broker.

2. Placing an order: After selecting the broker, the next step is to place an order
for purchase or sale of securities. The broker also guides the client about the type
of securities to be purchased and the proper time for it. If a client is to sell the
securities, then the broker shall tell him about the favourable time for sale.

3. Making the contract: The trading floor of the stock exchange is divided into
different parts known as trading posts. Different posts deal in different types of
securities. The authorised clerk of the broker goes to the concerned post and expresses
his intention to buy and sell the securities. A deal is struck when the other party also
agrees. The bargain is noted by both the parties in their note books. As soon as order
is executed a confirmation memo is prepared and is given to the client.

4. Contract Note: After issue of confirmation memo, a contract note is signed

between the broker and the client. This contract note will state the transaction fees
(commission of broker), number of shares bought or sold, price at which they are
bought or sold, etc.

5. Settlement: Settlement involves making payment to sellers of shares and

delivery of share certificate to the buyer of shares after receiving the price. The
settlement procedure depends upon the nature of the transactions. All the
transactions on the stock exchange may be classified into two- ready delivery
contracts and forward delivery contracts.

a. Ready delivery contract: A ready delivery contract involves the actual payment
of the amount by the buyer in cash and the delivery of securities by the seller. A
ready delivery contract is to be settled on the same day or within the time period
fixed by the stock exchange authorities.

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b. Forward delivery contracts: These contracts are entered into without any intention
of taking and giving delivery of the securities. The traders in forward delivery
securities are interested in profits out of price variations in the future. Such
transactions are settled on the settlement days fixed by the stock exchange authorities.
Such contracts can be postponed to the next settlement day, if both the parties agree
between themselves. Such postponement is called ‘Carry over’ or ‘badla’. Thus
‘carry over’ or ‘badla’ means the postponement of transaction from one settlement
period to the next settlement period.

Rolling Settlement

Rolling settlement has been introduced in the place of account period

settlement. Rolling settlement system was introduced by SEBI in January 1998. Under
this system of settlement, the trades executed on a certain day are settled based on the
net obligations for that day. At present, the trades relating to the rolling settlement
are settled on T + 2day basis where T stands for the trade day.It implies that the
trades executed on the first day (say on Monday) have to be settled on the 3rd day
(on Wednesday), i.e., after a gap of 2 days.

This cycle would be rolling and hence there would be number of set of
transactions for delivery every day. As each day’s transaction are settled in full,
rolling settlement helps in increasing the liquidity in the market. With effect from
January 2, 2002, all scrips have been brought under compulsory rolling mode.

Members in a Stock Exchange

Only members of the exchange are allowed to do business of buying and

selling of securities at the floor of the stock exchange. A non-member (client) can
buy and sell securities only through a broker who is a member of the stock
exchange. To deal in securities on recognised stock exchanges, the broker should
register his name as a broker with the SEBI.

Brokers are the main players in the secondary market. They may act in
different capacities as a principal, as an agent, as a speculator and so on.

Types of Members in a Stock Exchange

The various types of members of a stock exchange are as follows:-

1. Jobbers :- They are dealers in securities in a stock exchange. They cannot deal
on behalf of public. They purchase and sell securities on their own names. Their
main job is to earn profit due to price variations.

2. Commission brokers :- They are nothing but brokers. They buy and sell
securities no behalf of their clients for a commission. They are permitted to deal
with non-members directly. They do not purchase or sell in their own name.
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3. Tarawaniwalas :- They are like jobbers. They handle transactions on a

commission basis for their brokers. They buy and sell securities on their own
account and may act as brokers on behalf of the public.

4. Sub-brokers :- Sub brokers are agents of stock brokers. They are employed by
brokers to obtain business. They cannot carry on business in their own name. They
are also known as remisiers.

5. Arbitrageurs :- They are brokers. They buy security in one market and sell the
same in another market to get opportunistic profit.

6. Authorised clerks :- Authorised clerks are those who are appointed by stock
brokers to assist them in the business of securities trading.

Speculation

Speculation is an attempt to make capital gain from the price movement of

the scrips in the security market over a short span of time. Those who engaged in
such type of transactions are called speculators. They buy and sell securities
frequently and are not interested in keeping them for long term. Speculation
involves high risks. If the expectation of speculators comes true he can make profit
but if it goes wrong the loss could be detrimental.

Type of Speculators

The following on the different kinds of speculators:

1. Bull: A bull or Tejiwala is a speculator who buys shares in expectation of selling

them at higher prices in future. He believes that current prices are lower and will
rise in the future.

2. Bear: A bear or Mandiwala is a speculator who sells securities with the

intention to buy at a later date at a lower price. He expects a fall in price in
future.

3. Lame duck: A lame duck is a bear speculator. He finds it difficult to meet his
commitments and struggles like a lame duck. This happens because of the non-
availability of securities in the market which he has agreed to sell and at the
same time the other party is not willing to postpone the transaction.

4. Stag: Stag is a member who neither buys nor sells securities. He applies for
shares in the new issue market. He expects that the price of shares will soon
increase and the shares can be sold for a premium.

5. Wolf: Wolf is a broker who is fast speculator. He is very quick to perceive

changes in the market trends and trade fast and make fast profit.

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Speculative Transactions

Some of the speculative dealings are as follows:

1. Option deals: This is an arrangement or right to buy or sell securities at a

predetermined price on or before a specified date in future.

2. Wash sales: It is a device through which a speculator is able to reap huge profits
by creating a misleading picture in the market. It is a kind of fictitious transaction
in which a speculator sells a security and then buys the same at a higher price
through another broker. Thus he creates a false or misleading opinion in the
market about the price of a security.

3. Rigging: If refers to the process of creating an artificial condition in the market

whereby the market value of a particular security is pushed upon. Bulls buy
securities, create demand for the same and sell them at increased prices.

4. Arbitrage: It is the process of buying a security, from a market where price is lower
and selling at in another market where price is higher.

5. Cornering: Sometimes speculators make entire or a major share of supply of a

particular security with a view to create a scarcity against the existing contracts.
This is called cornering.

6. Blank transfer: When the transferor (seller) simply signs the transfer form
without specifying the name of the transferee (buyer), it is called blank transfer.
In this case share can further be transferred by mere delivery of transfer deed together
with the share certificate. A new transfer deed is not required at the timeof each
transfer. Hence, expenses such as registration fees, stamp duty, etc can be saved.

7. Margin trading: Under this method, the client opens an account with his
broker. The client makes a deposit of cash or securities in this account. He also
agrees to maintain a minimum margin of amount always in his account. When a
broker purchases securities on behalf of his client, his account (client’s account)
will be debited and vice versa. The debit balance, if any, is automatically secured
by the client’s securities lying with the broker. In case it falls short of the minimum
agreed amount, the client has to deposit further amount into his account or he has
to deposit further securities. If the prices are favourable, the client may instruct
his broker to sell the securities. When such securities aresold, his account will
be credited. The client may have a bigger margin now for further purchases.

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Factors Influencing Prices on Stock Exchange

The prices on stock exchange depend upon the following factors:
1. Financial position of the company
2. Demand and supply position
3. Lending rates
4. Attitudes of the FIIs and the developments in the global financial markets.
5. Govt. Policies (credit policies, monetary policies, taxation policies etc.)
6. Trade cycle
7. Speculation activities

Defects of Stock Exchanges (or Capital Market) in India

The Indian stock market is suffering from a number of weaknesses.

Important weaknesses are as follows:

1. Speculative activities: Most of the transactions in stock exchange are carry

forward transactions with a speculative motive of deriving benefit from short term
price fluctuation. Genuine transactions are only less. Hence market is not subject
to free interplay of demand and supply for securities.

2. Insider trading: Insider trading has been a routine practice in India. Insiders are
those who have access to unpublished price-sensitive information. By virtue of
their position in the company they use such information for their own benefits.

3. Poor liquidity: The Indian stock exchanges suffer from poor liquidity. Though
there are approximately 8000 listed companies in India, the securities of only a few
companies are actively traded. Only those securities are liquid. This means other
stocks have very low liquidity.

4. Less floating securities: There is scarcity of floating securities in the Indian

stock exchanges. Out of the total stocks, only a small portion is being offered for
sale. The financial institutions and joint stock companies control over 75% of the
scrips. However, they do not offer their holdings for sale. The UTI, GIC, LIC etc.
indulge more in purchasing than in selling. This creates scarcity of stocks for
trading. Hence, the market becomes highly volatile. It is subject to easy price
manipulations.

5. Lack of transparency: Many brokers are violating the regulations with a view
to cheating the innocent investing community. No information is available to investors
regarding the volume of transactions carried out at the highest and lowest prices.
In short, there is no transparency in dealings in stock exchanges.

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6. High volatility: The Indian stock market is subject to high volatility in recent
years. The stock prices fluctuate from hour to hour. High volatility is not conducive
for the smooth functioning of the stock market.

7. Dominance of financial institutions: The Indian stock market is being

dominated by few financial institutions like UTI, LIC, GIC etc. This means these few
institutions can influence stock market greatly. This actually reduces thelevel of
competition in the stock market. This is not a healthy trend for the growth of any
stock market.

8. Competition of merchant bankers: The increasing number of merchant

bankers in the stock market has led to unhealthy competition in the stock market.
The merchant bankers help the unscrupulous promoters to raise funds for non-
existent projects. Investors are the ultimate sufferers.

9. Lack of professionalism: Some of the brokers are highly competent and

professional. At the same time, majority of the brokers are not so professional. They
lack proper education, business skills, infrastructure facilities etc. Hence they are
not able to provide proper service to their clients.

Difference between Primary and Secondary Market

Primary Market Secondary Market

1. It is a market for new securities. 1. It is a market for existing or

second hand securities
2. It is directly promotes capital
formation. 2. It is directly promotes capital
formation.
3. Investors can only buy securities.
They cannot sell them. 3. Both buying and selling of
securities takes place
4. There is no fixed geographical
4. There is a fixed geographical
location.
location (stock exchanges)

5. Securities need not be listed. 5. Only listed securities can be

bought and sold
6. It enables the borrowers to raise 6. It enables the investors to invest
capital money in securities and sell and
encash as they need money

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Major Stock Exchanges in India

At present there are 24 recognised stock exchanges in India. Further OTCEI,

NSE also has started functioning in our country. Brief descriptions ofmajor SEs are
given below:

1. Bombay Stock Exchange (BSE)

BSE is the leading and the oldest stock exchange in India as well as in Asia.
It was established in 1887 with the formation of "The Native Share and Stock
Brokers' Association". BSE is a very active stock exchange with highest number of
listed securities in India. Nearly 70% to 80% of all transactions in the India are
done alone in BSE. Companies traded on BSE were 3,049 by March, 2006. BSE is
now a national stock exchange as the BSE has started allowing its members to set-
up computer terminals outside the city of Mumbai (former Bombay). It is the only
stock exchange in India which is given permanent recognition by the government.

In 2005, BSE was given the status of a fully fledged public limited company along
with a new name as "Bombay Stock Exchange Limited". The BSE hascomputerized
its trading system by introducing BOLT (Bombay on Line Trading) since March 1995.
BSE is operating BOLT at 275 cities with 5 lakh (0.5 million) traders a day. Average
daily turnover of BSE is near Rs. 200 crores.

Some facts about BSE are:

 BSE exchange was the first in India to launch Equity Derivatives, Free Float Index,
USD adaptation of BSE Sensex and Exchange facilitated Internet buying and selling
policy.

