Financial Economics (ECM-506) M.A (lls Semester) CONTENT UNIT- I: FINANCIAL SYSTEM Structure 1.0 Introduction 1.1 Objectives 1.2 Genesis and Growth of Financial Economies 1.3. Structure of Financial ystem, 1.4 Role and Importance of Financial Economics in Modern World 1.5 Functions of Financial Sector 1.6 Equilibrium in Financial Markets 1.7 Money Market and its Constituents 1.8 Capital Market 1.8.1 Government Securities Market 1.8.2. Corporate Security Market 1.83 Primary and Secondary Market for Securities 1.11 Analysis of Financial Markets 1.11.1 Fundamental Analysis 1.11.2 Technical Analysis 1.12 Indicators of Financial Development 1.13 Indian Stock Markets and Role of SEBI 1.14 Answer the questions UNIT-IL VES’ iT AND SE! JRITY MARKET ANALYSIS Structure 2.0 Introduction 21 Objectives 2.2 Security Analysis- Meaning and Types of Risk 2.3 Concept and Types of Return 2.4 — Risk-Return Trade Off 2.5 Efficient Market Hypothesis 2.6 Mean-Variance Criterion 2.7 Measuring Risk and Return for a Single Asset and for a Portfolio Centre for Distance and Online Education, AMU 1Financial Economics (ECM-506) M.A (lls Semester} 2.8 Portfolio Diversification 2.9 Capital Market Line 2.10 Market Portfolio 2.11 Security Market Line 2.12 Extensions of the CAPM. 2.13 Performance Measures 2.14 Arbitrage Pricing Theory 2.15 Multifactor Models 2.16 Answer the questions UNIT-IIT: FINANCIAL DERIVATIVES Structure 3.1 Introduction 3.1 Objectives 3.2 Derivatives- Meaning 3.2.1 Types (Forwards, Futures and Options) and Uses 3.3. Difference between Forwards and Futures and Between Futures and Options 3.4 Valuation of Forwards/Futures 3.5 Valuation of Options (Black-Scholes Models) 3.6 Pricing and Valuation of Commodity Futures 3.6.1 Agricultural, Forest and Livestock Derivatives 3.6.2 Crude Oil Derivatives 3.6.3 Base Metal Derivatives and Precious Metal Derivatives 3.6.4 Weather Derivatives 3.6.5 Carbon Derivatives 3.6.6 Commodity and Forex Derivatives 3.7 Derivatives in India 3.8 Derivatives Markets Abroad-Growth and Structure 3.9 Shortcomings of Derivatives. 3.10 Answer the questions Centre for Distance and Online Education, AMU 2Financial Economics (BCM-506} M.A (lls Semester} Unit-I FINANCIAL SYSTEM Structure 1.0 Introduction Ll Objectives 1.2 Genesis and Growth of Financial Economies 1.3 Structure of Financial System 14 Role and Importance of Financial Economics in Modern World 1.5 Functions of Financial Sector 1.6 Equilibrium in Financial Markets 1.7 Money Market and its Constituents 1.8 Capital Market 1.8.1 Government Securities Market 1.8.2 Corporate Security Market 1.8.3. Primary and Secondary Market for Securities 1.11 Analysis of Financial Markets 1.11.1 Fundamental Analysis 1.11.2 Technical Analysis 1.12. Indicators of Financial Development 1.13 Indian Stock Markets and Role of SEBI 1.14 Answer the questions 1.0 Introduction The economic development of any Country depends upon the existence of a well- organized financial system. When the system functions properly, it channelizes funds from savers Sto investors. By increasing productivity, the financial system helps super economic growth and raise the standard of living. The financial system is possibly the most important institutional and functional vehicle for economic transformation. Finance is a bridge between the present and the future and whether it is mobilization of savings or their efficient, effective and equitable allocation for investment, it is the su s with which the financial system performs its functions that sets the pace for the achievement of broader national objectives. Centre for Distance and Online Education, AMU 3Financial Economics (BCM-506} M.A (lls Semester) Financial system is a concept derived from the wide concept of finance. The financial system is a system that allows the transfer of money between savers and investors. It plays an important role in global, national, regional, institutional and individual areas. This states the healthy and soundness of financial status from global to individual 1.1 Objectives Know the concept of Financial Markets. * Classify different types of Financial Markets: Money market and Capital Market Know about the indicators of financial development. ‘© Understand the analysis of financial markets. 1.2. Genesis and Growth of Financial Economies Financial Economies is a generic term applicable to a vast array of topics relating Finance with Economies. It is well-known that, finance is a lubricating mechanism to the Economic Activity. Finance, under the head of capital is becoming a Factor of Production. Finance under the head of inputs is becoming a factor in input-output matrix. Finance under head of money is becoming a measure of value, medium of exchange and a store of value. In its function as a medium of exchange and measure of value, its use is for transaction and precautionary purposes, wherein cash is needed for all and by all. Cash is a financial asset and current asset. In its store of Value Function, money is an asset — a Financial asset and one of the facets of wealth. Wealth is a basket of assets both physical and financial in one’s possession. Finance and wealth are also inter-related. Finance is a scarce input and particularly in developing economies like India, it is scarce, compared with their inputs, like labour, land and enterprise. All these factors are factors of production in the productive process, called the economic activity. Economics is a science dealing with scarce means and unlimited ends. Finance being scarce, the relation of finance with Economies is quite important. Economic activity is the circularity of relations between production, distribution and consumption. The end use of all activity is the consumption-demand backed by purchasing power. Production is a type of economic activity which combines all the factors of production as inputs and brings an output called production. The relationship between inputs and outputs is a function of technology, which in modem economic jargon leads to input-output matrix. The intermediary between production and consumption is distribution which is a vital link in the circularity of economic activity. Centre for Distance and Online Education, AMU 4Financial Economics (BCM-506} M.A (lls Semester) Importance of Finance in Economies The importance of Finance in Economics can hardly be over-emphasised in view of the above facts. In the classical Writings of Adam Smith and others, Economies is considered a handmaid of Ethies, but in the modem technology Economies is a handmaid of Finance. Economic activity relates to the real world of physical goods, and services while Finance relates to the money