FINANCIAL MARKETS & INSTITUTIONS, Study notes of Financial Management

Download FINANCIAL MARKETS & INSTITUTIONS and more Study notes Financial Management in PDF only on Docsity! it @ FINANCIAL MARKETS & INSTITUTIONS UNIT-I 2 CHAPTER-1 INDIAN FINANCIAL SYSTEM & RECENT REFORMS IN THE INDIAN CAPITAL MARKET 5 Financial System Financial System of a country consists of a network of an interconnected system of markets, institutions and services. • This system contributes to the economic development of a country. • The main function of the financial system are to encourage savings and to transfer them efficiently into investments. • Various components of financial system are: - Financial Institutions - Financial Markets - Financial Instruments - Financial Services 6 Flow of funds in financial system Financial intermediaries Borrower-Spenders 1. Business Firms 2. Government 3. Households 4. Foreigners Lender - Savers 1. Households 2. Business Firms Financial Markets 3. Government 4. Foreigners 1.Financial Institutions Mobilization of savings and transformation of direct claims in indirect are the focus of financial institutions. They can be Classified as • Intermediaries - Banks - Non Banks • Non-intermediaries • Others 10 2. Financial Markets: Participants & Instruments • Financial Markets are an important component • of financial system in an economy. • Financial Markets are the centers or arrangements facilitating buying and selling of financial claims, assets, services and securities. • They aim at establishing a regular, smooth, efficient and cost effective link between savers and investors. • It may be a specific place or location e.g. stock exchange, or it may be just an over-the-phone market. 11 Features • Real time India Financial Indices – BSE 30 index, Sector Indexes, Stock Quotes, Sensex charts, Bond Prices, Foreign exchane, Rupee and Dollar chart. • Indian Financial Market News • Stock news – BSE, BSE 30 closing index, S & P CNX- NIFTY NSE, stock quotes, company information, issue on market capitalization, corporate earning statements, Indian business directory. • Fixed income : Corporate bond prices, corporate debt details, debt trading activities, interest rates, money market, govt. securities, public sector debt, external debt services. • Foreign investment : Foreign debt database composed by BIS, IMF, OECD and World Bank, Investments in India and abroad. • Global Equity Indexes : Dow Jones Global indexes, Morgan Stanley Equity indexes. • Currency indexes : FX & Gold chart Plotter, J.P. Morgan Currency indexes. • National and global market relations. Indian Financial Market 12 Classification of Financial Markets Financial Markets Money Market Capital Market Forex Market 15 MONEY MARKET Money market is a specialised market geared to cater to the short term needs. It is a market for short term financial assets which near substitutes for money. Characteristics • Over-the-phone market. • Dealings with or without the help of brokers. • Short term financial assets that are close substitutes for money. • Period generally up to one year. • Financial assets which can be converted into money with ease, speed, without loss and with minimum transactions cost are regarded as close substitutes for money or near-money. • Consists sub markets such as commercial paper market, treasury bills market, etc. 16 Types of Money Market Call Money Market Treasury Bills Market Commercial Bills Market (CB) CD ICD CP Repo Short-term Loan market 17 Who Participates in the Money Markets? TABLE 2 Participant Money Market Participants Role U.S. Treasury Department Federal Reserve System Commercial banks Businesses Investment companies (brokerage firms) Finance companies (commercial leasing companies) Insurance companies (property and casualty insurance companies) Pension funds Individuals Money market mutual funds Sells U.S. Treasury securities to fund the national debt Buys and sells U.S. Treasury securities as its primary method of controlling the money supply Buy U.S. Treasury securities; sell certificates of deposit and make short-term loans; offer individual investors accounts that invest in money market securities Buy and sell various short-term securities as a regular part of their cash management Trade on behalf of commercial accounts Lend funds to individuals Maintain liquidity needed to meet unexpected demands Maintain funds in money market instruments in readiness for investment in stocks and bonds Buy money market mutual funds Allow small investors to participate in the money market by aggregating their funds to invest in large-denomination money market securities Distinction between