 BSE exchange was the first in India to acquire the ISO authorization for supervision,
clearance & Settlement

 BSE exchange was the first in India to have launched private service for economic
training

 Its On-Line Trading System has been felicitated by the internationally renowned
standard of Information Security Management System.

Bombay Online Trading System (BOLT)

BSE online trading was established in 1995 and is the first exchange to be
set up in Asia. It has the largest number of listed companies in the world and
currently has 4937 companies listed on the Exchange with over 7,700 traded
instruments.

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The only thing that an investor requires for online trading through BSE is
an online trading account. The trading can then be done within the trading hours
from any location in the world. In fact, BSE has replaced the open cry system
with automated trading. Open cry system is a common method of communication
between the investors at a stock exchange where they shout and use hand gestures
to communicate and transfer information about buy and sell orders. It usually
takes place on the 'pit' area of the trading floor and involves a lot of face to face
interaction. However, with the use of electronic trading systems trading is easier,
faster and cheaper; and is less prone to manipulation by market makers and
brokers/dealers.

The Bolt system has enabled the exchange to meet the following objective:

 Reduce and eliminate operational inefficiencies inherent in manual systems

 Increases trading capacity of the stock exchange

 Improve market transparency, eliminate unmatched trades and delayed reporting

 Promote fairness and speedy matching

 Provide for on-line and off-line monitoring, control and surveillance of the market

 Smooth market operations using technology while retaining the flexibility of

conventional trading practices

 Set up various limits, rules and controls centrally

 Provide brokers with their trade data on electronic media to interface with the
Broker's Back Office system

 Provide a sophisticated, easy to use, graphical user interface (GUI) to all the users
of the system

 Provide public information on scrip prices, indices for all users of the system and
allow the stock exchange to do information vending

 Provide analytical data for use of the Stock Exchange

2. National Stock Exchange (NSE)

Formation of National Stock Exchange of India Limited (NSE) in 1992 is one

important development in the Indian capital market. The need was felt by the
industry and investing community since 1991. The NSE is slowly becoming the
leading stock exchange in terms of technology, systems and practices in duecourse
of time. NSE is the largest and most modern stock exchange in India. In addition, it
is the third largest exchange in the world next to two exchangesoperating in
the USA.

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The NSE boasts of screen based trading system. In the NSE, the availablesystem
provides complete market transparency of trading operations to both trading
members and the participates and finds a suitable match. The NSE does not have
trading floors as in conventional stock exchanges. The trading is entirely screen
based with automated order machine. The screen provides entire market
information at the press of a button. At the same time, the system provides for
concealment of the identity of market operations. The screen gives all information
which is dynamically updated. As the market participants sit in their own offices,
they have all the advantages of back office support, and facility to get in touch with
their constituents. The trading segments of NSE are:

 Wholesale debt market segment,

 Capital market segment, and

 Futures & options trading.

NEAT

NSE uses satellite communication expertise to strengthen contribution from

around 400 Indian cities. It is one of the biggest VSAT incorporated stock exchange
across the world.

NSE is the first exchange in the world to use satellite communication

technology for trading. Its trading system, called National Exchange for
Automated Trading (NEAT), is a state of-the-art client server based application. At
the server end all trading information is stored in an in memory database to
achieve minimum response time and maximum system availability for users. It has
uptime record of 99.7%. For all trades entered into NEAT system, there is uniform
response time of less than one second.

3. over the Counter Exchange of India (OTCEI)

The OTCEI was incorporated in October, 1990 as a Company under the

Companies Act 1956. It became fully operational in 1992 with opening of a counter
at Mumbai. It is recognised by the Government of India as a recognised stock
exchange under the Securities Control and Regulation Act 1956. It was promoted
jointly by the financial institutions like UTI, ICICI, IDBI, LIC, GIC, SBI, IFCI, etc.

The Features of OTCEI are:-

 OTCEI is a floorless exchange where all the activities are fully

computerised.

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 Its promoters have been designated as sponsor members and they

alone are entitled to sponsor a company for listing there.

 Trading on the OTCEI takes place through a network of computers or

OTC dealers located at different places within the same city and even
across the cities. These computers allow dealers to quote, query &
transact through a central OTC computer using the
telecommunication links.

 A Company which is listed on any other recognised stock exchange

in India is not permitted simultaneously for listing on OTCEI.

 OTCEI deals in equity shares, preference shares, bonds, debentures

and warrants.

 OTC Exchange of India designed trading in debt instruments

commonly known as PSU bonds and also in the equity shares of
unlisted companies.

Stock Indices (indexes)

Indexes are constructed to measure the price movements of shares, bonds
and other types of instruments in market. A stock market index is a
measurement which indicates the nature, direction and the extent of day to day
fluctuations in the stock prices. It is a simple indication of the trends in themarket
and investors expectations about future price movements. The stock market index
is a barometer of market behaviour. It functions as an indicator of the general
economic scenario of a country. If stock market indices are growing,it indicates
that the overall general economy of country is stable if however the index goes
down it shows some trouble in economy.

Construction of Stock Index: A stock index is created by choosing high

performing stocks. Index can be calculated by two ways by considering the price
of component stock alone. By considering the market value or size of the company
called market capitalization method. Two main stock index of India are Sensex and
Nifty.

Any of the following methods can be used for calculating index

 Weighted capitalisation method - full market capitalisation and free

float market capitalisation.

 Price weighted index method

 Equal weighting method

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The important indices in India:

 BSE Sensex

 S&P CNX Nifty

 S&P CNX 500

 BSE 500

 BSE 100

 BSE 200/Dollex

 BSE IT

 BSE CG

 BSE FMCG

 S&P CNX Defty

BSE SENSEX

The 'BSE Sensex' or 'Bombay Stock Exchange' is value-weighted index

composed of 30 stocks and was started in January 1, 1986. The Sensex is regarded
as the pulse of the domestic stock markets in India. It consists of the 30 largest and
most actively traded stocks, representative of various sectors, on the Bombay
Stock Exchange. These companies account for around fifty per cent of the market
capitalization of the BSE

S&P CNX NIFTY

The Standard & Poor's CRISIL NSE Index 50 or S&P CNX Nifty nicknamed
Nifty 50 or simply Nifty (NSE: ^NSEI), is the leading index for large companies on
the National Stock Exchange of India. The Nifty is a well diversified 50 stock
index accounting for 23 sectors of the economy. It is used for a variety of purposes
such as benchmarking fund portfolios, index based derivatives and index funds.
Nifty is owned and managed by India Index Services and Products Ltd. (IISL),
which is a joint venture between NSE and CRISIL. IISL is India's first specialized
company focused upon the index as a core product. IISL has a marketing and
licensing agreement with Standard & Poor's.

Merchant Banking

Merchant banking was first started in India in 1967 by Grindlays Bank. It has
made rapid progress since 1970. Merchant Banking is a combinationof
Banking and consultancy services. It provides consultancy, to its clients, for
financial, marketing, managerial and legal matters. Consultancy means to
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provide advice, guidance and service for a fee. It helps a businessman to start a
business. It helps to raise (collect) finance. It helps to expand and modernise
the business. It helps in restructuring of a business. It helps to revive sick business
units. It also helps companies to register, buy and sell shares at the stock
exchange.

In short, merchant banking provides a wide range of services for starting

until running a business. It acts as Financial Engineer for a business.

The functions of merchant banking are listed as follows:

1. Raising Finance for Clients: Merchant Banking helps its clients to raise
finance through issue of shares, debentures, bank loans, etc. It helps its clients
to raise finance from the domestic and international market. This finance is
used for starting a new business or project or for modernization or
expansion of the business.

2. Broker in Stock Exchange: Merchant bankers act as brokers in the stock

exchange. They buy and sell shares on behalf of their clients. They conduct
research on equity shares. They also advise their clients about which shares
to buy, when to buy, how much to buy and when to sell. Large brokers,
Mutual Funds, Venture capital companies and Investment Banks offer
merchant banking services.

3. Project Management: Merchant bankers help their clients in the many ways.
For e.g. advising about location of a project, preparing a project report,
conducting feasibility studies, making a plan for financing the project, finding
out sources of finance, advising about concessions and incentives from the
government.

4. Advice on Expansion and Modernization: Merchant bankers give advice for

expansion and modernization of the business units. They give expert advice on
mergers and amalgamations, acquisition and takeovers, diversification of
business, foreign collaborations and joint-ventures, technology up gradation,
etc.

5. Managing Public Issue of Companies: Merchant bank advice and manage

the public issue of companies. They provide following services:

a. Advise on the timing of the public issue.

b. Advise on the size and price of the issue.

c. Acting as manager to the issue, and helping in accepting applications

and allotment of securities.

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d. Help in appointing underwriters and brokers to the issue.

e. Listing of shares on the stock exchange, etc.

6. Handling Government Consent for Industrial Projects: A businessman has

to get government permission for starting of the project. Similarly, a company
requires permission for expansion or modernization activities. For this, many
formalities have to be completed. Merchant banks do all this work for their
clients.

7. Special Assistance to Small Companies and Entrepreneurs: Merchant

banks advise small companies about business opportunities, government
policies, incentives and concessions available. It also helps them to take
advantage of these opportunities, concessions, etc.

8. Services to Public Sector Units: Merchant banks offer many services to

public sector units and public utilities. They help in raising long-term capital,
marketing of securities, foreign collaborations and arranging long- term
finance from term lending institutions.

9. Revival of Sick Industrial Units: Merchant banks help to revive (cure) sick
industrial units. It negotiates with different agencies like banks, term lending
institutions, and BIFR (Board for Industrial and Financial Reconstruction).
It also plans and executes the full revival package.

10. Portfolio Management: A merchant bank manages the portfolios

(investments) of its clients. This makes investments safe, liquid and profitable
for the client. It offers expert guidance to its clients for taking investment
decisions.

11. Corporate Restructuring: It includes mergers or acquisitions of existing

business units, sale of existing unit or disinvestment. This requires proper
negotiations, preparation of documents and completion of legal formalities.
Merchant bankers offer all these services to their clients.

12. Money Market Operation: Merchant bankers deal with and underwrite
short-term money market instruments, such as:

a. Government Bonds.

b. Certificate of deposit issued by banks and financial institutions.

c. Commercial paper issued by large corporate firms.

d. Treasury bills issued by the Government (Here in India by RBI).

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13. Leasing Services: Merchant bankers also help in leasing services. Lease is
a contract between the lessor and lessee, whereby the lessor allows the use
of his specific asset such as equipment by the lessee for a certain period.
The lessor charges a fee called rentals.

14. Management of Interest and Dividend: Merchant bankers help their clients
in the management of interest on debentures / loans, and dividendon shares.
They also advise their client about the timing (interim / yearly)and rate of
dividend.

Dematerialisation (Demat Shares)

According to SEBI guidelines, all foreign financial institutions, financial

institutions’ mutual funds and banks will have to compulsorily settle their trades
only in dematerialised form. Dematerialisation implies conversion of a share
certificate from its physical form to electronic form. It is a process by which the
physical share certificates of an investor are taken back by the company and an
equivalent number of securities are credited in electronic form at the request of
the investor.

Dematerialisation requires an investor to open an account with a

depository participant. Financial institutions, banks, stock brokers etc. can act as
depository participants. A depository participant acts as custodian of the
electronic accounts of the clients and takes care of trading and settlement thereof.
In this system an account is opened in a computerized electronic form. Securities
are received and delivered from this account through computerized electronic
form.