world, The distinction between real values and money values will be clear if one keeps in mind the functions of money. Since we are used to denominate everything in terms of money, the distinction between them is blurred. If we know the distinction between the barter economy and money economy, the role money and the distinction between money economy and real economy becomes clear. In barter economy goods and services are exchanged for goods and services and the value of each is set by the relative scarcity and abundance in relation to demand for it. This brings us to the demand and supply factors in the money economy. Genesis and Growth of Financial Economics: In classical writings money is neutral. But the Genesis of the Financial Economics ‘goes back to the Fisher's writings. Money was introduced then as a variable influencing the value of transactions in the Fisher’s equation of Exchange, namely: MV =PT Where, “Mis quantity of Money *V" is velocity or the number of times that one unit of money changes hands in a year P is price level T is the volume of transactions. This equation sets up an identity between the total Money in demand (MV) and the total value of transactions (PT). While PT is a function of real variables, MV is a function of money variables. Given the quantity of money, velocity will change as per the total value of real transactions. If ‘V’ is also set constant ‘M’ will change as per the requirements of real transactions. This equation emphasises the role of money in transactions. The next stage of development of the concept of Money as a functional variable in the real economy is given by the Cambridge Equation of Exchange as expounded by Marshall and Pigou. Here money demand is based on the peoples’ preferences, choices and behaviour. People prefer to hold only a proportion (K) of the level of income or output represented by PT. Here the equation boils down to- Md (Money demand) is equal to K (PT) Centre for Distance and Online Education, AMU 5Financial Economics (ECM M.A (lls Semester) Md=K (PT) Md/K = PT ‘Therefore 1/K here is equal to V in the equation of exchange of Fisher. Cambridge equation is an improvement in that it brings in the peoples’ preferences and habits of how much cash balances they would like to hold among other altemative assets out of their total income, The other improvement is the introduction of the concept of choice and the alternatives foregone in holding cash balances as the income in the form of interest foregone on the alternatives. So money is considered desirable to hold, but this desire is influenced by the opportunities, lost through holding idle cash balances out of the total income PT. But the role of interest rate, which determines the liquidity preference of the people and as a determinant of the demand for money is not brought out clearly by the Cambridge school of thought. It was left to Keynes in his book (The General Theory of Employment, Interest and Money) to bring out the real integration of Money (or Finance) with the real economy. 1.3 Structure of Financial System Financial structure refers to shape, components and their order in the financial system. ‘The formal Indian financial system consists of financial Institutions, financial market, financial instruments and financial services. There are four components of Indian financial system as shown in the chart. They are: A. Financial Institutions. B. Financial Markets, C. Financial Instruments. D. Financial Services. A, FINANCIAL INSTITUTIONS Financial Institutions are business organizations serving as a link between savers and. investors and so help in the credit allocation process. In simple, Financial Institutions are the institutions which offer financial services for its clients or members, The most probable service is financial intermediation, The institutions include banks, trust, companies, insurance companies and investment dealers. Financial institution is defined as “an establishment that focuses on dealing with financial transactions, such as investment, loans and deposits.” In other words, the financial institution is an organization which may be either profit or non-profit, that takes money from Centre for Distance and Online Education, AMU 6Financial Economics (BCM-506} M.A (ill! Semester) clients and places it in any of a variety of investment vehicles for the benefit of both the client and the organization, Salient feature of Financial Institutions ‘An understanding of the above meaning and definition provides the following salient features of financial institutions: ‘* Iti an institution as well as intermediary. ‘© Itchannelizes savings fund into investment fund. + Itcreates financial assets such as deposits, loans, securities ete. ‘* It includes banking and non-banking institutions. ‘* It includes both organized and unorganized institutions, ‘Established with a clear operating function. ‘+ Regulated by the government and regulating authority, * Itaccepts deposits ‘* Itprovides commercial loans, real estate loans and mortgage loans. ‘* Financial institutions keep money flowing through the economy among consumers, businesses and government Classification of Financial Institutions The financial institutions are classified into term lending institutions, refinance institutions, investment institutions and state level institutions. These are also to be classified into banking and non-banking institutions. Banking Institutions These are the type of financial institutions which involve in accepting public deposits and lending the same to the needy customers. These are fundamentally established to eam profit, secondarily to safeguard the interest of the members. The banking institutions ensure that deposits accumulated from people are productively utilized. The following are the types of banking institutions which are running their business in India. Commercial banks: These are also called as business banks. The following are the types of commercial banks. i. Public sector. ii. Private sector. iii. Regional Rural Banks (RRB's) iv. Foreign banks. Cooperative Banks: These are established to safeguard the interest of its members. These are organized on a co-operative basis, accept deposits and lend money to the required members. Centre for Distance and Online Education, AMU 7Financial Economics (BCM-506} M.A (lls Semester} Non-banking Institutions ‘These are the financial institutions that provide banking services without meeting the legal definition of a bank. The non-banking financial institutions also mobilize financial resources directly or indirectly from the people. They lend the financial resources mobilized. The