Financial Management

Dr. Kinshuk Saurabh

CHAPTER 1
An Overview of Financial Management

What is financial management?

Managerial activity which concerned with the
planning and controlling of the firms financial
resources

What is corporate finance?

The activities involved in managing cash flows in a
business environment

What are basic finance activities?

Financing
(Raising Capital)
Financial Management

Capital Budgeting

Risk Management

Corporate Governance

What are financial resources?

Securities, are financial papers or instruments
such as Equity or Debt which are claims to
income generated by firms real assets

What are equity or debt?

Equity represent ownership rights of their
holders. Shareholders are owners of the
company. It can of two types:
Equity Shares
Preference Shares

Debts: represent liability of the firm towards

outsiders. Lenders are not owners of the
company. These provide interest tax shield.
Bonds or debentures

Role of Finance Manager

(2)

Firm's
operations

Real assets

(1)

Financial
Manager

(4a)

(4b)

(3)

(PPE)
(1) Cash raised from investors
(2) Cash invested in firm

Investors
(stockholders/
debtholders
save and invest
in a closely
held firm.

(3) Cash generated by operations (timber harvest)

(4a) Cash reinvested
(4b) Cash returned to investors

What is the finance function?

Long term financial decisions
Investment decision
Capital Budgeting

Finance decision
Debt or equity mix or capital structure

Dividend decision
Payout ratio
Bonus shares

Short term financial decisions

Liquidity decision

Goals: Profit vs. wealth maximization?

When does profit maximization happen?
Profit maximization causes efficient allocation of
resources under the competitive market

Would profit maximization or such a price

system in a free market economy serve the
interest of the society?

What are limitations of profit

maximization?
Definition of profit:
Short term or long term profit? Profit before tax or
profit after tax? Total profit or profit per share?
Operating profit or profit accruing to shareholders
Uncertainty effect
Owners may prefer smaller but surer profits over larger
but uncertain profits

Ignores time value of money

What if Profit after Tax?

Say a company has 10,000 shares outstanding,
PAT of 50,000 and EPS of Rs 5. If the company
sells 10,000 additional shares at Rs 50 per
share and invests the proceeds at 5% after
taxes then what is the new PAT and new EPS?

What if earning per share?

Ignores timing and risks of expected benefits
EPS is maximized when the firm makes no
dividend payments
Maximising PAT or EPS does not maximise the
economic welfare of the owners.
Earnings per share are backward-looking, dependent
on accounting principles
Does not fully consider cash flow timing
Ignores risk

Shareholder wealth maximization

Maximizes the net present value of a decision to
shareholders. Positive NPV creates wealth for
shareholders
Accounts for the timing and risk of the expected
benefits.
Benefits are measured in terms of cash flows.
Maximize stock price, not profits
Fundamental objectivemaximize the market value of
the firms shares. Shareholders, as residual claimants,
have better incentives to maximize firm value.

Agency costs
Maximize Profit?
Earnings per share are backward-looking,
dependent on accounting principles
Does not fully consider cash flow timing
Ignores risk

Maximize Shareholder Wealth?

Maximize stock price, not profits
Shareholders, as residual claimants, have better
incentives to maximize firm value.

Ethics & Management Objectives

Does value maximization justify unethical
behavior?
Enron example
WorldCom example
Putnam example

How agency costs can be controlled?

Ways to limit agency problems:
Activism by institutional investors
Takeover threat
Monitoring and bonding
Compensation contracts

The financial sector of India

Banks
Non-banking finance companies
Mutual Fund
Private equity market
Primary capital market
Secondary capital market

Banking sector : History

The state of banking sector in early 1990s

Cash reserve ratio as high as 15%

Statutory liquidity ratio as high as 38.5%
40% of funds went to priority sector lending
25% of advances of public sector banks turned into
non productive assets
Very high operating costs because of improper
manpower management
Existence of uneconomic branches
50% of banks had negative net worth in 1993

Since then what happened?

CRR 4%
SLR 22%
Provisioning for NPAs
Tribunals set up to recover NPAs
Narsimhan committee recommended to cut down NPAs to 3% of
advances.
Securitization and reconstruction of financial assets and
enforcement of security interest (SARFAESI Act, 2002) to allows
banks to recover their loans outside courts.
Asset reconstruction company of India (ARCIL) was set up in 2003 to
purchase NPAs of banks. PSB NPAs dropped to 1% in 2007-08.
How much is the NPA now.say as of June 2014?