Advantages of Dematerialisation

Advantages to the company

(a) No need of issuing share certificates

(b) Reduces the chances of fraud

(c) Reduces the cost of handling.

(d) Provides better facilities to communicate with each and every member of the
company.

Advantages to investor

(a) Provides liquidity in the matter of settlement of transactions.

(b) Eliminates bad deliveries.

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(c) Reduces trading costs.

(d) Provides paperless trading.

Advantages to government

(a) Helps in quick settlement of transactions.

(b) Avoids unnecessary frauds.

Rematerialisation

Rematerialisation is the process of converting dematted shares back into

physical shares. It is the process of conversion of electronic holdings of securities
into physical certificate form. In short, the process of withdrawing securities from
the Depository is called rematerialisation.

Depository Services

A depository is an organization which holds securities in electronic book

entries at the request of the shareholder through the medium of a depository
participant. A depository keeps the scrips on behalf of the investors. It undertakes
the custodian role. A depository participant is an agent of the depository through
which it interfaces with the investor. A depository can be compared to a bank.
Investors can avail the services offered by a depository. To utilize the services offered
by a depository, the investor is required to open an account called ‘demat account with
the depository. The demat account is opened through a depository participant. Thus it
is very similar to the opening of an account with any of the branches of a bank in
order to utilize the services of that bank. The objective is to allow for the faster,
convenient and easy mode of affecting the transfer of securities. Thus, financial
services relating to holding, maintaining and dealing securities in electronic form by a
financial intermediary known as depository are called depository services.

Constituents of Depository System

There are four players in the depository system. They are : (1) Depository
Participant, (2) Investor (Beneficial owner), (3) Issuer, and (4) Depository.

Depository Participant: DP is an agent of the depository. If an investor wants to

avail the services offered by the depository, the investor has to open an account
with a DP. It function as a bridge between the depository and the owners. A DP may
be a financial institution, bank, custodian, a clearing corporation, a stock broker or
a “NBFC.

Investor (Beneficial Owner): He is the real owner of the securities who has lodged
his securities with the depository in the form of a book entry.

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Issuer: This is the company which issues the security.

Depository: It is a firm which holds the securities of an investor in electronic form

in the same way a bank holds money. It carries out the transaction of securities by
means of book entry, without any physical movement of securities.

National Securities Depository Ltd. (NSDL)

NSDL was registered by SEBI on June 7, 1996 as India’s first depository to

facilitate trading and settlement of securities in the dematerialized form. It was
promoted by IDBI, UTI and NSE (National Stock Exchange). The objective is to provide
electronic depository facilities for securities traded in the equity and debt markets in
the country. NSDL has been set up to cater to the demanding needs of the Indian
capital markets.

Functions / Services of NSDL

The following are the functions or services of NSDL :

1. Maintenance of individual investors’ beneficial holdings in an electronic

form.

2. Trade settlement

3. Automatic delivery of securities to the clearing corporation

4. Dematerialisation and rematerialisation of securities.

5. Allotment in the electronic form in case of IPOs.

6. Distribution of dividend

7. Facility for freezing / locking of investor accounts

8. Facility for pledge and hypothecation of securities.

9. Internet based services such as SPEED-c and IDeAS

Central Depository Services (India) Ltd. (CDSL)

The CDSL is the second depository set up by the Bombay Stock Exchange and
co-sponsored by the SBI, Bank of India, Union bank of India, and Centurian Bank.
The CDSL commenced operations on March 22, 1996. The CDSL was setup with
the objectives of providing convenient, dependable and secure depositoryservices
at affordable cost to all market participants. All leading stock exchanges such as
Bombay Stock Exchange, National Stock Exchange, and Kolkata Stock Exchange
etc. have established connectivity with CDSL.

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MODULE IV
FINANCIAL INSTITUTIONS
Financial Institutions are an important component of financial system.
Financial institutions are also known as financial intermediaries. This is because
they collect the savings from the savers and pass on the same to desired channels.
They provide finance for the development of various sectors of the economy such
as industry, agriculture, service etc. Thus financial institutions play an important
role in the financial system or economy.

Role of Financial Institution in the Financial System

o Financial institutions are financial intermediaries.

o They provide the means and mechanism of transferring the resources from
those whose income is more than expenditure to those who need these
resources for productive purposes.

o The savings of the savers will reach the borrowers through the financial
intermediaries in the form of financial instruments such as shares, stocks,
debentures, deposits, loans etc. Thus, they play the role of intermediate between
the savings and investments.

o They provide safety, liquidity and ensure return for savings.

o Financial institutions develop the saving habit among the people.

o They mobilise huge amount of savings for the industrial development as a

productive capital. The financial institutions supply capital to the
small, medium and large scale industries in India in the form of capital,
venture capital, and services to promote the industrial growth in India.

o These contribute for the growth and development of industries, agriculture etc.

Classification of Financial Institutions

All financial institutions in India may be broadly clarified into two-banking

financial institutions and non-banking financial institutions.

I. Banking Financial Institutions

Banking financial institutions are those financial institutions which carry

on banking activities. Banking business is carried on by these institutions after
obtaining an approval under Banking Regulation Act, 1949 and RBI. It accepts
deposits from the public. It lends money to people engaged in commerce,

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industry and agriculture. It finances foreign trade and deals in foreign exchange.
It provides short, medium and long term credit. It acts as an agent of RBI. It
deals in stocks and shares, trusteeship, executorships etc. In short, the bank can be
aptly described, as ‘department store of finance’ because it engages itself in every
form of banking business.

Banking financial institutions mainly comprise of commercial banks.

A. Commercial banks

A Bank is a financial Institution whose main business is accepting deposits and

lending loans. A Banker is a dealer of money and credit. Banking is an evolutionary
concept i.e. expanding its network of operations. According to Banking revolutions
Act 1949, the word BANKING has been defined as “Accepting for the purpose of
lending and investment of deposits of money from the public repayable on demand
or otherwise”.
Functions of Commercial Banks

Globalisation transformed commercial banks into super markets of financial

services. The important functions of commercial banks are explained below:

I. Primary Functions

These are further classified into 2 categories

i) Accepting Deposits: -

Deposits are the capital of banker. Therefore, it is first Primary function of

the banker. He accepts deposits from those who can save and lend it to the needy
borrowers. The size of operation of every bank is determined by size and nature of
Deposits. To attract the saving from all sort (categories) of individuals, Commercial
banks accepts various types of deposits account they are:

a) Fixed Deposits

b) Current Deposits

c) Saving Bank account

d) Recurring Deposits

ii) Lending Loans: -

The 2nd important function of the commercial bank is advancing loans. Bank
accepts deposits to lend it at higher rate of interest. Every Commercial Bank keep
the rate of interest on its deposit at lower level or less that what he charges on its loans
which is as NIM (Net Interest Margin). The banker advances different types of loans
to the individual and firms. They are: -

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a) Overdraft

b) Cash Credit

c) Term Loan

d) Discounting Bill

II) Secondary Functions

i) Agency functions:

Bankers act as an agent to the customers it means he performs certain functions

on behalf of the customers such services are called Agency Services. Example:

a) Bank pay electricity bill, water bill, Insurance Premium etc.

b) They guide the customer in Task Planning.

c) Bank provides safety locker facility.

d) Pay salaries of customer’s employees.

ii) General Utility Services: -

Bankers are the past of society. They offer: several services to general public they are:-

a) It provides cheap remittance (transfer) facilities.

b) The banks issue traveller cheque for safe travelling to its customers.

c) Banks accepts and collects foreign Bills of Exchanges.

d) Other than these services the bankers also provide ATM services, Internet
Banking, Electronic fund transfer (EFT), E-Banking to provide quick and proper
services to its customers.

iii) Credit Creation: -

It is a unique function of Commercial Banks. When a bank advances loan to

its customer if doesn’t lend cash but opens an account in the borrowers name
and credits the amount of loan to that account. Thus, whenever a bank grants loan,
it creates an equal amount of bank deposits. Creation of deposits is called Credit
Creation. In simple words we can define Credit creation as multiple expansions of
deposits. Creation of such deposits will results an increase in the stock deposits.
Creation of such deposits will results an increase in the stock of money in
an economy.

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II. Non-Banking Financial Institutions

These are the financial institutions which are not permitted to carry on the
banking activities as per Banking Regulation Act, 1949 and RBI regulations. These
institutions have been established by special legislations to provide finance to
specified categories of industries or persons.

Classification of Non-Banking Financial Institutions

Non-banking financial institutions can be classified to three. They are :

1. All-India Financial Institutions or All-India Development Banks or Specialised

Financial Institutions

2. State Level Financial Institutions

3. Investment Institutions

These may be described in the following pages:

A. All-India Financial Institutions

Government of India has nationalised 20 commercial banks (excluding

subsidiaries of SBI) so far. A number of financial institutions have also been set
up to supply finance to industry and agriculture. Unfortunately, these
commercial banks and financial institutions fail to provide long term finance to
industries. With the objective of giving term loans, Govt. has set up some
specialised financial institutions. These specialised financial institutions are called
development banks. The development banks have to sacrifice business principles
of conventional financial institutions and pay due regard to publicinterest so as
to act as an instrument of economic development in conformitywith national
objectives, plans and priorities.

Development banks are expected to act as catalysts in performing

developmental and promotional functions. As regards banking obligations, it is
supposed to undertake the primary task of providing financial assistance in
different forms. These are something more than pure financial institutions.
Development banks are viewed as financial intermediary supplying medium and
long term funds to bankable economic development projects and providing related
services. They are expected to mobilise large capital from other sources.
Accordingly, the task of economic transformation and rapid industrialisation can
best be handled only through development banks rather than through the normal
process of governmental machinery.

Important development or specialised financial institutions may be

discussed as follows:

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 Industrial Finance Corporation of India (IFCI)

The IFCI is the first Development Financial Institution in India. It is a pioneer

in development banking in India. It was established in 1948 under an Act of
Parliament. The main objective of IFCI is to render financial assistance to large
scale industrial units, particularly at a time when the ordinary banks are not
forth coming to assist these concerns. Its activities include project financing,
financial services, merchant banking and investment.

Till 1993, IFCI continued to be Developmental Financial Institution. After 1993,

it was changed from a statutory corporation to a company under the Indian
Companies Act, 1956 and was named as IFCI Ltd with effect from October 1999.

Functions of IFCI

Functions of IFCI can be classified into three: (a) financial assistance (b)
Promotional activities, and (c) financial Services.

(a) Financial Assistance: IFCI renders financial assistance in one or more of the
following forms:

1. Guaranteeing loans raised by industrial concerns which are repayable within a

period of 25 years.

2. Underwriting the issue of stock, shares, bonds or debentures by industrial concerns

but must dispose of such securities within 7 years.

3. Granting loans or advances to or subscribing to debentures of industrial

concerns, repayable within 25 years.

4. Acting as agent for the Central Govt. and for the World Bank in respect of loans
sanctioned by them to industrial concerns.

5. Granting loans to industrial units

6. Guaranteeing deferred payments by importers of capital goods, which are able

to obtain this concession from foreign manufacturers.

7. Guaranteeing loans raised by industrial concerns from scheduled banks or state

co-operative banks.

8. Guaranteeing with the prior approval of the Central Govt. loans rose from any
bank or financial institution in any country outside India by industrial concerns
in foreign country.