non-banking institutions are classified into organized and unorganized financial institutions, The following are examples of non-banking institutions: ‘¢ Provident and pension fund. «Small Saving organization. ‘* Life Insurance Corporation (LIC). «General Insurance Corporation (GIC), ‘© Unit Trust of India (UTD. © Mutual funds, ‘Investment Trust, ete ‘Non-banking financial institutions can also be categorized as investment companies housing companies, leasing companies, hire purchase companies, specialized financial institutions (EXIM Bank), Investment Institutions, State level institutions etc. Importance of Financial Institutions: Financial institutions are the key institutions which provide fund for economic activities. There are many advantages for having sound and healthy financial institutions in a country, The importance of Fl is as follows: Provide funds: Financial institutions provide funds for the investment and industrial activities. Infrastructural facilities: Financial institutions also offer basic infrastructural facilities needed for the development and promotion of lucrative ventures. Infrastructural facilities involve development of industrial estates tech parks, road and water etc. Promotional activiti Promotional activities are undertaken by the financial institutions to mobilize the funds, reduce the risk of selling financial securities, arrangement of working and Jong term capital of the business. Development of backward areas: Apart from the financial activities, financial institutions also take some social responsibilities of developing the backward areas at free of cost by offering credit facilities, free education, employment creation ete, Centre for Distance and Online Education, AMU 8‘nancial Economics (ECM M.A (ills Semester) Planned development: Financial institutions initiate all planned developments in the view of economic growth of the s te, All planned developments are coordinated with the government plan and social welfare. Accelerating industrialization: Since the financial institutions are established to cam the profit and safeguard interest of its members, they accelerate the industrialization to contribute industrial growth, They support industries by granting finance, project development and consultancy, Employment generatio Channelizing the funds for investment, building of infrastructural facilities, and acceleration of industries generates employment to the educated and qualified people of the state. Funetions of Financial Institutions: ‘The functions of financial institutions are classified into primary functions and secondary functions. Primary functions: These are the basic functions of financial institutions which come in the respective group of institutions like banks, co-operative societies, insurance industries ete. the primary functions are as follows: Accepting deposits: Most of the financial institutions viz, commercial banks, cooperative societies ete., accept deposits from the public. They offer different schemes to mobilize public deposits from the customers. For the accepted deposits, financial institutions give return in the form of interest on deposit tenure basis, Providing commercial loans: Accepted deposits are used for commercial lending operations in the form of loans, advances, cash credits, bill discounting etc., these fetch good return to the financial institutions. Providing Real estate loans: The financial institutions also provide loans and advances for real estate industries to purchase sit, build premises, construction of industrial and residential parks. Providing mortgage loans: The financial institutions also provide loans to the needy group on mortgage of properties and collateral securit For example, Gold loan, property loan ete. where gold and properties are mortgaged to avail the loan. Issuing share certificates: Financial institutions also undertake the job of issuing share certificates of any established corporate to its share-holders. It also constitutes accepting shares investment money from the investors and issuing them certificates on behalf of the companies. Centre for Distance and Online Education, AMU 9Financial Economics (BCM-506} M.A (ills Semester) Secondary Functions: These are the additional functions performed by the financial institutions along with the above primary functions. Secondary functions are as follow: Act as an intermediary: Financial institutions act as an intermediary in between the savings community and industrialist. They receive the public deposit at a lower rate of interest and lend the same fund to the needy group at higher rate of interest, The difference amount of interest is the profit for their intermediary work. Facilitate the flow of money: They also facilitate the flow/channelize the money to the investment activities. Financial institutions are the interlinked path stones to make smooth flow of fund from small savers to giant business ventures. B, FINANCIAL MARK! Financial markets are another 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 are the backbone of the economy. This is because they provide monetary Support for the growth of the economy. Financial markets refer to any market place where buyers and sellers participate in ‘trading of assets such as shares, bonds, currencies, and other financial instruments. A financial market may be further divided into capital market and money market. The capital market deals in long term securities having maturity period of more than one year. The money market deals with short term debt instruments having maturity period of less than one year. Financial markets are the essential players in the economic development of a nation. They function as facilitating originations in the savings-investment process and act as an effective part of a financial system. Financial markets facilitate easy and quick liquidity of funds. Due to advancement in intemet and technology, financial markets through demat/online accounts ensure speedy conversion of assets (securities) in to cash and vice versa, The individuals, financial institutions, corporations and government trade in this market either directly or indirectly through brokers and dealers. Definitions Financial market is defined as a market for the exchange of capital and credit, including the money markets and the capital markets, Centre for Distance and Online Education, AMU 10Financial Economics (BCM-506} M.A (ill! Semester) Financial market refers to a market place, where creation and trading of financial assets such as shares, debentures, bonds, derivatives, currencies, ete. take place. It plays a crucial role in allocating limited resources, in