History of Interest rate administration

Interest rate was GoI administered before October,
1994.
In 2001-02 RBI permitted banks to lend at less than PLR
prime lending rate. 2003-04 banks started announcing
their own PLR by taking account of cost of funds and
operating expenses.
Average lending rate was 19% in 1991-92 fell to 10% in
2004-05. How much is the lending rate in 2014?
RBI since April, 2010 introduced base rate system. Now
banks set their lending rates in reference to the base
rate. Base rate is the minimum rate and banks are now
allowed to lend below base rate.

Non-banking finance companies

Registered and regulated by RBI
Equipment leasing companies
Hire-purchase finance companies
Investment companies

Not registered but regulated by RBI:

Nidhi companies
Chit funds

Neither registered nor regulated by RBIs:

Insurance company
Merchant banks
Housing finance
Microfinance

Mutual Funds
Till 1986 entire mutual fund activities were vested in UTI. In 1993
private sector was allowed to operate.
The open ended schemes have perpetual existence and end only
when the number of outstanding units fall below 50% of number of
units. Sale and repurchase based on Net Asset Value are
announced. The sale price is normally kept above NAV and
repurchase price is below NPV.
Close ended scheme exist only for an specified period after which
the investment is liquidated and distributed among unit holders.
Money market mutual funds the funds are invested in T-bills and
certificate of deposits.
Gilt funds invest in govt. securities.
Index funds try to replicate a stock market index
Funds of funds makes investments in units of other mutual funds.

Reforms in mutual funds

SEBI (Mutual funds) regulations 1993
Mutual fund is constituted as a trust registered with SEBI.
It has a sponsor, trustees, an asset management company
and a custodian. Trustees hold its assets for the benefit of
unit holders. AMC manages the mutual fund. Custodian
holds the securities in custody.

SEBI (Mutual funds) regulations 1996

Trustee now has to monitor the AMC as well. The
minimum networth of AMC was raised to 100 million.
Conversion of close ended scheme to open ended scheme
was permitted. Weekly publication of NAV was now
mandatory. Repurchase and resale price could not now
move beyond +/- 7% of NAV.

Reforms in mutual funds

Since then disclosure norms have been more
tightened and a trustee can not be trustee of
another mutual fund. Risk management system is
must for fund management, operations, disaster
recovery etc. investment policy has been
liberalized. MFs can now invest abroad. MFs can
now invest in listed/unlisted entities, and units of
venture capital funds. In 2003-04 MFs were
allowed to invest in derivative market equity
oriented schemes for portfolio balancing. Each
MF can now have a maximum of net derivative
position of 50% of portfolio

Resource mobilization

Growth in Net Asset under Management

The Hierarchy of Markets

Asset backed
securities &
derivatives
Corporate bonds &
equities
Government bond
market
Govt T Bills
Money market

Financial Market

Money market

Primary
Mkt Inst

Capital
market

Insurance
cos
NIS

Commercial
banks

Short term
instruments

Credit
unions

Primary
market

Firms raise
capital
debt
equity
Public

Private
placement

Stock
exchan
ge

Secondary
market

Investors
trade
securities
issued in
primary
market

Regulation & Supervision

A few questions

Ever wondered how the capital markets

work
Who sets the rules
What does the stock exchange do
What is the role of the stock broker
How to become a registered broker

Capital Market

Role and Functions of

a stock exchange
Established for the purpose of assisting, regulating and
controlling business of buying, selling and dealing in
securities
Provides a market for the trading of securities to
individuals and organizations seeking to invest their
saving or excess funds through the purchase of
securities
The exchange itself does not buy or sell the securities,
nor does it set prices for them

Role and Functions of

a stock exchange contd
Fair
The exchange assures that no investor will have an undue
advantage over other market participants

Efficient Market
This means that orders are executed and transactions are
settled in the fastest possible way

Transparency
Investor make informed and intelligent decision about
the particular stock based on information
Listed companies must disclose information in timely,
complete and accurate manner to the Exchange and the
public on a regular basis

Primary Equity Market

When the rms go public for the rst time, the
primary market is known as the initial public offering
(IPO) market.
The subsequent offerings known as the subsequent
equity offering (SEO) market.
The offerings are made either through prospectus or
through private placement. In case of the issue of
securities through prospectus, the general public, at
least 50 in number, subscribe to them directly.