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(b) Promotional Activities: The IFCI has been playing a very important role as a
financial institution in providing financial assistance to eligible industrial concerns.
It is playing a promotional role too. It has been creating industrial opportunities. It
discovers the opportunities for promoting new enterprises. It helps in developing
small and medium scale entrepreneurs by providing them guidance through its
specialized agencies in identification of projects, preparing project profiles,
implementation of the projects etc. It acts as an instrument of accelerating the
industrial growth and reducing regional industrial and income disparities.

(c) Financial Services: The following financial services are provided by IFCI.

(i) Corporate counselling for financial reconstruction

(ii) Assistance in settlement of terms and conditions with foreign collaborators.

(iii) Revival of sick units

(iv) Financing of risky projects

(v) Merchant banking services

The IFCI has promoted ICRA Ltd, a credit rating agency to help investors
undertake investment decisions. It has also established Management Development
Institute (MDI) with the objective of imparting training in modern management
techniques to entrepreneurs, govt. officers, and people from public and private
sector.

Industrial Development Bank of India (IDBI)

The IDBI was established on July 1, 1964 under an Act of Parliament. It

was set up as the central co-ordinating agency, leader of development banks and
principal financing institution for industrial finance in the country. Originally, IDBI
was a wholly owned subsidiary of RBI. But it was delinked from RBI w.e.f. Feb. 16,
1976.

IDBI is an apex institution to co-ordinate, supplement and integrate the

activities of all existing specialised financial institutions. It is a refinancing and re-
discounting institution operating in the capital market to refinance term loans and
export credits. It is in charge of conducting techno-economic studies. It was
expected to fulfil the needs of rapid industrialisation.

The IDBI is empowered to finance all types of concerns engaged or to be

engaged in the manufacture or processing of goods, mining, transport, generation
and distribution of power etc., both in the public and private sectors.

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Assistance
The composition of assistance given by IDBI may be broadly grouped as direct
assistance, indirect assistance and Promotional activities.

Direct Assistance: Direct assistance takes the form of loan/soft loans,

underwriting/subscriptions to shares and debentures and guarantees.

Indirect Assistance: It provides assistance to tiny, small and medium enterprises

indirectly by way of refinance of loans granted by SFCs, commercial banks, co-
operative banks and regional rural banks, through discounting of bills of exchange
arising out of the sale of indigenous machinery on deferred payment basis and seed
capital assistance to new entrepreneurs through SFCs etc.

Promotional Activities: These include the following:

(a) Assistance for the development of backward areas: This is provided through
direct financial assistance at concessional terms and through concessional
refinance assistance to projects located in specified backward areas/districts.

(b) Assistance by way of seed capital scheme: This is to help technician

entrepreneurs who have technically feasible and economically viable projects but
do not have sufficient capital.

(c) A large range of consultancy services: Another promotional scheme is the setting
up of TCOs with the principal idea of providing different types of consultancy
services to small and medium enterprises, Government departments, commercial
banks and others engaged in industrial development. It also provides assistance to
voluntary agencies for setting up of science and technology entrepreneurship parks
etc., under its network of promotional activities.

In order to boost capital market as well as to play its catalyst role in

development and promotional activities for the benefit of industry, IDBI has set up
Small Industries Development Fund, Stockholding Co-operation of India, SEBI,
National Stock Exchange of India, OTC Ex-change of India, Entrepreneurship
Development Institute of India, SCICI, TFCI, mutual fund and commercial bank.

Functions of IDBI

1. It co-ordinates the operation of other institutions providing term finance to

industries.

2. It provides assistance to medium and large industries by way of direct finance

and refinance of industrial loans.

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3. It extends resource support to all India and state level financial institutions and
other financial intermediaries.

4. It renders services like asset credit equipment finance, equipment leasing and
bridge loans.

5. It also undertakes merchant banking.

6. It provides technical and administrative assistance to industrial concerns.

7. It guarantees deferred payments due from any industrial concern. It

guarantees loans raised by industrial concerns from any financial institution.

8. It promotes and develops key industries which are necessary to meet the overall
needs of the economy.

9. It undertakes techno-economic studies and surveys on its own with a view to

promoting the establishment of new enterprises.

Industrial Credit and Investment Corporation of India (ICICI)

ICICI was set up in 1955 as a public limited company. It was to be a private

sector development bank in so far as there was no participation by the Government in
its share capital. It is a diversified long term financial institution and provides a
comprehensive range of financial products and services including project and
equipment financing, underwriting and direct subscription to capital issues, leasing,
deferred credit, trusteeship and custodial services, advisory services and business
consultancy.

Objectives of ICICI

The main objective of the ICICI was to meet the needs of the industry for long
term funds in the private sector. Other objectives include:

(a) To assist in the creation, expansion and modernisation of industrial enterprises

in the private sector.

(b) To encourage and promote the participation of private capital, both internal
and external, in such enterprises; and

(c) To encourage and promote private ownership of industrial investment and

expansion of markets.

Functions of ICICI

1. It sanctions rupee loans for capital assets such as land, building, machinery etc,
for long term, and foreign exchange loans for import of machinery and equipment.

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2. It guarantees loans from other private investment sources.

3. It subscribes to ordinary or preference capital and underwrites new issues of

securities.

4. It renders consultancy services to Indian industry in the form of managerial

and technical advice.

5. It also undertakes financial services such as deferred credit, equipment

leasing, instalment sale etc.

As already mentioned, the ICICI was initially created to provide finance to

industrial units in the private sector only. Subsequently its scope of operations was
extended to include public and joint sectors and also the co-operative projects.

It has also set up an Asset Management Company for its mutual fund. Ithas
set up a Commercial Bank (India's first internet bank). Recently, ICICI has merged
with ICICI bank.

State Level Financial Institutions

Some financial institutions are working at the state level. The important
state level institutions are State Financial Corporations and State Industrial
Development Corporations.

Here we discuss only SFCs.

State Finance Corporations (SFCs)

The Govt. after independence realised the need of creating a financial

corporation at the state level for catering to the needs of industrial entrepreneurs.
As a result, the Govt of India after consultation with the State governments and the
Reserve Bank of India, introduced State Finance Corporations bill in the Parliament
in 1951. SFC Act came into existence with effect from August 1, 1952. The Act
permitted the State Governments. to establish financial corporation’s for the
purpose of promoting industrial development in their respective states by
providing financial assistance to medium and small scale industries.

Functions of State Finance Corporations

The main function of the SFCs is to provide loans to small and medium scale
industries engaged in the manufacture, preservation or processing of goods,
mining, hotel industry, generation or distribution of power, transportation, fishing,
assembling, repairing or packaging articles with the aid of power etc. Other
functions are follows:

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1. Granting loans or advances or subscribing to shares and debentures of the

industrial undertaking repayable within twenty years.

2. Guaranteeing loans raised by the industrial concerns repayable within twenty

years.

3. Underwriting of the shares, bonds and debentures subject to their disposal in the
market within seven years.

4. Guaranteeing deferred payments for the purchase of capital goods by

industrial concerns within India.

5. Providing loans for setting up new industrial units as well as for expansion and
modernisation of the existing units.

6. Discounting the bills of small and medium scale industries

Kerala Financial Corporation (KFC)

KFC has been incorporated under the SFC Act 1951. It provides financial
assistance for starting of new industrial units, expansion, diversification or
modernisation of existing units. Assistance is also available for setting up of Tourist
Hotel in tourists centres and district head quarters, for the development of
industrial estates and for the purchase of vehicles for transport undertakings.
Concessional terms are offered to industrial units in the backward districts and for
small scale units.

Functions of Kerala Financial Corporation

1. To grant long term loans to new and existing small scale industrial units.
Maximum amount of loan is Rs. 60 lakh subject to the condition that the project
cost does not exceed Rs. 3 crores.

2. To underwrite shares and debentures floated in the open market.

3. To guarantee deferred payments to machinery suppliers for indigenous

machinery purchased by borrowers in Kerala.

4. To guarantee the loan raised by industrial concerns in public market. ‘

5. To provide liberalised financial assistance to entrepreneurs under ‘Techno crafts

Assistance Scheme’. The corporation is financing 90% of the cost of fixed assets
accepted as security subject to a maximum of Rs. 5 lakhs.

It gives financial assistance to professionals, Ex-servicemen technocrats,

women entrepreneurs etc. It gives working capital assistance up to a certain limit
to SSI units.

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Investment Institutions
The important investment institutions are:

1. Unit Trust of India (UTI)

2. Life Insurance Corporation of India (LIC)

3. General Insurance Corporation of India (GIC)

1. Life Insurance Corporation of India (LIC)

The Life Insurance Corporation of India was set up under the LIC Act, 1956
under which the life insurance was nationalised. As a result, business of 243
insurance companies was taken over by LIC on 1-9-1956.

It is basically an investment institution, in as much as the funds of policy holders

are invested and dispersed over different classes of securities, industries and
regions, to safeguard their maximum interest on long term basis. Life Insurance
Corporation of India is required to invest not less than 75% of its funds in Central
and State Government securities, the government guaranteed marketable securities
and in the socially-oriented sectors. At present, it is the largest institutional investor.
It provides long term finance to industries. Besides, it extends resource support to
other term lending institutions by way of subscription to their shares and bonds
and also by way of term loans.

Life Insurance Corporation of India which has entered into its 57th year has
emerged as the world’s largest insurance co. in terms of number of policies covered.
The Life Insurance Corporation of India’s total coverage of policies including
individual, group and social schemes has crossed the 11 crore.

Objectives of Life Insurance Corporation of India

The Life Insurance Corporation of India was established with the following
objectives:

1. Spread life insurance widely and in particular to the rural areas, to the socially
and economically backward claries with a view to reaching all insurable persons
in the country and providing them adequate financial cover against death at a
reasonable cost

2. Maximisation of mobilisation of people’s savings for nation building activities.

3. Provide complete security and promote efficient service to the policy-holders at

economic premium rates.

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4. Conduct business with utmost economy and with the full realisation that the
money belong to the policy holders.

5. Act as trustees of the insured public in their individual and collective capacities.

6. Meet the various life insurance needs of the community that would arise in the
changing social and economic environment

7. Involve all people working in the corporation to the best of their capability in
furthering the interest of the insured public by providing efficient service with
courtesy.

Role and Functions of Life Insurance Corporation of India

The role and functions of Life Insurance Corporation of India may be

summarised as below:

1. It collects the savings of the people through life policies and invests the fund in
a variety of investments.

2. It invests the funds in profitable investments so as to get good return. Hence

the policy holders get benefits in the form of lower rates of premium and increased
bonus. In short, Life Insurance Corporation of India is answerable to the policy
holders.

3. It subscribes to the shares of companies and corporations. It is a major

shareholder in a large number of blue chip companies.

4. It provides direct loans to industries at a lower rate of interest. It is giving loans

to industrial enterprises to the extent of 12% of its total commitment.

5. It provides refinancing activities through SFCs in different states and other

industrial loan-giving institutions.

6. It has provided indirect support to industry through subscriptions to shares and

bonds of financial institutions such as IDBI, IFCI, ICICI, SFCs etc. at the time
when they required initial capital. It also directly subscribed to the shares of
Agricultural Refinance Corporation and SBI.

7. It gives loans to those projects which are important for national economic
welfare. The socially oriented projects such as electrification, sewage and water
channelising are given priority by the Life Insurance Corporation of India.

8. It nominates directors on the boards of companies in which it makes its

investments.

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9. It gives housing loans at reasonable rates of interest.

10. It acts as a link between the saving and the investing process. It generates the
savings of the small savers, middle income group and the rich through several
schemes.