Money Market and Capital Market Money Market • SHORT DURATION. • Institutional source of working capital to the industry, financial instruments and other corporate entities. • Large sized participants. • Over the phone market. • Wholesale market. • Generally on a same day settlement basis. • Consists of a number of interrelated sub-markets such as call market, treasury bill market, commercial bill market, etc. Capital Market • LONGER DURATION • Financing fixed investments. • Both large and small sized participants. • Over the phone, stock exchanges, intermediaries, etc. • Both whole sale and retail market. • May involve short term period or long term holding. • Consists of primary market and secondary market. 21 Indian Money Market till 1991 • In 1935, RBI was formed. • Commencement of planning process in 1951. • Nationalisation of bank in 1969. • Setting of Sukhmoy Chakraborthy committee and Vaghul Working Group in 1982 and 1986 respectively. • Submission of their report in 1985 and 1987 respectively. • Setting of Discount and Finance House of India Ltd. (DFHI) in 1988. • Setting of Securities Trading Corporation of India (STCI) in 1994. • Commencement of liberalisation and globalisation process in 1991. 22 CAPITAL MARKET RECENT REFORMS Capital Market • Capital Market is generally understood as the market for long term funds. • However, sometimes the term is used in broad sense to include also the market for short term funds. • But in most of the cases, the term Capial Market is used to refer to the market for long term lonable funds as distinct from money market. • Money Market & Capital Market are in fact inter dependent markets 26 Capital Market: Constituents • Marketable Securities includes: - Government Securities - Corporate securities - P.S.U. Bonds - Mutual Funds • Non-Marketable securities includes: - Bank Deposits - Deposit with Companies - Loans & advances of Banks and FIs. - Post Office Certificates and Deposits 27 How Trading Mechanisms have changed • Technology has been a change driver • Created Virtual market place • Widened reach • Increased market efficiencies • Competitive market structures- ECNs? 30 Impact of changes • Reach – Geographical – Made a distribution framework available • Product Diversity • Efficiencies – Better order executions – Increased liquidity 31 Impact of changes(contd.) – Price transparency – Cost reduction – Shorter settlement cycles – Full line service from order capture to settlement and risk management – Regulatory issues with each new development 32 Emerging Trends (contd.) • Services becoming more commoditised • Need to add value propositions • Single line of service model to clients right through to Risk Management • Need to facilitate Technology Leverage by Intermediaries • Leverage the trading infrastructure 35 Emerging Trends (contd) • Customised products and OTC • Large value investors and OTC • Standardised products and contracts • Changing product profile • Time Horizons changing to span time zones 36 Emerging Trends (contd.) • Changing Settlement scenario • Changing Risk Management scenario • Straight Through Processing • Processing oriented to client level • Interfaces with other settlement Agencies • Integration emerging across markets 37 1. Commercial banks, primary deposits (PDs) and other authorised institutions are allowed to borrow and lend in call market for adjusting their cash reserve requirement. 2. Banks and other institutions can even out their day to day deficits and surplus of money. 3. Specified FIIs, Mutual Funds and other specified entities are allowed to operate in Call/ Notice money market as lenders only. 4. Call/ Notice money market is becoming a pure inter-bank market. 5. Both the borrowers and lenders are required to have current accounts with the RBI so that transactions in call market are very speedy and efficient. 6. Interest rates in Call/ Notice money market are fully market determined. 7. Lenders with steady inflow of funds can deploy funds on short-term basis in call market. 40 Benefits of Call Money Market Features of Call Money Market  Part of the national money market.  Day-to day surplus funds mainly of banks are traded.  Short term in nature.  Maturity of these loans vary from 1 to 15 days.  Lent for 1 day: Call money.  Lent for more than 1 day but less than 15 days: Notice money.  Convenient interest rate.  Highly liquid loan repayable on demand.  In India, CMM provides facilities for inter-bank lending.  