Reform in primary market

Capital Issues (Control) Act was abolished in 1992
to avoid rigidity in the system. SEBI was set up in
1992 to regulate the primary market.
Since then what improvement has happened?
Disclosure norms have improved, transactions cost
has reduced and procedures have been simplified.
companies were allowed to raise funds in the international nancial market under the global depository
receipt (GDR)/American depository receipt (ADR)
mechanism.
Allowed all categories of companies to apply for an
IPO of Indian depository receipts

Reform in primary market 2

Initiated mandatory grading of IPOs,
Launched an electronic platform in collaboration with
the BSE and NSE for ling and displaying information
about the listed companies.
As a condition for continuous listing, listed companies,
except some, have to maintain a minimum level of public
shareholding at 25 % of the total shares issued.
Mandatory: foreign companies desirous of issuing IDRs
in India must have been listed in their home country,
must have a good track record of performance and must
not have been barred in their home country for doing so
Clause 49 of Corporate governance
SEBI can investigate and send offenders to jail.

Debt or Equity

Secondary Capital Market

1875, the Bombay Stock Exchange (BSE) was
set up, followed by some other stock
exchanges in major cities.
By the end of 1990, there were 19 stock
exchanges in the country with a market
capitalization of over Rs. 70.5 billion.
But the Indian stock market remained
underdeveloped till the early 1990s with the
result that the pricing, delivery and settlement
systems were much behind the mark.

What were problems in secondary capital market?

The cost of transactions was high
Stock exchanges were broker owned and managed with
the result that many of the deals lacked transparency.
The interests of general investors were hardly protected.
Risk management mechanism was utterly lacking.
Market closures were a recurring phenomenon.
The size of turnover was only limited
Mutual funds were limited to the UTI and a few banks
Foreign participants were not permitted to trade at the
Indian stock exchanges.

Debt securities never received the desired focus

Equity shares dominated the stock exchange transactions.

Reforms in Secondary Market

SEBI was set up as statutory body in 1992.
NSE was set up as a demutualised exchange
divorce between ownership and management on the
one hand and the stock trading rights on the other.
Hinders insiders trading or any broker-sponsored scam
and sets a healthy secondary market. It was this reason that
the government made demutualisation mandatory for all the stock exchanges
after the 2001 crisis. In 2005, demutualisation of all the stock exchanges was
approved and notified. Under this process, the BSE turned into a company in
August 2005.

Feb, 2000, the SEBI allowed stock exchanges to set

up trading terminal in foreign countries so as to
attract the nonresident Indians to the secondary
market trading.

Reform in Secondary Market..2

OCTEI and NSE introduced screen-based trading
enhances the efficiency of the market where larger
number of persons can participate,
helps participants to have a full view of the entire
market and ensures transparency.
generates trust among the participants which is vital
for the secondary market operations.

NSE helped set up the National Securities

Depository Limited (NSDL) in 1996 for keeping
ownership records in a dematerialised form
transfer of ownership through electronic book entries
No more problems related with the physical delivery of
securities after trading.

 computer-based clearing and settlement system

Buyer and the seller settle the deal without delay; settlement period was reduced from a
fortnight to a week from August 1996. Now settled within 2 working days after trading day
Trade is recorded automatically showing the quantity, price and the settlement date to
participants being in different locations
complete transparency
Information efficiency of the market is now much improved

Clearing Corporation receives the online information from the stock exchange
about the details of the trade and ensures that trading members meet their
settlement obligations.
The clearing bank opens an account with the Clearing Corporation on behalf of
the trading members and receives funds for the pay-in obligation from the
trading member before the dead line. The Clearing Corporation sweeps the
funds from the account and credits the designated account of the seller with
the swept funds.
Again, depository transfers the securities in electronic form from the account
of the custodian as per the schedule set by the Clearing Corporation.

What is settlement?
Who ensures the settlement?
What is a settlement cycle?
How many times can one buy and sell within a
settlement cycle?
What are rolling settlements?
How is the schedule followed?

Types of orders

Limit order
Market order
Day order
Open
All or none
Any part
Good through

Limit order
A limit order is an order to buy or sell a stock at a
specific price or better. A buy limit order can only
be executed at the limit price or lower, and a sell
limit order can only be executed at the limit price
or higher.
A limit order is not guaranteed to execute. A limit
order can only be filled if the stocks market price
reaches the limit price.
Limit orders help ensure that investors do not pay
more than a pre-determined price for a stock.
Note that if the price of the stock never reaches
your limit price, your trade won't be executed.