11. Formerly LIC has played a major role in the Indian capital market. To stabilise
the capital market it has underwritten capital issues. But recently it has moved to other
avenues of financing. Now it has become very selective in its underwriting pattern.

2. General Insurance Corporation of India (GIC)

General insurance industry in India was nationalised and a

government company known as General Insurance Corporation of India was
formed by the central government in November, 1972. General insurance
companies have willingly catered to these increasing demands and have offered a
plethora of insurance covers that almost cover anything under the sun. Any
insurance other than ‘Life Insurance’ falls under the classification of General
Insurance. It comprises of:-

a. Insurance of property against fire, theft, burglary, terrorism, natural

disasters etc

b. Personal insurance such as Accident Policy, Health Insurance and liability

insurance which cover legal liabilities.

c. Errors and Omissions Insurance for professionals, credit insurance etc.

d. Policy covers such as coverage of machinery against breakdown or loss or

damage during the transit.

e. Policies that provide marine insurance covering goods in transit by sea, air,
railways, waterways and road and cover the hull of ships.

f. Insurance of motor vehicles against damages or accidents and theft

All these above mentioned form a major chunk of non-life insurance business.

General insurance products and services are being offered as package

policies offering a combination of the covers mentioned above in various
permutations and combinations. There are package policies specially designed for
householders, shopkeepers, industrialists, agriculturists, entrepreneurs,
employees and for professionals such as doctors, engineers, chartered
accountants etc. Apart from standard covers, General insurance companies also
offer customized or tailor-made policies based on the personal requirements of the
customer.

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Classification of Indian General Insurance Industry

General Insurance is also known as Non-Life Insurance in India. There are

totally 16 General Insurance (Non-Life) Companies in India. These 16 General
Insurance companies have been classified into two broad categories namely:

a) PSUs (Public Sector Undertakings)

b) Private Insurance Companies

a) PSUs (Public Sector Undertakings):-

These insurance companies are wholly owned by the Government of India.

There are totally 4 PSUs in India namely:-

• National Insurance Company Ltd

• Oriental Insurance Company Ltd

• The New India Assurance Company Ltd

• United India Insurance Company Ltd

b) Private Insurance Companies:-

There are totally 12 private General Insurance companies in India namely:-

• Apollo DKV Health Insurance Ltd

• Bajaj Allianz General Insurance Co. Ltd

• Cholamandalam MS General Insurance Co. Ltd

• Future General Insurance Company Ltd

• HDFC Ergo General Insurance Co Ltd

• ICICI Lombard General Insurance Ltd

• Iffco Tokio General Insurance Pvt Ltd

• Reliance General Insurance Ltd

• Royal Sundaram General Insurance Co Ltd

• Star Health and Allied Insurance

• Tata AIG General Insurance Co Ltd

• Universal Sompo General Insurance Pvt Ltd

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3. Unit Trust of India (UTI)

The Unit Trust of India was set up in February 1964 under the Unit Trust of
India Act of 1963, in the public sector. It plays an important role in mobilising
savings of investors through sale of units and channelizing them into corporate
investments. Over the years, it has introduced a variety of growth schemes to meet
needs of diverse section of investors. After an amendment to its Act in April 1986,
Unit Trust of India has started extending assistance to corporate sector by way of
term loans, bills rediscounting, equipment leasing and hire purchase facilities.

The management of the trust is entrusted to the Board of Trustees. The

chairman of the Board and 4 other trustees are appointed by the RBI. One trustee
each is nominated by the LIC and the SBI, and 2 other trustees are elected by
other subscribers to the capital of the trust.

Unit Trust of India has recently set up an Asset Management Company to

bring some of its mutual fund schemes under its purview. It also engaged in
investment banking business, stock broking, consultancy etc.

Sanctions up to March, 1993, amounted to Rs. 7520.6 crores. One of the striking
features of purpose-wise UTI sanctions reveals that working capitalrequirements of
industrial concerns have received the maximum attention (over50-55%). Similarly
private sector accounts for the highest share in Unit Trust of India sanctions (about
67%) followed by public sector (32%). Unit Trust of Indiais the first unit trust in
the public sector in the world.

Objectives of Unit Trust of India

The basic objective of the establishment of Unit Trust of India was to encourage
investment and participation in the income, profits and gains accruing to the
corporation from the acquisition, holding, management and dispersal of securities.
The other objectives are as follows :

1. To stimulate and pool the savings of the middle and low income groups.

2. To enable unit holders to share the benefits and prosperity of the rapidly
growing industrialisation in the country.

3. To sell units among as many investors as possible.

4. To invest the money raised from the sale of units and its own capital in
corporate and industrial securities

5. To pay dividend to the unit holders.

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Advantages of Units of Unit Trust of India

1. Investment in units is safe.

2. Units are highly liquid.

3. Unit holders get a steady and decent income in the form of dividend.

4. Dividend on unit is exempt from income tax upto a certain amount.

5. Wealth tax payers get a benefit.

Disadvantages of Units of Unit Trust of India

1. Unit holders have no right to attend the annual general meeting of the Unit
Trust of India.

2. Unit holders are not entitled to certain concessions which are offered to
shareholders by certain companies

3. Only 90% of the income of the trust can be distributed among the unit
holders.

IV. Non-Banking Financial Corporation (NBFC)

Financial intermediaries are that institution which link lenders and borrows.

The process of transferring saving from savers to investors is known as financial

intermediation. Commercial banks and cooperative credit societies are called
“finance corporations”, or “finance companies”. These finance companies with very
little capital have been mobilizing deposits by offering attractive interestrates and
incentives and advance loans to wholesale and retail traders, small industries and
self-employed persons. They grant unsecured loans at very ratesof interest.
These are non-banking companies performing
the functions of financial intermediaries. They cannot be called banks.

A Non-Banking Financial Company (NBFC) is a company registered under the

Companies Act, 1956 and is engaged in the business of loans and advances,
acquisition of shares, securities, leasing, hire-purchase, insurance business, and
chit business.

Number of Non-Banking Financial Corporation s

The number of Non-Banking Financial Corporations continued to grow year after

year in the nineties. During 1996-97, the aggregate deposits of 13,970 Non-
Banking Financial Corporations totalled up to Rs.3,57,150 crores. As on March 31,
2012 the total number of Non-Banking Financial Corporations registered with RBI
stood at 12,385 compared with 12,409 in 2011. The number of deposit
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taking Non-Banking Financial Corporation’s (NBFC-D), including residuary

NBFCs (RNBC), also reduced from 297 at end-March 2011 to 271 as on endMarch
2012. The size of total assets of Non-Banking Financial Corporations grew from Rs
1,169 billion to Rs 1,244 billion as at end March 2012. Net owned funds of NBFCs
too grew 25% from Rs 180 billion in 2011 to Rs 225 billion at end- March 2012.The
large finance companies numbering 2,376 accounted for 63 per cent of deposits.

Functions of Non-Banking Financial Corporations:

The functions performed by Non-Banking Financial Corporations may be

described as under:

• They are able to attract deposits of huge amounts by offering attractive rates of
interest and other incentives. Half of the deposits are below two years time
period.

•
They provide loans to wholesale and retail merchants’ small industries, self empl
oyment schemes.

• They provide loans without security also. Hence they are able to charge 24 to 36 per
cent interest rate.

• They run Chit Funds, discount hundies, provide hire-purchase, leasing finance,
merchant banking activities.

• They ventures to provide loans to enterprises with high risks. So they areable
to charge high rate of interest. They renew short period loans from time to time. They
therefore become long period loans.

• They are able to attract deposits by offering very high rate of interest. In the
process many companies sustained losses and went into liquidation. The
bankruptcy of many companies adversely affected middle-class and lower income
people. There is no insurance protection for deposits as in the case of bank
deposits.

• The finance companies are able to fill credit gaps by providing lease finance, hire
purchase and instalment buying. They provide loans to buy scooter, cars,TVs
and other consumer durables. Such extension of functions makes them almost
commercial banks. The only difference is that Non-Banking Financial Corporations
cannot introduce cheque system. This is the difference b/w the two

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Difference between banks & Non-Banking Financial Corporations:

Non-Banking Financial Corporations are doing functions similar to that of banks;

however there are a few differences:

1) A Non-Banking Financial Corporations cannot accept demand deposits,

2) It is not a part of the payment and settlement system and as such cannot
issue cheques to its customers,

3) Deposit insurance facility of DICGC is not available for Non-Banking Financial

Corporations depositors unlike in case of banks

Different types of Non-Banking Financial Corporations:

There are different categories of Non-Banking Financial Corporations 's operating

in India under the supervisory control of RBI. They are:

1. Non-Banking Financial Companies (NBFCs)

2. Residuary Non-banking Finance companies (RNBCs).

3. Miscellaneous Non-Banking Finance Companies (MNBCs)

Residuary Non-Banking Company is a class of Non-Banking Financial

Corporations, which is a company and has as its principal business the receiving of
deposits, under any scheme or arrangement or in any other manner and not being
Investment, Leasing, Hire-Purchase, Loan Company. These companies are required
to maintain investments as per directions of RBI, in addition to liquid assets. The
functioning of these companies is different from those of NBFCs in terms of method
of mobilization of deposits and requirement of deployment of depositors' funds.
Peerless Financial Company is the example of RNBCs.

Miscellaneous Non-Banking Financial Companies are another type of Non-

Banking Financial Corporations and MNBC means a company carrying on all or any
of the types of business as collecting, managing, conducting or supervisingas a
promoter or in any other capacity, conducting any other form of chit or kuri which
is different from the type of business mentioned above and any other business
similar to the business as referred above.

Type of Services provided by Non-Banking Financial Corporations:

Non-Banking Financial Corporations provide range of financial services to their

clients. Types of services under non-banking finance services include the
following:
1. Hire Purchase Services
2. Leasing Services
3. Housing Finance Services
4. Asset Management Services
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5. Venture Capital Services

6. Mutual Benefit Finance Services (Nidhi) banks.

The above type of companies may be further classified into those accepting deposits
or those not accepting deposits.

1. Hire Purchase Services

Hire purchase the legal term for a conditional sale contract with an intention
to finance consumers towards vehicles, white goods etc. If a buyer cannot afford to
pay the price as a lump sum but can afford to pay a percentage as a deposit, the
contract allows the buyer to hire the goods for a monthly rent. If the buyer defaults
in paying the instalments, the owner can repossess the goods. Hire purchase is a
different form of credit system among other unsecured consumer credit systems
and benefits. Hero Honda Motor Finance Co., Bajaj Auto Finance Company is some
of the Hire purchase financing companies.

2. Leasing Services

A lease or tenancy is a contract that transfers the right to possess specific

property. Leasing service includes the leasing of assets to other companies either
on operating lease or finance lease. An NBFC may obtain license to commence
leasing services subject to, they shall not hold, deal or trade in real estate business
and shall not fix the period of lease for less than 3 years in the case of any finance
lease agreement except in case of computers and other IT accessories. First
Century Leasing Company Ltd., Sundaram Finance Ltd. is some of the Leasing
companies in India.

3. Housing Finance Services

Housing Finance Services means financial services related to development and

construction of residential and commercial properties. An Housing Finance
Company approved by the National Housing Bank may undertake the services
/activities such as Providing long term finance for the purpose of constructing,
purchasing or renovating any property, Managing public or private sector projects
in the housing and urban development sector and Financing against existing
property by way of mortgage. ICICI Home Finance Ltd., LIC HousingFinance Co.
Ltd., HDFC is some of the housing finance companies in our country.