the country's economy. It acts as an intermediary between the savers and investors by mobilizing funds between them. Classification of Financial Markets The financial markets in India are classified into two broad categories, viz. unorganized markets and organized markets. ‘* Unorganized Financi: Market: These are comprised with private money lenders, pawn brokers, indigenous bankers, traders etc. they lend money to the public from their ‘own funds. The operations and activities of these people are not regulated by the Reserve Bank of India or by any other controlling authority. But still the Reserve Bank of India is trying to fold them to the class of organized financial markets through its strategies, © Organized Financial Market: These are the markets strictly controlled and regulated by Reserve Bank of India and other regulating authorities. They follow high degree of institutionalization and instrumentalization. The organized financial markets are further classified into capital market and money market. * Capital Market: Capital market is one of the significant aspects of every financial market, Broadly speaking the capital market is a market for financial assets which have a long or indefinite maturity. The capital market instruments mature for the period above one year. It is also called as long term securities market. It is an institutional arrangement to borrow and lend money for a longer period of time. It consists of financial institutions like IDBI, ICICI, UTI, LIC etc. These institutions play the role of lenders in the capital market. Business units and corporates are the borrowers in the capital market. «Money Market: Money market is an organized financial market. It plays an important role in the Indian financial system. Money market is a market where money or its equivalent can be traded. It does not actually deal in cash or money. It actually deals with near money substitutes like trade bills, promissory notes and government papers drawn for a short period not exceeding one year. The very feature of these instruments is they can be converted into cash readily without any loss and at low transaction cost. This market consists of financial institutions and dealers in money or eredit who wish to Centre for Distance and Online Education, AMU 11Financial Economics (ECM M.A (lls Semester} generate liquidity. Hence, money market is a market where short term obligations such as treasury bills, commercial papers and bankers acceptances are bought and sold. C. FINANCIAL INSTRUMENTS/ASSETS In any financial transaction, these should be a creation or transfer of financial asset. Hence, the basic product of any financial system is the financial asset. A financial asset is one which is used for production or consumption or for further creation of assets. One must know the distinction between financial assets and physical assets. Physical assets are not useful for further production of goods or for earning incomes. For instance, if a building is bought for residential purpose, it becomes a physical asset. If the same is bought for hiring it becomes a financial asset. Financial instruments are also called as financial assets/securities. Financial assets are the intangible assets which receive value due to contractual transactions. Financial assets/instruments indicate a claim on the settlement of principal or payment of a regular amount of by means of interest or dividend, Equity shares, debentures, bonds ete., are some examples. Financial assets like deposits banks, companies and post offices, insurance policies, |CS, provident funds and pension funds are not tradable. Financial assets like equity shares and debentures, or government securities and bonds are tradable. 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, certificate of deposits, commercial bills, money market mutual funds.Hybrid instruments are those instruments which have both the features of equity and debentures, Examples are convertible debentures, warrants ete. Definition: Financial assets are defined as “an asset that derives value because of contractual claim,” Financial assets represent claims for the payment of a sum of money sometime in the future (repayment of principal) and / or a payment in the form of interest or dividend. Characteristics of Financial Instruments: Centre for Distance and Online Education, AMU 12Financial Economics (ECM M.A (lls Semester} «Liquidity: Financial instruments provide liquidity. These can be easily and quickly converted into cash. © Marketing: Financial instruments facilitate easy trading on the market. They have a ready market. © Collateral value: Financial instruments can be pledged for getting loans. ‘Transferability: Financial instruments can be transferred from one person to another. © Maturity period: The maturity period of financial instruments may be short term, medium term or long term. ‘© Transaction cost: Financial instruments involve buying and selling cost. The buying and selling costs are called transaction costs. «Risk: Financial instruments carry risk. Equity based instruments are riskier in comparison to debt based instruments because the payment of dividend is uncertain, A company may not declare dividend in a particular year. « Future trading: Financial instruments facilitate future trading so as to cover risks arising out of price fluctuations, interest rate fluctuations ete. Classification of Financial Instruments Financial instruments are classified into term financial instruments and type financial instruments. Term financial instruments: These are the tradable financial assets and exchanged on term basis. These are again classified into short term, medium term and long term securities. ‘© Short term securities: This sub category comprises securities with maturity of one sub year or less. Medium term securities: Basis for classifying securities under this category depends on pract es applied in financial markets of the given Country, Normally, this sub-category includes securities with maturity from 1 to 5 years. + Long term securities: This sub-category comprises securities with maturity longer than those of short and medium term securities. Type based securities: Under this classification financial securities are classified into primary, secondary and innovative securities. + Primary instruments/securities: Primary securities are defined as a financial instrument whose value is not derived from that of another instrument, but instead is determined directly by the market.” These are issued by non-financial institutions. The examples for the primary instruments are equity shares, preference shares and debentures, Centre