Limit order
For example, you want to buy ABC Inc. at $50.
The stock is currently trading at $51, so you set a
limit order to buy at $50. The price may go up or
it may go down, but you know that as soon the
stock trades at $50, your order will be triggered
and you'll buy at your predetermined price.
Once you buy ABC at $50, let's say you decide
you want to sell at $53. Again, you place your
limit order and wait. Once ABC trades at $53,
your order becomes active and will sell at your
target price of $53.
Limit orders are especially useful in volatile
environments.

Market order
A market order is an order to buy or sell a stock at the
best available price. Generally, this type of order will be
executed immediately. However, the price at which a
market order will be executed is not guaranteed.
buy/sell order to be executed at best price
-- get lowest price for buy order
-- get highest price for sell order
market orders given priority in trading
no guarantee of execution price
-- price could rise/fall from time order is placed to
time it is executed

Day order
A day order is an order that is good for that
day only. If it is not filled it will be canceled,
and it will not be filled if the limit or stop
order price was not met during the trading
session

Short selling
Sale of borrowed stock
Short sellers profit from belief that stock price is
too high will fall soon. If prices rise and then face
unlimited losses.
how?
borrow stock through broker
sell stock
buy and return later

Short selling could further destabilize falling prices

Circuit breakers
An index based market-wide circuit breaker
system applies at three stages of the index
movement either way at 10%, 15% and 20%.
The breakers are triggered by movement of
either S&P CNX Nifty or Sensex, whichever is
breached earlier

Clearing and Settlement

Stock Markets follow a system of settling trades on T+2
basis, which means transactions done on Monday, are
to be settled by Wednesday by way of giving securities
or funds.
Providing of securities or funds to
Exchange / Clearing Corporation is called Pay-In.
Receiving securities or funds from
Exchange / Clearing corporation is called
Pay-Out.

Desirable Characteristics
of a stock market
Liquidity
Ability to sell an asset quickly at a fairly known price Low
transactions costs

Market efficiency
Availability of information
Prices react quickly to new information

Small Volatility
Price fluctuations
Narrow price spread

Disclosure
Protection to minority Shareholder
Corporate Governance

BOMBAY STOCK EXCHANGE

The BSE sensitive Index(Sensex) is a value weighted
index. Composed of 30stocks with the base April
1979=100.

These companies account for around one-fifth of the

market capitalization of the BSE
The index has increased by over13 times from June 1990
to today. Using information from April 1979 onwards the
long run rate of return on the BSE Sensex can be
estimated to be 0.52%per week (continuously
compounded) with a standard deviation of 3.67%.this
translates to 27%per annum, which translate to roughly
18% pa after compensating for inflation.
16 February 2016 IIPM

Turnover and Market Cap at BSE and NSE

(Cash Segment)

Stock Market Indices and the Price/Earning

Ratio

What is the Debt Market?

The Debt Market is the market where fixed
income securities of various types and
features are issued and traded.
Fixed income securities issued by Central and
State Governments, Municipal Corporations,
Govt. bodies and commercial entities like
Financial Institutions, Banks, Public Sector
Units, Public Ltd. companies and also
structured finance instruments.

Main features of G-Secs?

All G-Secs in India currently have a face value of Rs.100/- and
are issued by the RBI on behalf of the GoI. All G-Secs are
normally coupon (Interest rate) bearing and have semi-annual
coupon or interest payments with a tenor of between 5 to 30
years.
Issued by the Government for raising a public loan or as
notified in the official Gazette.
No default risk as the securities carry sovereign guarantee.
Ample liquidity as the investor can sell the security in the
secondary market
e.g: a 11.50% GOI 2005 security will carry a coupon
rate(Interest Rate) of 11.50% p.a. on a face value per unit of
Rs.100/- payable semi-annually and maturing in the year 2005

Main features of Treasury Bills

Treasury Bills are for short-term instruments
issued by the RBI for the Govt. for financing the
temporary funding requirements and are issued
for maturities of 91 Days and 364 Days. T-Bills
have a face value of Rs.100 but have no coupon
(no interest payment). T-Bills are instead issued
at a discount to the face value (say @ Rs.95) and
redeemed at par (Rs.100). The difference of Rs.
5 (100 - 95) represents the return to the
investor obtained at the end of the maturity
period.