4. Asset Management Company

Asset Management Company is managing and investing the pooled funds of retail
investors in securities in line with the stated investment objectives and provides
more diversification, liquidity, and professional management service to the
individual investors. Mutual Funds are comes under this category. Most of the
financial institutions having their subsidiaries as Asset Management Company like
SBI, BOB, UTI and many others.

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5. Venture Capital Companies

Venture capital Finance is a unique form of financing activity that is undertaken on

the belief of high-risk-high-return. Venture capitalists invest in those risky projects
or companies (ventures) that have success potential and could promise sufficient
return to justify such gamble. Venture capitalist not only provides finance but also
often provides managerial or technical expertise to venture projects. In India,
venture capitals concentrate on seed capital finance for high technology and for
research & development. Industrial Credit and Investment corporation ventures
and Gujarat Venture are one of the first venture capital organizations in India and
SIDBI, Industrial development bank of India and others also promoting venture
capital finance activities.

6. Mutual Benefit Finance Companies (MBFC's)

A mutual fund is a financial intermediary that allows a group of investorsto

pool their money together with a predetermined investment objective. The mutual
fund will have a fund manager who is responsible for investing the pooled money into
specific securities/bonds. Mutual funds are one of the best investments ever created
because they are very cost efficient and very easy to invest in. By pooling money
together in a mutual fund, investors can purchase stocks or bonds with much lower
trading costs than if they tried to do it on their own. But the biggest advantage to
mutual funds is diversification.

There are two main types of such funds, open-ended fund and close-ended
mutual funds. In case of open-ended fund, the fund manager continuously allows
investors to join or leave the fund. The fund is set up as a trust, with an independent
trustee, who keeps custody over the assets of the trust. Each shareof the trust is
called a Unit and the fund itself is called a Mutual Fund. Theportfolio of investments
of the Mutual Fund is normally evaluated daily by the fund manager on the basis
of prevailing market prices of the securities in the portfolio and this will be divided
by the number of units issued to determine the Net Asset Value (NAV) per unit.
An investor can join or leave the fund on thebasis of the NAV per unit.

In contrast, a close-end fund is similar to a listed company with respect to

its share capital. These shares are not redeemable and are traded in the stock exchange
like any other listed securities. Value of units of close-end funds is determined by
market forces and is available at 20-30% discount to their NAV.

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MODULE V

REGULATORY INSTITUTIONS

Financial institutions, financial markets, financial instruments and

financial services are all regulated by regulators like Ministry of Finance, the
Company Law Board, RBI, SEBI, IRDA, Dept. of Economic Affairs, Department of
Company Affairs etc. The two major Regulatory and Promotional Institutions in
India are Reserve Bank of India (RBI) and Securities Exchange Board of India
(SEBI). Both RBI and SEBI administer, legislate, supervise, monitor, control and
discipline the entire financial system. RBI is the apex of all financial institutions in
India. All financial institutions are under the control of RBI. The financial markets
are under the control of SEBI. Both RBI and SEBI have laid down several policies,
procedures and guidelines. These policies, procedures and guidelines are changed
from time to time so as to set the financial system in the right direction.

V-I. RESERVE BANK OF INDIA

The Reserve Bank of India is the Central Bank of our country. The Reserve
Bank of India is the apex financial institution of the country’s financial system
entrusted with the task of control, supervision, promotion, development and
planning. Reserve Bank of India came into existence on 1 st April, 1935 as per the
Reserve Bank of India act 1935. But the bank was nationalised by the
government after Independence. It became the public sector bank from 1st January,
1949. Thus, Reserve Bank of India was established as per the Act 1935 and
empowerment took place in Banking Regulation Act 1949.

Reserve Bank of India is the queen bee of the Indian financial system which
influences the commercial banks’ management in more than one way. The Reserve
Bank of India influences the management of commercial banks through its various
policies, directions and regulations. Its role in bank management is quite unique.
In fact, the Reserve Bank of India performs the four basic functions of management,
viz., planning, organising, directing and controlling in laying a strong foundation
for the functioning of commercial banks. Reserve Bank of India has 4 local boards
basically in North, South, East and West – Delhi, Chennai, Calcutta, and Mumbai.

Objectives of the Reserve Bank of India

The Preamble to the Reserve Bank of India Act, 1934 spells out the objectives
of the Reserve Bank as: “to regulate the issue of Bank notes and the keeping of
reserves with a view to securing monetary stability in India and generally to operate
the currency and credit system of the country to its advantage.”

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Prior to the establishment of the Reserve Bank, the Indian financial system
was totally inadequate on account of the inherent weakness of the dual control of
currency by the Central Government and of credit by the Imperial Bank of India.
The Hilton-Young Commission, therefore, recommended that the dichotomy of
functions and division of responsibility for control of currency and credit and the
divergent policies in this respect must be ended by setting-up of a central bank – called
the Reserve Bank of India – which would regulate the financial policy and develop
banking facilities throughout the country. Hence, the Bank wasestablished with this
primary object in view.

Another objective of the Reserve Bank has been to remain free from political
influence and be in successful operation for maintaining financial stability and
credit. The fundamental object of the Reserve Bank of India is to discharge purely
central banking functions in the Indian money market, i.e., to act as the note-
issuing authority, bankers’ bank and banker to government, and to promote the
growth of the economy within the framework of the general economic policy of the
Government, consistent with the need of maintenance ofprice stability.

A significant object of the Reserve -Bank of India has also been to assist the
planned process of development of the Indian economy. Besides the traditional
central banking functions, with the launching of the five-year plans in the country,
the Reserve Bank of India has been moving ahead in performing a host of
developmental and promotional functions, which are normally beyond the purview of
a traditional Central Bank.

Functions of the Reserve Bank of India

The Reserve Bank of India performs all the typical functions of a good Central Bank.
In addition, it carries out a variety of developmental and promotional functions which
are tuned to the course of economic planning in the country:

 Issuing currency notes, i.e. to act as a currency authority.

 Serving as banker to the Government.

 Acting as bankers’ bank and supervisor.

 Monetary regulation and management.

 Exchange management and control.

 Collection of data and their publication.

 Miscellaneous developmental and promotional functions and activities.

 Agricultural Finance.

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 Industrial Finance

 Export Finance.

 Institutional promotion.

Important functions of Reserve Bank of India are briefed below

i) Monopoly in Note Issue: - Reserve Bank of India enjoys monopoly of Notes

issue since its establishment. The bank issues the currency notes of all
denominations. Except coins which are issued by the ministry of finance
in the government of India. But these coins are put into circulation only
through the RBI. The Bank (RBI) issue currencies to a minimum reserve
system under which Rs 200\- crores worth of Gold and foreign exchange
reserve should be kept out of these 200 crores, 115 crores values should
be in the form of Gold only. To undertake this functionRBI established
2 department i.e.

a) Issue Department

b) Banking department

Issue department is involved in issue of currencies and manages currencies

circulation.

ii) Banker to the Government: - Reserve Bank of India acts as a banker to the
central and state Government. As a banker it provides all the services like
a commercial bank to these Governments. It accepts deposits of the
Government and allows them to withdrawal of cheques. It makes
payments and collect receipts on behalf of the government. It also
provides temporary advances for maximum period of 3 months to these
governments. It is known as “Ways” and “Means advances”. It is also the
financial advisor to the central and states. It also helps them in
formulation of financial policies.

iii) Bankers bank: - Reserve Bank of India is the apex financial institution acts
as banker to other bank. RBI accepts deposits, maintains cash reserves
and lends loans to all the banks operating under its preview. It is a
banker’s bank in the following grounds: It provides short-term loans to
the banks for 3 months against (security) i.e. eligible securities.

It is known as lenders of last resort in the times of financial emergency.

It also gives loans at concessional rate of Interest for a specific purpose.
It also offers refinance facilities to all the eligible banks.

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iv) Regulatory and Supervisor Function: -The most significant provision of the
Banking regulation act is supervision and regulation of banks. Section 35 of
the act say’s that RBI can inspect any branch of Indian Bank located in or
outside the country. Further, it issued licensing for the banks and can
establish new branches to maintain regional balance in the country. It also
arranges for training colleges to the banks employees and officers.

v) Controller of Credit: - Reserve Bank of India is an important controller of

credit in our credit. The credit created by bank leads to inflation or
depression and disturbs the smooth functioning of the economy. Therefore,
to regulate credit Reserve Bank of India uses qualitative as well as
Quantitative credit control measures.

Role of Reserve Bank of India in Credit Control

The Reserve Bank of India adopts two methods to control credit in modern times
for regulating bank advances. They are as follows

(A) Quantitative or General Credit Control

This method aims to regulate the amount of bank advance.

(a) Bank rate

It is the rate at which central bank discounts the securities of commercial

banks or advance loans to commercial banks. This rate is the minimum and
it affects rate is the rate of discount prevailing in the money market among
other lending institutions. Generally bank rate is higher than the marketrate.
If the bank rate is changed all the other rates normally change at the same
direction. A central bank control credit by manipulating the bank rate. If the
central bank raises the bank rate to control credit, the market discount rate
and other lending rates in the money will go up. The cost of credit goes up and
demand for credit goes down. As a result, the volume of bank loans and
advances is curtailed. Thus raise in bank rate will contract credit.

(b) Open Market Operation:

It refers to buying and selling of Government securities by the central bank in

the open market. This method of credit control becomes very popular afterthe
1st World War. During inflation, the banks will securities and during
depression, it will purchase securities from the public and financial
institutions. The Reserve Bank of India is empowered to buy and sell
government securities from the public and financial institutions. The
Reserve Bank of India is empowered to buy and sell government securities,
treasury bills and other approved securities. The central bank uses the
weapon to overcome seasonal stringency in funds during the slack season.

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When the central bank sells securities, they are purchased by the commercial
banks and private individuals. So money supply is reduced in the economy and
there is contraction in credit.

When the securities are purchased by the central bank, money goes to the
commercial banks and the customers. SO money supply is increased in the
economy and there is more demand for credit.

(c) Variable Reserve Ratio (VRR):

This is a new method of credit control adopted by central bank. Commercial

banks keep cash reserves with the central bank to maintain for the purpose of
liquidity and also to provide the means for credit control. The cash reserveis
also called minimum legal reserve requirement. The percentage of this ratio can
be changed legally by the central bank. The credit creation of commercial banks
depends on the value of cash reserves. If the value of reserve ratio increase and
other things remain constant, the power of credit creation by the commercial bank
is decreased and vice versa. Thus by varying the reserve ratio, the lending
capacity of commercial banks can be affected.

(B) Qualitative or Selective Control Method:

It is also known as qualitative credit control. This method is used to control the
flow of credit to particular sectors of the economy. The direction of creditis
regulated by the central bank. This method is used as a complementary to
quantitative credit control discourages the flow of credit to unproductive sectors
and speculative activities and also to attain price stability. The main instruments
used for this purpose are:

(1) Varying margin requirements for certain bank:

While lending commercial banks accept securities, deduct a certain

margin from the market value of the security. This margin is fixed by the central
bank and adjusts according to the requirements. This method affects the
demand for credit rather than the quantity and cost of credit. This method is
very effective to control supply of credit for speculative dealing in the stock
exchange market. It also helps for checking inflation when the margin is raised.
If the margin is fixed as 30%, the commercial banks canlend up to 70% of
the market value of security. This method has been used by RBI since 1956 with
suitable modifications from time to time as per the demand and supply of
commodities.