for Distance and Online Education, AMU 13Financial Economics (ECM M.A (lls Semester} © Secondary instruments/securities: A primary security is an instrument issued directly by the financial institutions to an investor. For example, when you are investing in a mutual fund, you are investing in a secondary security. Some other examples for primary securities are mutual fund, money market funds, commercial paper, and certificate of deposits. Innovative instruments: These are the financial innovative instruments to suit the need ‘of co-operates and investors group. For example, Derivatives, securitized assets, foreign currency mortgages and so on. D. FINANCIAL SERVICES Financial service refers to services which are financial in nature offered by financial industries to its customer, Its objective is to intermediate and facilitate financial transactions. of individuals and institutional investors, In other words financial services are the products or services offered by institutions like banks, credit card companies, insurance companies, stock brokerage companies ete. Financial services are also called as financial intermediation. Financial intermediation is a process of mobilization of surplus of people and allocation of mobilized fund to various needy groups (industries, companies, business people, individuals ete.) for economic development. Financial Services is concerned with the design and delivery of financial instruments, advisory services to individuals and businesses with in the area of banking and related institutions, personal financial planning, leasing, investment, assets, insurance etc. these financial services are essential for the creation of new busine: , expansion of existing industries and economic growth. Definition: Financial Services can be defined as the products and services offered by institutions like banks of various kinds for the facilitation of various financial transactions and other related activities in the world of financial like loans, insurance, credit cards, investment opportunities and money management as well as providing information on the stock market and other issues like market trends.” Financial services help with borrowing selling and purchasing securities, lending and investing, making and allowing payments and settlements and taking care of risk exposures in financial markets. These range from the leasing companies, mutual fund houses, merchant bankers, portfolio managers, and bill discounting and acceptance houses. The financial Centre for Distance and Online Education, AMU 14Financial Economics (BCM-506} M.A (lls Semester} services like credit rating, venture capital financial, mutual funds, merchant banking, depository services, book building ete. Financial institutions and financial markets help in the working of the financial system by means of financial instruments. To be able to carry out the jobs given, they need several services of financial nature, Therefore, financial services are considered as one of the component of the financial system. Types of Financial Services There are so many financial services that the financial market offers. The most important ones are as follows: Banking Ser ices: The primary operations of banks include: «Keeping money safe while allowing withdrawals when needed. «Issuance of cheque books. «Provide personal loans, commercial loans and mortgage loans. «Issuance of credit cards and processing of credit card transactions and billing. «Issuance of debit cards for use as a substitute for cheques. ‘Allow financial transactions at branches or at Automatic Teller Machines (ATMS). * Provide Electronic fund transfers between banks. Facilitation of standing orders and direct debits, so payments can be made automatically. «Provide overdraft agreements. Notary service for financial and other documents. ‘Provide wealth management and tax planning services. ‘Provide credit card machine services and networks for business entities. Foreign Exchange Services: Foreign exchange services are provided by many banks around the world. Foreign exchange services include: ‘© Currency Exchange: Clients can purchase and sell foreign currency bank note ‘© Wire Transfer: Clients can send funds to international banks abroad. + Foreign Curreney Banking: ‘The transactions are done in foreign currency. Investment Services: ‘+ Asset Management: The term usually given to describe companies which run collective investment funds. Centre for Distance and Online Education, AMU 15Financial Economics (BCM-506} M.A (lls Semester} © Hedge Fund Management: Hedge funds often employ the services “prime brokerage” divisions at major investment banks to execute their trades. © Custody Services: Custody services and securities processing is a kind of “back- office” notes administration for financial services. Insurance Services: It deals with the selling of insurance policies, brokerages, insurance underwriting or the reinsurance. Other Financial Services « Intermediation or advisory services: These services involve stock brokers (private client services) and discount brokers. Stock brokers assist investors in buying or selling shares. ‘+ Private Equity: Private equity funds are typically closed-end funds, which usually take controlling equity stakes in business that are either private or taken private once acquired. The most successful private equity funds can generate returns significantly higher than provided by the equity markets. ‘© Venture Capital: Venture capital is a type of private equity capital typically provided by professional, outside investors to new, high potential growth companies in the interest of taking the company to an IPO or trade sale of the business. © Angel Investmei ‘An angel investor or angel; is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. A small but increasing number of angel investors organize themselves into angel groups or angel networks to share rescarch and pool their investment capital. Classification of Financial Services Financial Services are classified into Fund Based Services and Fee Based Services, which are as follows: Fund Based Services Fund based or asset based financial services are those services which are rendered for commission basis or for ascertain amount of interest. ‘© Leasing: It refers to a written agreement between lessor and lessee where lessor allows lessee to use his property for specified period of time or rent is called lease. © Factoring: Factoring is a facility provided by factor (financial institution) to its clients (company), whereas factor purchase debts and receivable accounts of the Centre for Distance and Online Education, AMU 