Surplus suppliers of funds: UTI, SBI, LIC. 41 Participants in Call Money Market • Those permitted to operate both as lenders and borrowers: - Commercial Banks both Indain & Foreign - State Bank of India - Co-operative Banks - Discount & Finance House of India (DFHI) - Securities Trading Corporation of India (STCI) - Primary Dealers. • Those permitted to operate as lenders: - LIC - UTI - GIC - IDBI - NABARD - specified institutions already operating - Entities/ corporates/ mutual funds etc. 42 Working in Call Money Market • Transactions in this market include: - Call loans between banks - Borrowings and lending by DFHI & STCI - Lending by LIC, UTI, GIC, IDBI, NABARD - Call loans to the Bills Market - Call loans for dealing in Stock Exchanges and Bullion Market - Call loans to the individuals of very high status for trade purposes. - Lending by the entities which provide an evidence to RBI that they have bulk lend able resources with no outstanding borrowings. 45 Working contd. • Call money market is basically over the telephone market. • Call money market has small number of large operators. Each operator is financially very sound. • Despite large volume of transactions, direct deals between lenders & borrowers easily take place. • Borrowers & lenders contact each other over telephone and arrive at a deal after negotiating the amount of loan and rate of interest. • After this lender issues RBI cheque in favour of borrowing bank. In return Borrowing Bank issues Call Money Borrowing Receipt. • On the next day or on the date of reversal of the transaction the lender returns the duly discharged receipt while the borrowing bank repays the amount with interest by issuing RBI cheque. • Call loans can be renewed with the mutual consent of the borrowers and lenders. Such renewals are at the interest rate mutually agreed. However such renewals are allowed up to a maximum of 14 days from the original transaction after which transaction is to reversed. • Commercial Banks, primary Dealers and other financial institutions are allowed to operate in this market for adjusting their cash reserve requirement. • Banks and other institutions can event out their day to day deficits and surpluses of money. • Call /Notice money market are fully market determined. • Call /Notice market is becoming a pre inter–bank market. 46 Volatility in Call Money Market Reasons: • Large borrowings by banks on reporting Fridays to meet CRR requirements raise demand for liquid resources and call rates move up. • When banks extend their credit operations beyond their own resources, they approach call money market for meeting market disequilibrium. • When institutional lenders are short of liquidity and instead of lending they start selling securities for meeting their loan repayment or maturity of their instruments. • During the quarter ends when advance tax becomes payable by companies by companies and other institutes, there is a spurt in call rates. • When stock market is buoyant, call rates goes up and vice versa. • When subscription to government loans opens, the demand for loans go up and call rates increases. When securities matures and are encashed by the public and private institutions, supply of call loans increases and therefore call rates come down. • Liquidity crisis also result in soaring call rates. 47 CHAPTER-3 TREASURY BILLS MARKET (T-BILLS) • Treasury Bills or T-Bills are the promissory notes or a kind of finance bill issued by the government under discount for a fixed period, not extending beyond one year, with a promise to pay the amount stated therein to the bearer of the instrument. • Treasury Bills are an important instrument of short term borrowing by the government. • TBs are the used by the govt. for raising short term funds from institutions or the public for bridging temporary gaps between receipts ( both revenue & capital) and expenditure. • TBs are issued for a minimum of Rs. 25,000 and in multiples thereof. 51 History of T-Bills • TBs were first issued by Bank of England. • In India TBs were first issued in October, 1917 with the twin objectives of raising more resources for the First World War efforts of the Govt. and for mopping up excess liquidity in the economy due to heavy war expenditure. • Initially TBs were sold by the Govt. by tender for maturities of 3 months, 6 months, 9 months and 12 months. • Later on, the function of issuing TBs developed on the RBI after it was set up in 1935. • Sale of TBs to public through auction was suspended in 1965. 52 Participants of TB Market The main participants in 14-day, 28-day, 91-day, and 364-day are: • The Reserve Bank of India. • The State Bank of India. • Commercial Banks. • State Governments and other approved bodies. • Discount and Finance House of India (DFHI). • The Securities Trading Corporation of India (STCI). • Other Financial institutions such as LIC, UTI, GIC, NABARD, IDBI, IFCI and ICICI, etc. • Corporate entities. • General public. • Foreign Institutional Investors (FIIs) from April 29, 1998. 