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(2) Regulation of consumer's credit:

Apart from trade and industry a great amount of credit is given to the
consumers for purchasing durable goods also. Reserve Bank of India seeks to
control such credit in the following ways:

(a) By regulating the minimum down payments on specific goods.

(b) By fixing the coverage of selective consumers’ durable goods.

(c) By regulating the maximum maturities on all instalment credit and

(d) By fixing exemption costs of instalment purchase of specific goods.

(3) Control through Directives:

Under this system, the central bank can issue directives for the credit control.
There may be a written or oral voluntary agreement between the central bank
and commercial banks in this regard. Sometimes the commercial banks do not
follow these directives of the Reserve Bank of India.

(4) Rationing of credit:

The amount of credit to be granted is fixed by the central bank. Credit is

rationed by limiting the amount available to each commercial bank. The
Reserve Bank of India can also restrict the discounting of bills. Credit can also
be rationed by the fixation of ceiling for loans and advances.

(5) Direct Action:

It is an extreme step taken by the Reserve Bank of India. It involves refusal

by Reserve Bank of India to extend credit facilities, denial of permission to open
new branches etc. Reserve Bank of India also gives wide publicity about the
erring banks to create awareness amongst the public.

(6) Moral suasion:

Reserve Bank of India uses persuasion to influence lending activities of banks.

It sends letters to banks periodically, advising them to follow sound principles of
banking. Discussions are held by the Reserve Bank of India with banks to control
the flow of credit to the desired sectors.

Role of Reserve Bank of India in Money market

RBI is the most important constituent of the money market. The money market
comes within the direct purview of the Reserve Bank of India regulations. The
Reserve Bank of India influences liquidity and interest rates through a number of
operating instruments such as CRR, Open Market Operations, repos, change in

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bank rates etc. The RBI has been taking several measures to develop money
market in India. A committee to review the working of the monetary system under
the chairmanship of Sukhamoy Chakravorty was set up in 1985. It underlined the
need to develop money market instruments. As follow up, the RBIset up a working
group on the money market under the chairmanship of N.Vaghul. The committee
submitted its report in 1987. This committee laid the blueprint for the institution
of a money market. Based on its recommendations, the RBI initiated the following
measures:

1. The DFHI was set up as a money market institution jointly by the RBI, public
sector banks, and financial institutions in 1988 to impart liquidity to moneymarket
instruments and help the development of a secondary market for such
instruments.

2. Money market instruments such as the 182-day T-bill, CD and interbank

participation certificate were introduced in 1988-89. CP was introduced in January
1990.

3. To enable price discovery, the interest rate ceiling on call money was freed in
stages from October 1988. As a first step, operations of the DFHI in the call/notice
money market were freed from the interest rate ceiling in 1988. Interest rate
ceiling on interbank term money, rediscounting of commercial bills and interbank
participation without risk were withdrawn in May 1989. All the money market
interest rates are, by and large, determined by market forces.

In August 1991, the RBI set up a high level committee under the
chairmanship of M.Narasimham (the Narasimham Committee) to examine all
aspects relating to structure, organization, functions and procedures of the
financial system. The committee made several recommendations for the
development of the money market. Based on its recommendations, the RBI
initiated the following measures:

4. The Securities Trading Corporation of India was set up in June 1994, to provide
an active secondary market in government securities.

5. Barriers to entry were gradually eased by (a) setting up the primary dealer
system in 1995 and satellite dealer system in 1999 to inject liquidity in themarket,
(b) enabling market evaluation of associated risks by withdrawing regulatory
restrictions such as bank guarantees in respect of CPs, and (c) increasing the
number of participants by allowing the entry of foreign institutional investors.

6. Several financial innovations in instruments and methods were introduced. T- bills

of varying maturities and RBI repos were introduced. Auctioned T-bills were
introduced leading to market-determined interest rates.

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7. The development of a market for short term funds at market-determined rates

has been fostered by a gradual switch from a cash credit system to a loan based system.

8. Adhoc and on-tap 91-day T-bills were discontinued.

9. Liquidity Adjustment Facility (LAF) was introduced in June 2000.

10. The minimum lock in period for money market instruments was brought
down to 7 days.

11. The RBI started repos both on auction and fixed interest rate basis for liquidity
management.

12. New money market derivatives such as forward rate agreements and interest rate
swaps were introduced in 1999.

13. Money market instruments such as CDs and CPs are freely accessible to non-
bank participants.

14. The payment system infrastructure was strengthened with the introduction of the
negotiated dealing system (NDS) in February 2002, setting up of the Clearing
Corporation of India Ltd. (CCIL) in April 2002, and the implementation of real time
grow settlement system from April 2004.

15. Collateral Borrowing and Lending Obligations was operationalising as a

money market instruments through the CCIL in June 2003.

A basic objective of money market reforms in the recent years has been to
facilitate the introduction of new instruments and their appropriate pricing. The
RBI has endeavoured to develop market segments which exclusively deal in specific
assets and liabilities as well as participants. Accordingly, the call/notice money market
is now a pure inter-bank market. Standing liquidity support to banks from the RBI
and facilities for exceptional liquidity support has been rationalized. The various
segments of the money market have integrated with the introduction and successful
implementation of the LAF. The NDS and CCIL have improved the functioning of money
markets. Thus, RBI has been attempting to develop the Indian money market. RBI is
playing a key role in the development of Indian money market.

V-2. Securities Exchange Board of India (SEBI)

Securities and Exchange Board of India (SEBI) is the nodal agency to regulate
the capital market and other related issues in India. It was establishedin 1988 as
an administrative body and was given statutory recognition in January 1992
under the SEBI Act 1992 which came into force on January 30,

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1992. Before that, the Capital Issues (Control) Act, 1947 was repealed. SEBI hasbeen
constituted on the lines of Securities and Exchange Commission of USA. SEBI is
consisting of the Chairman and 8 Members (one member representing the Reserve
Bank of India, two members from the officials of Central Governmentand five other
public representatives to be appointed by the Central Government from different
fields). Securities and Exchange Board of India has been playing an active role in the
Indian Capital Market to achieve the objectives enshrined in the Securities and
Exchange Board of India Act, 1992.

The major objective of the SEBI may be summarised as follows:

 To provide a degree of protection to the investors and safeguard their rights and
to ensure that there is a steady flow of funds in the market.

 To promote fair dealings by the issuer of securities and ensure a market

where they can raise funds at a relatively low cost.

 To regulate and develop a code of conduct for the financial intermediaries

and to make them competitive and professional.

 To provide for the matters connecting with or incidental to the above.

Section 11 of the SEBI Act deals with the powers and functions of the SEBI
as follows:

 It shall be the duty of Board to protect the interests of the investors in securities
and to promote the development of and to regulate the securities market by
measures as deemed fit.

 To achieve the above, the Board may undertake the following measures :

1. Regulating the business in stock exchanges;

2. Registering and regulating the working of stock brokers, sub-brokers, share

transfer agents, bankers to an issue, merchant bankers, underwriters,
portfolio managers;

3. Registering and regulating the working of the depositories, participants, credit

rating agencies;

4. Registering and regulating the working of venture capital funds and collective
investment schemes, including mutual funds;

5. Prohibiting fraudulent and unfair trade practices relating to securities

markets;

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6. Promoting investors education and training of intermediaries of securities

markets;

7. Prohibiting insider trading in securities;

8. Regulating substantial acquisition of shares and take-over of companies;

and

9. Calling for information from undertaking, inspection, concluding inquiries and

audits of the stock exchanges, mutual funds, other persons associated with the
securities market intermediaries and self-regulatory organisations in the
securities market.

In order to attain these objectives, Securities and Exchange Board of India has issued
Guidelines, Rules and Regulations from time to time. The most important of these
is the “SEBI (Disclosure and Investor Protection) Guidelines, 2000″. The provisions of
these Guidelines, 2000 are aimed to protect the interest of the investors in securities.

The Guidelines, 2000 deals with the following areas:

 Eligibility norms for companies issuing securities,

 Pricing of securities by companies,

 Promoters contribution and lock-in requirements,

 Pre-issue obligations of the merchant bankers,

 Contents of the prospectus/abridged prospectus letter of offer,

 Post issue obligation, of merchant bankers,

 Green shoe option,

 Guidelines on advertisements,

 Guidelines for issue of debt instruments,

 Guidelines for book building process

 Guidelines on public offer through stock exchange on-Iine system,

 Guidelines for issue of capital by financial institutions,

 Guidelines for preferential issues of securities,

 Guidelines for bonus issues,

 Other operational and miscellaneous matters.

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In order to regulate and control and to provide a code of conduct for the merchant
bankers, other participants of capital market, and other matters relating to trading
of securities, SEBI has issued several Rules and Regulations. These are related to
Bankers to the issues, Buy back of securities, Collective Investments Schemes,
Delisting of securities, Depositors, Derivatives, Employee stock options, Foreign
Institutional Investors(FII’s), Insider Trading, Lead Manager, Market Makers,
Merchant Bankers, Mutual Funds, Ombudsman, Portfolio Manager, Registrars and
Share Transfer Agents, Securities Lending Scheme, Sweat Equity, Stock Brokers and
sub-brokers, Takeover Regulations, Transfer of Shares, Underwriters, unfair Trade
Practices, venture capital Funds, Annual Reports, etc.

Role of SEBI in Primary Market

The primary market is under the control of Securities and Exchange Board
of India. Securities and Exchange Board of India has an important role to keep
the primary market healthy and efficient. It has been taking several measures
for the development of primary market in India. In the meantime it is attempting
to protect the interest of investors. It is issuing guidelines in respect of new issues
of securities in the primary market. The role being played by the Securities and
Exchange Board of India in the primary market can be understood from the
following points:

1. The prime objective of establishing Securities and Exchange Board of India was
to protect the interests of investors in securities, promoting the development of,
and regulating the securities markets.

2. The Securities and Exchange Board of India Act came into force on 30th January,
1992. With its establishment, all public issues are governed by the rules and
regulations issued by Securities and Exchange Board of India.

3. Securities and Exchange Board of India was formed to promote fair dealing in
issue of securities and to ensure that the capital markets function efficiently,
transparently and economically in the better interests of both the issuers and
investors.

4. The promoters should be able to raise funds at a relatively low cost. At the same
time, investors must be protected from the unethical practices. Their rights must be
safeguarded so that there is a ready flow of savings into the market. There must be
proper regulation and code of conduct and fair practice by intermediaries to make
them competitive and professional. These are taken care of by Securities and
Exchange Board of India.

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5. Since its formation, Securities and Exchange Board of India has been
instrumental in bringing greater transparency in capital issues. Under the
umbrella of Securities and Exchange Board of India, companies issuing shares
are free to fix the premium provided that adequate disclosure is made in the offer
documents. Securities and Exchange Board of India has become a vigilant
watchdog with the focus towards investor protection.

6. The Securities and Exchange Board of India introduced the concept of anchor
investor on June 18, 2009 to enhance issuer’s ability to sell the issue, generate
more confidence in the minds of retail investors and better price discovery in the
issue process. Anchor investors are qualified institutional buyers that buy a large
chunk of shares a day before an IPO opens. They help arriving at an appropriate
benchmark price for share sales and generate confidence in retail investors. A
retail investor is one who can bid in a book-built issue or applies for securities for
a value of not more than Rs. 1,00,000.