16Financial Economics (ECM M.A (lls Semester} discount rates and offers immediate cash. This facility is called as factoring. It is also called as account receivable finance. Bills Discounting: Trading or selling bills to financial institution prior to its maturity period for discount rate is called discounting bill of exchange. The rate of discount depends on the time left before the bill mature and risk attached to it. Venture Capital: Venture capital is a way of financial by investor to companies for its start-up and to promote project. Investor joins entrepreneurs as co-promoter and share risk and returns. Loan: Loan is an oral or written agreement between lender and borrower for temporary transfer of property (cash) from lender to borrower where borrower promises to return the same property for cash along with pre-determined interest as per the agreement. HousingFinane Housing finance is a finance facility provided by housing finance company on acquisition or construction of houses, which includes acquisition or development of land in connection therewith. Hire Purchase: Hire purchase system is a method of selling goods on credit where purchaser is allowed to purchase goods and allow him to pay the amount in instalment basis and the title of the goods transferred from seller to buyer at the end of financial instalment. Fee Based Services commission, Those services are known as fees based services are as follows: Fees based financial services are those which are paid for a flat fee rather than Portfolio management: Portfolio management is a method of managing and allocating funds on various known as portfolio alternatives to reduce the uncertainty is, known as portfolio management. Loan Syndication: Loan syndication is the process where large number of lenders contributes amount and grant loans to company or any project and share risk and retuins of the same. Corporate Counseling: Corporate counseling refers to a set of activities performed to ensure the efficient running of a corporate enterprise and to improve the performance. Foreign Collaboration: Foreign collaboration is an alliance in corporate to carry on agreed task collectively with the participation of resident and non-resident entiti Centre for Distance and Online Education, AMU 17Financial Economics (ECM 14 |-506) M.A (lls Semester} Role and Importance of Financial Economics in Modern World It plays a vital role in the economic development of a country. Objectiv It encourages both savings and investments. Ithelps in lowering the transaction costs and increase returns. This will motivate people to save more It links both 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. So, financial system helps in capital formation. It helps in bringing investments. It facilitates expansion of financial markets. helps in allocation of funds. Iis a set of inter-related activities or services. It ereates a bridge between investors and companies. Ithelps in fiscal discipline and control of the economy It brings accountability for investors. Ithelps to monitor corporate performance. It provides a mechanism for managing uncertainty and controlling risk. 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. It allows transfer of money between savers and borrowers. Itis applicable at global, regional and firm level, It includes financial institutions, markets, instruments, services, practices and transactions The main objective is to formulate capital, investment and profit generation. of Financial System The primary objectives of a financial system are concemed to formulate capital, facilitate investment and profit generation. These objectives are also the significance or Centre for Distance and Online Education, AMU 18Financial Economics (ECM |-506) M.A (lls Semester) importance of financial system in an economy. The major and primary objectives of a financial system are as follows: To mobilize the Savings: The financial system begins its operations by the mobilizing of savings from the small saving community. It collects the funds by offering different schemes which attract the investors’ i.e., savers to fund their savings in different institutions, services, securities ete. To distribute the savings for the industrial investment: The purpose of mobilizing the fund from the saving community is to invest them in different industries. Thereby it meets the fund requirement of industrial sector. Hence it helps in the growth of industrial sector. To stimulate capital formation: The objective of supporting the industries is not ‘ended with sanctioning of fund to them. Further, it makes them to formulate the capital out of their earnings for the further capital requirement and industrial investment. To accelerate the pace of economic growth: The ultimate aim of the financial institutions is to support the process of economic growth of a nation. Directing the saving fund to the industrial capital need, motivating them for capital formation support the acceleration of the process of economic growth. It has been said that there has been a direct link of prosperity and long term growth with the effective and efficient financial system. A strong financial system results in good economie progress, reduction in poverty, increase in the standard of living of the people. But there are many question marks to this link, The role of financial system in the economic development depends upon happenings of many a factors which, if does not happen, will not result into growth, Some of those factors are as follows: The financial system will help in the financial development if the financial system itself is efficient, Thus, the development of economy based on financial system is possible only when system works efficiently which in reality may not happen. There has been asymmetric dissemination of information which does not lead to equitable gains for all Stock market rarely depicts fundamental valuation efficiency. Good volumes at stock market have no necessary relation with real investment. Risk reduction and better risk management is also not assured even with multiple ancial instruments. Centre for Distance and Online Education, AMU 19Financial Economics (BCM-506} M.A (ills Semester) © Raising of funds from debt or new issue is also less and therefore, there is less funds for real new investment. ‘© Market speculation leads to high volatility in share prices. ‘Fluctuations in trade balances also result in high volatility in foreign exchange rates. ‘* Utilization of society’s resources into more productive channels is less facilitated by financial markets. It has been seen that private benefit is more than public benefit. Thus, it may be concluded that if financial system works efficiently, only then it results into long term prosperity and growth of the economy. 