55 Types of Treasury Bills 1. Ordinary T- Bills: These are issued to public, banks and other institutions for enabling the central bank to raise resources for its short term financial needs. 2. Ad Hoc T-Bills: These are issued in favour of RBI only. These are not sold through tenders or auctions. The RBI is authorized to issue currency notes against it. These are not marketable in India but the investor can sell them back to RBI. The purpose behind it is: – Replenish cash balance of the Central Government. – Provide an investment outlet for the state government, semi government departments and foreign central bank. – Discount Rate Fluctuations caused by state government intervention are avoided. 56 Periodicity of T-Bills • Initially towards First World War, T-Bills of 3,6,9 and 12 months. • After the commencement of RBI in 1935, 2 types of Bills were there:- TAP Bills and Intermediate bills, both of 91 days maturity. • In Nov. 1986, Chakraborthy Committee recommended 182 days T- Bills because 91 days T-Bills failed to yield. • In May 1997, RBI introduced 14 days T-Bills. • On Oct. 21, 1997, 28 days T-Bills were introduced. • During 1996-97, RBI discounted 91 days Ad Hoc T-Bills issued on the behalf of RBI. • 14, 91, 182 and 364 days T- Bills are issued on weekly and fortnightly auction basis; 182 T-Bills on Wednesday preceding non- reporting Friday and 364 on Wednesday preceding reporting Friday. • From April 1, 1998, all T-bills are issued on a fixed notified amount by RBI. 57 Importance of T-Bills Importance to the Issuer / Government • For raising short – term funds for meeting temporary budget deficits. • Govt. can mop up excess liquidity in the economy through issue of TBs. • Its issuance cannot be monetised and their issue does not lead to inflationary pressure. Importance to the Purchaser / Investor • Liquidity at short notice because DFHI offers daily two–way quotes, they can be discounted from RBI. • Investments are kept in non-earning cash to the minimum and supplementing it with TBs which earn a return. • Eligible securities for determining statutory liquidity requirement (SLR) of banks. Most investments in TBs is by commercial banks. • Instrument of meeting mismatch between realisation of assets and payments on account of liabilities. • Provides complete safety regarding the payment of interest and the repayment of principal. 60 • TBs are available on tap basis as well as fortnightly auctions, they facilitate proper spread of asset mix with different maturities. • A hedge against volatility of call loan market and interest ate fluctuations. • The yield on 364-day TBs is a benchmark for several floating rate bond issues that have been made by various public sector undertakings. 61 CHAPTER-4 COMMERCIAL BILLS MARKET (C.B. MARKET) 8. Import Bill – Bills drawn on importers in India by the exporters outside India. 9. Hundis – Indigenous bills of exchange and promissory notes for financing agriculture and inland trade. 10. Genuine Trade Bill – Bills of exchange by genuine trade or commercial transactions of purchase and sale. 11. Accommodation Bills or Kite Bills or Wind Bills – Bills created by borrowers or lenders simply to help each other, without any trading transactions backing the bills. 12. Supply Bills – a bill drawn by a supplier or a contractor on the government or semi government departments for the supplies made to such departments. 65 Process of Bill writing and Discounting • A genuine trade bill comes into existance when a seller sells goods to buyer. • The seller needs money on completion of the sale and buyer would like to pay out of the earnings of his purchase. • To satisfy the requirement of both parties, the seller draws a bill of agreed maturity on buyer who accepts the bill, thus acknowledging his liability to pay on due date. • The buyer can take the accepted bill to the bank for discounting within his sanctioned limit, or to an NBFC for outside consortium discounting and receives ready cash in return. • The difference between bill value of the sale transaction and the amount received by seller is known as discount charge which is calculated at a rate percent per annum on the maturity value. 