Important qualities of treasury bills

The high liquidity

Absence of risk of default
Ready availability
Assured yield
Low transaction cost
Eligibility for inclusion in statutory liquidity
ratio (SLR)
Negligible capital depreciation

TREASURY BILLS MARKET

Treasury bills are available for a minimum
amount of Rs.25K and in multiples of Rs. 25K.
T-bills auctions are held on the Negotiated
Dealing System (NDS) and the members
electronically submit their bids on the system
91- Day, 182- day, 364- day, and 14- day TBs
91 day T-bills, auctioned every week on
Wednesdays, are not self-liquidating in the way
genuine trade bills are, although the degree of
their liquidity is greater than that of trade bills.
According to their liquidity, the descending order
would be cash, call loans, treasury bills and
commercial bills.

 182 day T-bills sold in the market fortnightly by the RBI.

It is quite liquid because of the availability of refinance
facility against it and the existence of the secondary
market in it.
364 day T-bills sold in the market fortnightly by the RBI.
The RBI dose not purchase and rediscount this bill
Two types of 14-day TBs: known as intermediate
treasury bill (ITB)
It can be repaid/renewed at par on the expiration of 14
days from the date of issue.
The disadvantage of 14-day ITB is that it is not tradable
or transferable.

Type of T-bills

Day of Auction

Day of Payment

91-day

Wednesday

Following Friday

182-day

Wednesday of nonreporting week

Following Friday

364-day

Wednesday of
reporting week

Following Friday

COMMERCIAL BILLS MARKET

Funds for working capital required by industry
are mainly provided by banks through cash
credits, overdrafts, and purchase/ discontinuing
of commercial bills

BILL OF EXCHANGE
The financial instrument which is traded in the
bill market of exchange. It is used for financing a
transaction in goods that takes some time to
complete.
It shows the liquidity to make the payment on a
fixed date when goods are bought on credit.
Accordingly to the Indian Negotiable Instruments
Act, 1881, it is a written instrument containing as
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.

 INLAND BILLS
Be drawn or made in India, and must be payable in
India
Be drawn upon any person resident in India

FOREIGN BILLS
Drawn outside India and may be payable in and by a
party outside India, or may be payable in India or
drawn on a party resident in India
Drawn in India and made payable outside India.
A related classification of bills is export bills and
import bills

What purpose bill of exchange used?

Commercial bills may be used for financing
the movement and storage of goods between
countries, before export (pre-export credit),
and also within the country.
In India the use of bill of exchange appears to
be in vogue for financing agricultural
operations, cottage and small scale industries,
and other commercial and trade transactions.

ACCOMMODATION AND SUPPLY BILLS

Apart from the genuine bill of exchange, i.e. bills
which evidence sale and /or dispatch of goods,
there are other bills which are known to the
money market. They are accommodation bills
and supply bills.
As accommodation bill is defined as one in
which a person, called as accommodation party,
puts his name (accept it) to accommodate
another person without receiving and
consideration. Such bill is sometimes called, a kite
or wind bill.

BANKERS ACCEPTANCE
A banker's acceptance is a short-term investment
plan created by a company or firm with a
guarantee from a bank.

It is a guarantee from the bank that a buyer

will pay the seller at a future date. A good
credit rating is required by the company or
firm drawing the bill.
This is especially useful when the credit
worthiness of a foreign trade partner is
unknown.

BANKERS ACCEPTANCE..2
The terms for these instruments are usually 90 days,
but this period can vary between 30 and 180 days.
Companies use the acceptance as a time draft for
financing imports, exports and trade.
In India, there are neither specialised acceptance
agencies for providing this service on a commission
basis nor is it provided to any significant extent by
commercial banks.
Under the bill market schemes introduced by RBI in
1952, banks are required to select the borrowers after
careful examination of their means, respectability, and
dealings for conversion of their advances in to bills.

 Banks maintain opinion registers on different

drawers of bills and they get reports from time to
time on these drawers of bills.
BA acts as a negotiable time draft for financing
imports, exports or other transactions in goods.
Acceptances are traded at discounts from face
value in the secondary market.
BAs are guaranteed by a bank to make payment.

DISCOUNT MARKET
DISCOUNTING SERVICE
The central banks help banks in their liquidity
management by providing them discounting
and refinancing facilities.
The RBI are in abundance liquidity (funds) to
banks on occasions when liquidity shortages
threaten economic stability.
The central bank performs his function
through its discount window or discounting
mechanism.

 Bank borrow funds temporarily at the

discount window of the central bank.
They are permitted to borrow or are given the
privilege of doing so from the central bank
against certain types of eligible paper, such as
the commercial bill or treasury bill, which the
central bank stands ready to discount for the
purpose of financial accommodation to banks.