1.5 Functions of Financial Sector The following are the functions performed by the financial system of a nation. These are the aggregate functions performed by the sub classes of financial system viz. financial markets, financial institutions and financial services. * Provision of Liquidity: The provision of liquidity is one of the primary functions of financial system, It states the ability of meeting the obligations as and when they are required. In other words, it states the ability of converting the assets into liquid cash without any loss. «Mobilization of savings: Savings are done by millions of people. But amount saved are of no use unless they are mobilized into financial assets, whether currency, bank deposits, post office savings deposits, life insurance policies, mutual funds bonds or equity shares. It is the function of financial institutions, a sub division of financial system to mobilize the savings from the saver or investment group. ‘+ Small Savings to big investment: Financial system acts as an intermediary in transforming the mobilized fund of savings to the big investments. It channelizes small savings fund received from the savings group to the industries to investments. + Maturity Transformation function: It is also one of the intermediary functions of financial system. The financial institutions receive the saving fund from the depositors for a particular tenure and lend the same fund to the required people on term basis. «Risk Transformation function: The financial system also does a function of risk transformation. The small savers are usually risk averse, who doesn’t want to invest their small saving fund in the risky ventures. Hence the financial institutions take the responsibility of transforming their risk in investing their funds in profitable and safe venture by bearing the risk. Centre for Distance and Online Education, AMU 20‘nancial Economics (ECM M.A (ills Semester) ‘© Payment function: The financial system offers a very convenient mode of payment for ‘goods and services. The cheque system and credit card system are the easiest methods of paymen the economy. The cost and time of transactions are considerably reduced. ‘The payment mechanism is now being increasingly made through electronic means + Pooling of funds: A financial system provides a mechanism for pooling of funds to invest in large scale enterprises. * Monitor Corporate performance: A financial system not only helps in selecting the projects to be funded but also motivates the various stakeholders of the financial system to monitor the performance of the investment, « Provide price related information: Financial markets provide information which enables the investors to make an informed decision about whether to buy, sell or hold a financial asset. This information dissemination facilitates valuation of financial assets. ¢ Information function: Financial markets disseminate information for enabling participants to develop informed opinion about investment, disinvestment, reinvestment or holding a particular asset. © Transfer function: A financial system provides a mechanism for the transfer of resources across geographic boundaries. © Reformatory function: A financial system, undertakes the functions of developing, introducing innovative financial assets/instruments. Services and practices and restructuring the existing assets, services efc., to cater to the emerging needs of borrowers and investors. Le. financial engineering and reengineering, * Other funetions: 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. How efficient and effective is the transfer of funds depends upon the efficiency and soundness of the financial system of any economy. Thus, a strong and vibrant financial system contributes towards the most effective and efficient allocation of resources from surplus spending economic units to deficit spending economic units. This optimal use of resources leads to economic development. However, there are conflicting opinions about the role of financial system in economic development. According to the Solow’s model of economic growth, growth results Centre for Distance and Online Education, AMU 21Financial Economics (BCM-506} M.A (lls Semester) predominantly not from the increase in labour and capital but from the technological progress, Therefore, money and finance and the policies about them cannot contribute to growth process. The other view regards money as the most important tool for economic development. 1.6 Equilibrium in Financial Markets Demand and Supply in Financial Markets In any market, the price is what suppliers receive and what demanders pay. In financial markets, those who supply financial capital through saving expect to receive a rate of return, while those who demand financial capital by receiving funds expect to pay a rate of return, This rate of return can come in a variety of forms, depending on the type of investment. The simplest example of a rate of retum is the interest rate. For example, when you supply money into a savings account at a bank, you receive interest on your deposit. The interest paid to you as a percent of your deposits is the interest rate, Similarly, if you demand a loan to buy a car or a computer, you will need to pay interest on the money you borrow. Let’s consider the market for borrowing money with credit cards, In 2014, almost 200 million Americans were cardholders. Credit cards allow you to borrow money from the card’s issuer, and pay back the borrowed amount plus interest, though most allow you a period of time in which you can repay the loan without paying interest. A typical credit card interest rate ranges from 12% to 18% per year. In 2014, Americans had about $793 billion outstanding in credit card debts. About half of U.S. families with credit cards report that they almost always pay the full balance on time, but one-quarter of U.S. families with credit cards say that they “hardly ever” pay off the card in full. In fact, in 2014, 56% of consumers carried an unpaid balance in the last 12 months. Let’s say that, on average, the annual interest rate for credit card borrowing is 15% per year. So, Americans pay tens of billions of dollars every year in interest on their credit cards—plus basic fees for the credit card or fees for late payments, Figure 1 illustrates demand and supply in the financial market for credit cards. The horizontal axis of the financial market shows the quantity of money that is loaned or borrowed in this market, The vertical