Primary Market Reforms by the SEBI:

The Securities and Exchange Board of India (SEBI) has introduced various
guidelines and regulatory measures for capital issues for healthy and efficient
functioning of capital market in India. The issuing companies are required to make
material disclosure about the risk factors, in their offer documents and also to
get their debt instruments rated. Steps have been taken to ensure that continuous
disclosures are made by firms so as to enable to investors to make a comparison
between promises and performance. The merchant bankers now have greater
degree of accountability in the offer document and the issue process. The due
diligence certificate by the lead manager regarding disclosure made in the offer
document, has been made a part of the offer document itself for better
accountability and transparency on the part of the lead managers.

New reforms by Securities and Exchange Board of India, in the primary

market, include improved disclosure standards. Introduction of prudential norms
and simplifications of issue procedures. Companies are now required to disclose
all material facts and specific risk factors associated with their projects while
making public issues. SEBI has also introduced a code for advertisement for public
issues for ensuring fair and true picture. In order to reduce the cost of issue, the
underwriting of issues has been made optional subject to the conditions that if
the subscription is less than 90% f the amount offered, the entire amount collected
would be refunded to the investors.

The book-building process in the primary market has been introduced with
a view to further strengthen the price fixing process. Indian companies have been
allowed to raise funds from abroad by issue of ADR/GDR/FCCB, etc.

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Role of SEBI in Secondary Market

Since its birth, Securities and Exchange Board of India has been playing an
active role to make the secondary market healthy and efficient. It will issue guidelines
for the proper functioning of the secondary market. It has the power to call
periodical returns from stock exchanges. It has the power to prescribe maintenance of
certain documents by the stock exchanges. It may call upon the exchange or any
member to furnish explanation or information relating to the affairs of the stock
exchange or any members.

Recent Developments in the Secondary Market (Steps taken by SEBI and Govt to
reform the Secondary Market)

In recent years several steps have been taken to reform the secondary market
with a view to improve the efficiency and effectiveness of secondary market. Some
of the developments in this direction are as follows:

1. Regulation of intermediaries: Strict control is being exercised on the

intermediaries in the capital market with a view to improve their functioning. The
intermediaries such as merchant bankers, underwriters, brokers, sub-brokersetc.
must be registered with the Securities and Exchange Board of India. To improve
their financial adequacy, capital adequacy norms have been fixed.

2. Insistence on quality securities: Securities and Exchange Board of India has

announced recently revised norms for companies accessing the capital market so
that only quality securities are listed and traded in stock exchanges. Further,
participation of financial institutions in the capital is essential for entry into the
capital market.

3. Prohibition of insider trading: Now Securities and Exchange Board of India

(Insider Trading) Amendment Regulations, 2002 have been formed giving more
powers to Securities and Exchange Board of India to curb insider trading. An
insider is prevented from dealing in securities of any listed company on the basis
of any unpublished price sensitive information.

4. Transparency of accounting practices: To ensure correct pricing and wider

participation, greater efforts are being taken to achieve transparency in trading
and accounting practices. Brokers are asked to show their prices, brokerage,
service tax etc. separately in the contract notes and their accounts.

5. Strict supervision of stock market operations: The Ministry of Finance and

Securities and Exchange Board of India supervise the operations in stock exchanges
very strictly. The Securities and Exchange Board of India monitors the operations of
stock exchanges very closely in order to ensure that the dealings are conducted in
the best interest of the overall financial environment in the

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country in general and the investors in particular. Strict rules have been framed
with regard to recognition of stock exchanges, membership, management,
maintenance of accounts etc. Again, stock exchanges are inspected by the officers
of the Securities and Exchange Board of India from time to time.

6. Discouragement of manipulations: The Securities and Exchange Board of India

is taking all steps to prevent price manipulations in all stock exchanges. It has given
instructions to all stock exchanges to keep special margins in addition to normal
ones on the scrips which are subject to wide price fluctuations. The Securities and
Exchange Board of India itself insists upon a special margin of 25% or more (in
addition to the regular margin) on purchases of scrips which are subject to sharp
rise in prices. All stock exchanges have been directed to suspend trading in scrip
in case any one of the stock exchanges suspends trading in that scrip for more than
a day due to price manipulation or fluctuation.

7. Prevention of price rigging: Greater powers have been given to Securities and
Exchange Board of India under Securities and Exchange Board of India
(Prohibition of fraudulent and unfair trade practices relating to security markets)
Regulations, 1995 to curb price rigging.

8. Protection of investors’ interests: Stock exchanges are given instructions to take

timely action for the redressal of grievances of investors. For this purpose, the
Securities and Exchange Board of India issues “Investors Guidance Service’to
guide and educate the investors about grievances and remedies available. It also
gives information about various investment avenues, their merits, tax benefits
available etc. Disciplinary Action Committees have been set up in each stock
exchange to take up complaints against companies, brokers etc. The Securities and
Exchange Board of India itself takes up complaints against companies, brokers etc.
Further, each stock exchange is under a legal obligation to create an investor
protection fund.

9. Free pricing of securities: Now any company is free to enter the capital market
to raise the necessary capital at any price that it wants. Recently, the Securities and
Exchange Board of India has permitted companies to issue shares below the face
value of Rs. 10 and liberalised the norms for initial public offerings.

10. Freeing of interest rates: Interest rates on debentures and on PSU bonds were
freed in August 1991 with a view to raising funds from the capital market at
attractive rates depending on the credit rating.

11. Setting up of credit rating agencies: Credit rating agencies have been set upfor
awarding credit rating to the money market instruments, debt instruments, deposits
and equity shares also. Now all debt instruments must be compulsorily credit rated by
a credit rating agency so that the investing public may not be deceived by financially
unsound companies.
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12. Introduction of electronic trading: The OTCEI has started its trading
operations through the electronic media. Similarly, BSE switched over to
electronic trading system in 1995, called BOLT. Again, NSE went over to screen
based trading with a national network.

13. Establishment of OTC / OTCEI / NSE: To overcome delay, price rigging,

manipulation etc., OTC/ OTCEI and NSE have been established. OTC markets are
fully automated exchanges where trading would be carried out through network
of telephone/ computers/ tellers spread throughout the country.

14. Introduction of depository system: To avoid bad delivery, forgery, theft, delay
in settlement and to speed up the transfer of securities, the depository system has
been approved by the Parliament on July 23, 1996.

15. Buy back of shares: Now companies have been permitted to buy back their
own shares.

16. Disinvestment of shares of PSUs: To bring down the Govt. holding and to
push up the privatisation process, the disinvestment programme has been
implemented. A Disinvestment Commission has been established for this
purpose.

17. Stock watch system: The Securities and Exchange Board of India introduced
a new stock watch system to trace out the source of undesirable trading if any in
the market. The stock watch system simply works as a mathematical model which
keeps a constant watch on the market movements.

18. Trading in derivatives: L.C. Gupta Committee which had gone into the question
of introduction of derivative trading, has recommended introducing trading in index
futures to start with and then trading in options. Recently, future funds also have
been permitted to trade in derivatives.

19. Stock lending mechanism: To make the capital market active by putting idle
stocks to work, stock lending scheme has been introduced by the Securities and
Exchange Board of India.

20. International listing: The big event in the history of Indian capital market is the
listing company’s share on an American stock exchange.

21. Rolling settlement: In July 2001, Securities and Exchange Board of India made
rolling settlement on a T + 5 cycles compulsory in 414 stocks and the restof the
stocks should follow it from January 2002. But now T + 2 rolling settlement have
been introduced for all securities.

22. Margin trading: Another development in the secondary market is the

introduction of margin trade.

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Secondary Market Reforms by the SEBI:

Since the establishment of Securities and Exchange Board of India (SEBI)
in 1992, the decade’s old trading system in stock exchanges has been underreview.
The main deficiencies of the system were found in two areas: (i) the clearing and
settlement system in stock exchanges whereby physical delivery of shares by the
seller and the payment by the buyer was made, and (ii) procedure for transfer of
shares in the name of the purchaser by the company. The procedure was involving
a lot of paper work, delays in settlement and non- transparency in costs and prices
of the transactions. The prevalence of ‘Badla’ system had often been identified as a
factor encouraging speculative activities. As a part of the process of establishing
transparent rules for trading, the ‘Badla’ system was discontinued in December
1993. The Securities and Exchange Board of India directed the stock exchanges at
Mumbai, Kolkata, Delhi and Ahmadabad to ensure that all transactions in
securities are concluded by delivery and payments and not to allow any carry
forward of the transactions.
The floor-based open outcry system has been replaced by on-line electronic
system. The period settlement system has given way to the rolling settlement system.
Physical share certificates system has been outdated by the electronic depository
system. The risk management system has been made more comprehensive with
different types of margins introduced. FII’s have been allowed to participate in the
capital market. Stringent steps have been taken to check insider trading. The interest
of minority shareholders has been protected by introducing takeover code. Several
types of derivative instalments have beenintroduced for hedging.
As a result of the reforms/initiatives taken by Government and the Regulators,
the market structure has been refined and modernized. The investment choices for
the investors have also broadened. The securities market moved from T+3 settlement
periods to T+2 rolling settlement with effect from April 1, 2003. Further, straight
through processing has been made mandatory for all institutional trades executed
on the stock exchange. Real time gross settlement has also been introduced by RBI
to settle inter-bank transactions online real time mode.
References

1. Gordon E. & Natarajan K.: Financial Markets & Services, Himalaya

Publishing House.
2. Machiraju.R.H: Indian Financial System, Vikas Publishing House.
3. Khan M.Y: Indian Financial System, Tata Mcgraw Hill.
4. Bhole L.M: Financial Institutions and Markets, Tata Mcgraw Hill.
5. Desai, Vasantha: The Indian Financial System, Himalaya Publishing House.
6. Preserve Articles.Com
7. Kalyan City Blogspot

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MODEL QUESTION PAPER 1

FIFTH SEMESTER B.COM. DEGREE (PRIVATE/SDE)

EXAMINATION 2013

(CCSS)

BC5 B10-INDIAN FINANCIAL SYSTEM

Time Weightage

Part I- Descriptive questions 2.45 hours 27

Part II-Multiple choice questions 0.15 hours 3

Maximum 3 hours 30 weightage

Part I

Part A

Answer all questions.

Each question carries a weightage of 1

8. What do you mean by financial system?

9. What do you mean by financial intermediation?

10.Define money market.

11.What is certificate of deposit?

12.What are the important development banks in India?

13.Expand the following : a. DFHI b. MMMF

14.Define stock exchange.

15.What are NBFCs?

16.What you mean by Deep Discount Bond? ( 9 x1= 9 weightage)

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Part B

Answer any 5 questions.

Each question carries a weightage of 2

17.Distinguish between money market and capital market.

18.Discuss various modes of floating of new securities.

19.Briefly explain the functions of merchant banks.

20.Briefly explain dematerialisation and its benefits.

21.Discuss the role and functions of Securities and Exchange Board of India.

22.Explain the following terms;

a. Commercial paper

b. Treasury bills

c. Repo

d. GDR

23.What are the importance of gilt edged securities? ( 5 x2= 10 weightage)

Part c

Answer any 2 questions.

Each question carries a weightage of 4

24.Explain the role and functions of financial system. Also explain the defects of
Indian financial system.

25.Discuss various components of money market.

26.Briefly explain the role and guidelines of SEBI in Primary and secondary market.
(2 x4 =8 weightage)

Part II

20 No’s of multiple choice questions

**********

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