DISCOUNT AND FINANCE HOUSE OF

INDIA
It should be the sole depository of the surplus
liquid funds of the banking system as well as the
non-banking financial institutions.
It should use surplus funds to even out the
imbalance in liquidity in the banking system
subject to the RBI guidelines.
It should create ready market for commercial
bills, treasury bills, and government guaranteed
securities by being ready to purchase from and
sell to the banking system such securities.

COMMERCIAL PAPER
Commercial Paper (CP) is an unsecured
money market instrument issued in the form
of a promissory note.
It was introduced in India in 1990 with a view
to enabling highly rated corporate borrowers/
to diversify their sources of short-term
borrowings and to provide an additional
instrument to investors.

 Only company with high credit rating issues CPs

Subsequently, primary dealers and satellite
dealers were also permitted to issue CP to enable
them to meet their short-term funding
requirements for their operations.
Primary dealers (PDs) and the All-India Financial
Institutions (FIs) are eligible to issue CP.
CP is very safe investment because the financial
situation of a company can easily be predicted
over a few months.

 CP can be issued for maturities between a minimum of 15

days and a maximum up to one year from the date of issue.
The aggregate amount of CP from an issuer shall be within
the limit as approved by its Board of Directors or the
quantum indicated by the Credit Rating Agency for the
specified rating, whichever is lower.
As regards FIs, they can issue CP within the overall umbrella
limit fixed by the RBI i.e., issue of CP together with other
instruments viz., term money borrowings, term deposits,
certificates of deposit and inter-corporate deposits should
not exceed 100 per cent of its net owned funds, as per the
latest audited balance sheet.

 Only a scheduled bank can act as an IPA for issuance of CP.

Individuals, banking companies, other corporate bodies registered
or incorporated in India and unincorporated bodies, Non-Resident
Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can
invest in CPs.
Amount invested by single investor should not be less than Rs.5
lakh (face value).
However, investment by FIIs would be within the limits set for their
investments by Securities and Exchange Board of India
CP will be issued at a discount to face value as may be determined
by the issuer.
The investor in CP is required to pay only the discounted value of
the CP by means of a crossed account payee cheque to the account
of the issuer through IPA.

CERTIFICATES OF DEPOSIT
With a view to further widening the range of
money market instruments and give investors
greater flexibility in deployment of their shortterm surplus funds, Certificates of Deposit (CDs)
were introduced in India in 1989.
Certificate of Deposit (CD) is a negotiable money
market instrument and issued in dematerialised
form or as a Usance Promissory Note against
funds deposited at a bank or other eligible
financial institution for a specified time period

CDs can be issued by

Scheduled commercial banks excluding
Regional Rural Banks (RRBs) and Local Area
Banks (LABs)
Select all-India Financial Institutions that have
been permitted by RBI to raise short-term
resources within the umbrella limit fixed by
RBI.

 Banks have the freedom to issue CDs depending on

their requirements.
An FI may issue CDs within the overall umbrella limit
fixed by RBI, i.e., issue of CD together with other
instruments, viz., term money, term deposits,
commercial papers and inter-corporate deposits should
not exceed 100 per cent of its net owned funds, as per
the latest audited balance sheet.
Minimum amount 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.

INVESTORS
CDs can be issued to individuals, corporations,
companies, trusts, funds, associations, etc.
Non- Resident Indians (NRIs) may also
subscribe to CDs, but only on non-repatriable
basis, which should be clearly stated on the
Certificate. Such CDs cannot be endorsed to
another NRI in the secondary market.

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

Other aspect of CD
CDs may be issued at a discount on face value.
Banks / FIs are also allowed to issue CDs on
floating rate basis provided the methodology of
compiling the floating rate is objective,
transparent and market-based.
Banks have to maintain appropriate reserve
requirements, i.e., cash reserve ratio (CRR) and
statutory liquidity ratio (SLR), on the issue price
of the CDs.
CDs in physical form are freely transferable by
endorsement and delivery.

Structure of Indian Money Market?

ORGANISED STRUCTURE
1. Reserve bank of India.
2. DFHI (Discount And Finance House of India).
3. Commercial banks
i. Public sector banks
SBI with 7 subsidiaries
Cooperative banks
20 nationalised banks
ii. Private banks
Indian Banks
Foreign banks
4. Development bank
IDBI, IFCI, ICICI, NABARD, LIC, GIC, UTI etc.