66 Importance of Commercial Bill Market • Bill financing is the prevalent method of meeting credit needs of trade and industry. • These are self liquidating in character because they have a fixed tenure. • These have high level of liquidity – next only to cash, call loans and treasury bills • It imposes financial discipline on borrowers as its payment must be made on the due date of the bill. • Banks can meet their short term liquidity requirements by rediscounting these bills. • Existence of bill market enables banks and other institutions to invest their surplus funds profitability by selecting appropriate maturities. • Imparts flexibility to money market by evening out liquidity with bankers. 67 Objectives of BRS Objectives : 1. Creation of an instrument of credit linked with the genuine transactions of purchase and sale. 2. Creation of money market instrument for evening out liquidity in the banking system. 3. Developing a subsidiary market in commercial bills and making the money market more deep and wide. 4. Creation of an instrument which banks could get rediscounted with other financial institutions. 5. Creation of an instrument of credit which encourages a more disciplined use of bank credit than that practiced under usual cash credit and book debt loan. 70 Bills eligible for rediscount All scheduled commercial banks are eligible to rediscount the eligible bills with the RBI and other approved institutions. Rediscounting can be done with the help of following conditions: • Genuine trade bill i.e. it should arise out of a genuine transaction of purchase and sale. • The nature of transaction and the particulars of the documents of title of goods relating to the transaction should be indicated on the face of the bill. • Bill has to be drawn on, and accepted by, the purchaser’s licensed scheduled bank. • In case the purchaser’s bank is not a licensed scheduled bank, the bill has to, in addition, bear an endorsement of a licensed scheduled bank. • Joint bills i.e. the bills drawn on the buyer and his bank jointly, and bills jointly accepted, are also eligible for rediscounting. 71 • Eligible bill should have usance of not more than 90 days. In exceptional cases, where the bills has usance upto 120 days, it can be rediscounted only if the remaining maturity period does not exceed 90 days at the time of its presentation for rediscounting. • Multani and accommodation bills are not eligible for rediscounting. • Banks enjoy refinance facilities against commercial bills throughout the year. • The bill should have atleast two good signatures, one of which has to be of a licensed scheduled bank. • Bills arising out of sale of commodities covered by the RBI under selective credit controls, are not eligible for rediscounting. • Bills drawn by textile mills, and traders and dealers in textiles are eligible for rediscount provided usance of the bill does not exceed 60 days. 72 Types of Bill market rates 1. Bazar Bill rate : the rate at which shroffs and other money lenders used to discount bills of small traders. 2. SBI hundi rate : SBI used to discount hundis to indigenous bankers. 3. Commercial banks bill finance rate : rate at which commercial banks can get bills discounted from each other. 4. SBI discount rate : At this rate SBI discounts first class usance bills. 5. Bank rate : The rate at which the RBI rediscounts eligible bills from commercial banks. 6. DFHI rate : the rate at which the DFHI buys and sells eligible bills from commercial banks and other approved institutions. DFHI quotes both for buying and selling rates. 75 Computation of yield Actual Yield = [(1 + B/ 100*P'P - 1] * 100 R=Rate of discount per annum P=Period of compounding in one year,e.g if itisa 3 months bill, then period of compounding in 12 tonths/3 months =4 or 365/ no. ofdays For example, if it isa 3 tonths bill and the discount rate is 15.5% hen yield will be: Yield=[(1 + 15.5/ 100*12/3)!4 - 1]* 100 [(1.03875)" - 1]* 100 16.4244 % CHAPTER-5 CERTIFICATE OF DEPOSITS (CD) Guidelines issued by Reserve Bank of India 1. These can be issued by scheduled commercial banks and specified All – India Financial Institutions, namely, IDBI, ICICI, IFCI, SIDBI, IRDA, etc. 2. It can be issued to individuals, associations, companies, corporations, trust funds, etc. 3. These attract stamp duty as applicable to negotiable instruments. 4. Banks have to maintain SLR and CRR on issue price if CDs. There is no ceiling on the amount of CDs to be issued. 5. The minimum amount for which a CD was permitted to be issued was also reduced from Rs. 25 lakhs to Rs. 5 lakhs. 6. These can be now transferred to any time after issue, following the prescribed rules. 7. On October 21, 1997, the minimum ize of issue of CDs to a single investor was reduced from Rs. 10 lakhs to s. 5 lakhs. Cds above Rs. 5 lakhs can be issued in multiples of Rs. 1 lakh. 8. Initially, the maximum amount for which a bank was permitted to issue a CD was fixed at 1% for its fortnightly aggregate average deposits. This limit was raised to 10% in 1992 and was subsequently abolished. 