II. UNORGANISED SECTOR

1. Indigenous banks
2 Money lenders
3. Chits
4. Nidhis
III. CO-OPERATIVE SECTOR
1. State cooperative
i. central cooperative banks
Primary Agri credit societies
Primary urban banks
2. State Land development banks
central land development banks
Primary land development banks

What are the segments in the secondary

debt market?
Wholesale Debt Market - where the investors
are mostly Banks, Financial Institutions, the RBI,
Primary Dealers, Insurance companies, MFs,
Cash rich corporates and FIIs, Co-operative
Banks, Investment Institutions
Retail Debt Market involving participation by
individual investors, provident funds, pension
funds, private trusts, NBFCs and other legal
entities in addition to the wholesale investor
classes.

What is the structure of the Wholesale

Debt Market?
A negotiated deal market where most of the
deals take place through telephones and are
reported to the Exchange for confirmation.
FIIs can now invest 100% of their funds
(earlier the limit was 30%). Since 98-99, FIIs
can invest in T-bills.

What is the issuance process of G-secs?

Issued by RBI in either a yield-based (participants bid
for the coupon payable) or price based (participants
bid a price for a bond with a fixed coupon) auction
basis.
The Auction can be either a Multiple price (participants
get allotments at their quoted prices/yields) Auction or
a Uniform price (all participants get allotments at the
same price).
RBI has recently announced a non-competitive bidding
facility for retail investors in G-Secs through which noncompetitive bids will be allowed up to 5 percent of the
notified amount in the specified auctions of dated
securities.

What are the types of trades in the

Wholesale Debt Market?

An outright sale or purchase

started in Jan, 2003 to ensure wider participation.

An anonymous screen-based order-matching
trading system was incorporated in the electronic
negotiated dealing system (NDS) repo/reverse
repo arrangement
No intended reversal of the trade at the point of
execution of the trade. The Buy or sell is in no way
connected with any other trade at the same or a
later point of time

A Repo trade

What is a Repo trade and how is it different

from a normal buy or sell transaction?
where the trade is intended to be reversed at a later
point of time at a rate which will include the interest
component for the period between the two opposite
legs of the transactions.
one party sells securities to other with an agreement to
purchase them back at a later date. The trade is called
a Repo transaction from the point of view of the seller
and it is called a Reverse Repo transaction from point
of view of the buyer.
Reverse repo meant injection of liquidity in the system.
Repo is undertaken by RBI, although inter-bank repo is
found in a highly regulated way.

What is the Money Market?

The Money Market is basically concerned with the issue and
trading of securities with short term maturities or quasimoney instruments.
The Instruments traded in the money-market are Treasury
Bills, Certificates of Deposits (CDs), Commercial Paper (CPs),
Bills of exchange and other such instruments of short-term
maturities (i.e. not exceeding 1 year with regard to the
original maturity)

Turnover of Debt Securities Traded at

NSE

 Secondary market for the corporate bonds was

shrinking in terms of depth and width. Moreover, the
trade in highly rated bonds dwindled in favour of
greater liquidity oriented bonds.

What are the various kinds of debt instruments

available in the Corporate Debt Market?
Non-Convertible Debentures
Partly-Convertible Debentures/Fully-Convertible
Debentures (convertible in to Equity Shares)
Secured Premium Notes
Debentures with Warrants
Deep Discount Bond
PSU Bonds/Tax-Free Bonds

How is the trading, clearing and settlement in

Corporate Debt carried out at BSE?

BOLT order-matching system based on pricetime priority. The trades in the 'F Group' at
BSE are to be settled on a rolling settlement
basis with a T+2 Cycle with effect from 1st
April 2003. Trading continues from Monday to
Friday during the week.

What are the securities/instruments

traded in the Retail Debt Segment
Central Government Securities commenced
on January 16, 2003 through the BOLT System
of the Exchange

FIIs Investment in Indian Secondary

Capital Market in 2000s

Return and Risk in BSE Sensex and

NSE Nifty

Inter-country Comparison of Return

and Risk during FY 200708

Corporate Debt Market

No transparency
Little information
Lack of legal enforcement mechanism
Lack of market making to provide liquidity
An active secondary market is needed for reaching a wider
investor base, reducing borrowing cost, and lengthening
maturity
Lack of uniform stamp duty structure
Stamp duty on debenture is 0.375%
Promissory notes 0.05%

Why do banks prefer to lend to firms but do not subscribe

to their debt issuances?

What is money market?

A segment of the financial market in which financial
instruments with high liquidity and very short
maturities (less than one year) are traded.
It doesnt actually deal in cash or money but deals with
substitute of cash like trade bills, promissory notes &
govt papers which can converted into cash without any
loss at low transaction cost
Money market transaction do not happen on stock
exchanges but take place through informal
mechanisms like over telephone without the help of
brokers

Characteristics of a developed
money market

A developed commercial banking system.

Presence of a central bank.
Sub-markets
Near money assets
Availability of ample resources
Integrated interest rate structure

Functions of money market

Economic development Money market assures supply of funds;

financing is done through discounting of the trade bills,
commercial banks, acceptance houses and brokers.
Profitable Investment the excess reserves of commercial banks
invested in near money assets.
Borrowings by the Government short term funds at very low
interest. It is non-inflationary source of finance to government.
Importance For Central Bank the central bank implements the
monetary policy successfully by influencing and regulating
liquidity in the economy through its interventions.
Mobilization of Funds helps in transferring funds from one
sector to another.
Savings And Investment encouraging savings and investment by
promoting liquidity and safety of financial assets.
Self-sufficiency Of Commercial Banks commercial banks can
meet their financial requirements by recalling some of their
loans.

Composition of Money Market?

Money Market consists of a number of submarkets which collectively constitute the
money market. They are,
Call Money Market
Commercial bills market or discount market
Acceptance market
Treasury bill market

MONEY MARKET INSTRUMENTS

Treasury bills
Money at call and short notice in the call loan market.
Commercial bills, promissory notes in the bill market.
Commercial papers.
Certificate of deposit.
Banker's Acceptance
Repurchase agreement
Money Market mutual fund

MONEY MARKET AT CALL AND SHORT NOTICE

Money at call is a loan that is repayable on
demand, and money at short notice is
repayable within 14 days of serving a notice.
Participants are banks & all other Indian
Financial Institutions as permitted by RBI.
Banks borrow call funds for a variety of
reasons to maintain their CRR, to meet their
heavy payments, to adjust their maturity
mismatch etc.

CALL MONEY MARKET

Call money market is that part of the national money
market where the day to day surplus funds, mostly of
banks are traded in.
They are highly liquid, their liquidity being exceed
only by cash.
The loans made in this market are of the short term
nature.
Banks borrow from other banks in order to meet a
sudden demand for funds, large payments, large
remittances, and to maintain cash or liquidity with
the RBI. Thus, to the extent that call money is used in
India for the purpose of adjustment of reserves.

Participants in the call money market

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

CALL RATES
The rate of interest paid on call loans is known as
call rate.
Call rate is highly variable from day to day, often
from hour to hour.
It is very sensitive to changes in demand for and
supply of call loans.
Eligible participants are free to decide on interest
rates in call/notice money market.
Calculation of interest payable would be based on
FIMMDAs (Fixed Income Money Market and
Derivatives Association of India).

CALL RATE IN INDIA

CALL RATE IN INDIA had reached as high a level as 30% in

December 1973.
It is an alarming level for any short-term rate of interest to
reach, and as bank defaulted in a major way in respect of
cash and liquidity requirements at that time due to the
prohibitively high cost of call money, it became necessary to
regulate call rates within reasonable limits.
Indian Banks Association (IBA) in 1973 fixed a ceiling of 15%
on the level of call rate.
The IBA lowered this ceiling of 15% to 12.5% in March 1976,
10 % in June 1977, and 8.6% in March 1978, and 10.0% in
April 1980.
And current call rate in India is 8%.
There are now two call rates in India: one, the interbank call
rate, and the other, the lending rate of DFHI.

CERTIFICATES OF DEPOSITS
A CD is a time deposit, financial product
commonly offered to consumers by banks.
CDs are negotiable instrument.
Financial Institutions are allowed to issue CDs
for a period between 1 year and up to 3 years.
normally give a higher return than Bank term
deposit, and are rated by approved rating
agencies.

COMMERCIAL BILLS
Commercial bill is a short term, negotiable,
and self-liquidating instrument with low risk.
Written instrument containing an
unconditional order.
Once the buyer signifies his acceptance on the
bill itself it becomes a legal document.
Commercial bill is a short term, negotiable,
and self-liquidating instrument with low risk.

COMMERCIAL PAPER
Commercial Paper is a money-market security
issued (sold) by large banks and corporations
to get money to meet short term debt
obligations .
Commercial paper is usually sold at a discount
from face value.
Interest rates fluctuate with market
conditions, but are typically lower than banks
rates.