80 Yield on Commercial Deposits ER= [(1+ OD /100*n)"- 1]* 100 ER = Effective rate of interest OD = Quoted discount rate n=Maturity period expressed as number of months ina year divided by maturity period in morths, eg. 12/3 =4 months. In case, CDs are issued onrear— end discount, then the effectrre Rate of interest is: DP =[12*100/ (12*100 + R*n)* F DP=Discourt price of CDs, R= Quoted rate of discount n=maturily period of CD expressed m months or days. F=FacevalueofCD CHAPTER-6 COMMERCIAL PAPER (CP) Participants of Commercial Paper Market Participants in Issue of commercial paper • Highly rated corporate borrowers, primary dealers (PDs) and satellite dealers (SDs) and all-India financial institutions (FIs) which have been permitted to raise resources through money market instruments under the umbrella limit fixed by Reserve Bank of India are eligible to issue CP. • A company shall be eligible to issue CP provided - (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the working capital (fund-based) limit of the company from the banking system is not less than Rs.4 crore and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s. • CP may be issued to and held by individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs). However, investment by FIIs would be within the 30 per cent limit set for their investments in debt instruments. 85 Rating and issue requirement • All eligible participants should obtain the credit rating for issuance of Commercial Paper, from either the Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE) or the Duff & Phelps Credit Rating India Pvt. Ltd. (DCR India) or such other credit rating agency as may be specified by the Reserve Bank of India from time to time, for the purpose. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies. Further, the participants shall ensure at the time of issuance of CP that the rating so obtained is current and has not fallen due for review. • CP can be issued in denominations of Rs.5 lakh or multiples thereof. 86 CHAPTER-7 CAPITAL MARKET & ROLE OF SEBI Relationship between NIM and stock market 1. Securities are first pass through primary market and only thereafter traded at stock exchange. 2. While issuing prospectus for fresh issue of capital, the companies stipulate in the prospectus that application has been made or will be made in the due course for listing of shares with the stock exchanges. 3. Stock exchanges exercise significant control over regulation of new issue market as a precondition for listing of shares. 4. Stock exchanges provide liquidity to the shares traded through new issue market and thus helps in expanding NIM. 5. A period of rising activities in stock exchanges is accompanied with higher activity in NIM resulting in large number of successful issues and vice versa. 6. In a period of rising prices in stock exchanges, premiums are high in NIM an d over subscription becomes a common phenomenon. 90 TYPES OF ISSUES 1. INITIAL ISSUES/ INITIAL PUBLIC OFFER (IPO). 2. FURTHER ISSUES. 91 Functions of NIM • Facilitates transfer of resources from savers to entrepreneurs establishing new companies. • Helps raising resources for expansion and/ or diversification of activities of existing companies. • Helps selling existing enterprises to the public as going concerns through conversion of existing proprietorship/ partnership/ private limited concerns into public limited companies. • Provides origination, underwriting and distribution of securities. 92 Role of SEBI (established on April 12,1988) 1. Regulating the business in stock exchanges and any other securities market. 2. Registering and regulating the working of stock brokers, sub brokers, share transfer agents, bankers to an issue, merchant bankers, underwriters, portfolio managers, investment advisors and other intermediaries. 3. Registering and regulating the working of collective investment schemes including mutual funds. 4. Promoting and regulating self regulatory organizations. 5. Prohibiting fraudulent and unfair trade practices relating to securities market. 6. Promoting investor’s education and training of intermediaries of securities market. 7. Prohibiting insider trading in securities. 8. Regulating substantial acquisition of shares and takeovers of companies. 9. Levying fees or other charges for carrying out the above purposes. 10. Conducting research for the above purposes. 95 CHAPTER-8 SECURITIES & EXCHANGE BOARD OF INDIA (SEBI) Securities & Exchange Board of India 97