or price axis shows the rate of retum, which in the ease of credit card borrowing can be measured with an interest rate, Centre for Distance and Online Education, AMU 22Financial Economics (ECM M.A (lls Semester} 25% Excess supply _OTSUpIUS An above-equilibrium $- interest rate % F auttrum z 2 15% +----~ MLE interest rate 2 13% Ct Se. a below-equilibrium % Ne. interest rate 8 10% © Excess interest rat 5 demand & orshortage 5% 5 \ 0% + T + T $0 $200 $400 $600 $800 $1,000 Quantity (billions of dollars) Figure 1: Equilibrium in Financial Markets The laws of demand and supply continue to apply in the financial markets. According, to the law of demand, a higher rate of return (that is, a higher price) will decrease the quantity demanded. As the interest rate rises, consumers will reduce the quantity that they borrow. According to the law of supply, a higher price increases the quantity supplied. Consequently, as the interest rate paid on credit card borrowing rises, more firms will be eager to issue credit cards and to encourage customers to use them, Conversely, if the interest rate on credit cards falls, the quantity of financial capital supplied in the credit card market will decrease and the quantity demanded will fall. In the financial market for credit cards shown in Figure 1, the supply curve (S) and the demand curve (D) cross at the equilibrium point (E). The equilibrium occurs at an interest rate of 15%, where the quantity of funds demanded and the quantity supplied are equal at an equilibrium quantity of $600 billion. If the interest rate (remember, this measures the “price” in the financial market) is above the equilibrium level, then an excess supply, or a surplus, of financial capital will arise in this market. For example, at an interest rate of 21%, the quantity of funds supplied increases to $750 billion, while the quantity demanded decreases to $480 billion. At this above-equilibrium interest rate, firms are eager to supply loans to credit card borrowers, but relatively few people or businesses wish to borrow. As a result, some credit card firms will lower the interest rates (or other fees) they charge to attract more business. This strategy will push the interest rate down toward the equilibrium level Centre for Distance and Online Education, AMU 23Financial Economics (BCM-506} M.A (lls Semester} If the interest rate is below the equilibrium, then excess demand or a shortage of funds occurs in this market, At an interest rate of 13%, the quantity of funds credit card borrowers demand increases to $700 billion; but the quantity credit card firms are willing to supply is only $510 billion, In this situation, credit card firms will perceive that they are overloaded interest rates or with eager borrowers and conclude that they have an opportunity to rai fees. The interest rate will face economic pressures to creep up toward the equilibrium level. 1.7 Money Market and its Constituents Money Market ‘Money market is a market for dealing in monetary assets of short-term nature, generally less than one year. It refers to that segment of the financial market which allows the raising up of short term funds for fulfilling temporary shortages of cash & obligations and the temporary deployment of excess funds for earning returns. The money market is a market for short-term funds, which deals in financial assets whose period of maturity is up to one year. It should be noted that money market does not deal in cash or money as such but simply provides a market for credit instruments such as bills of exchange, promissory notes, commercial paper, treasury bills, etc. These financial instruments are close substitute of money. These instruments help the business units, other organisations and the Government to borrow the funds to meet their short-term requirement. Money market does not imply to any specific market place. Rather it refers to the whole networks of financial institutions dealing in short-term funds, which provides an outlet to lenders and a source of supply for such funds to borrowers. Most of the money market transactions are taken place on telephone, fax or Internet, The Indian money market consists of Reserve Bank of India, Commercial banks, Cooperative banks, and other specialised financial institutions. The Reserve Bank of India is the leader of the money market in India Some Non-Banking Financial Companies (NBFCs) and financial institutions like LIC, GIC, UTI, ete. also operate in the Indian money market Major Participants of Money Market ‘The major participants of the money market are: © Central and State Government ‘© Public sector undertaking © Private sector companies © Non-banking financial institutions © Mutual funds Centre for Distance and Online Education, AMU 24Financial Economics (ECM |-506) M.A (lls Semester} Insurance companies Primary dealers Broad Objectives of Money Market An equilibrating mechanism for evening out short term surpluses and deficiencies. ‘A focal point of RBI (central bank) intervention for influencing liquidity in the economy. Access to the users of short term funds to meet their need at reasonable price and cost. Features of a developed Money Market Presence of central Bank Highly organized commercial Banking System Presence of sub-markets Integrated structure of money market Accessibility of proper credit instruments Acceptability & elasticity of funds International attraction Uniformity of interest rates Stability of prives Highly developed Industrial system Structure of Indian Money Market The Money Market is considered as an alternative for money for short term time span stretching from overnight to a year. It consists of both the organised and the unorganised segment. reture of gion Money Moret | igen ornare Money oder Sassy —— peda 7 Figure 2: Structure of the Indian Money Market Centre for Distance and Online Education, AMU 25Financial Economics (ECM M.A (lls Semester} Indian money market can be separated into several sub-markets depending on their nature & tions and the features of the instruments, scope of the tran: ‘call Money Bill Market 964 Days Bill Gerthioates or Commerola! Papers Markee Market Deposits (cbs) (CPs) colnmereial Tréasury aus Bis (90 days) Figure 3: Sub-markets of Money Market Money Market Instruments Money Market instruments essentially includes Government securities, securities issued by private sector & banking institutions ‘+ Government Securities: RBI issues securities on behalf of the Government known as Government Securities. It includes Central Govt Securities, State Govt Securities and Treasury Bills. The various form of this Securities are given as following: ‘Table 1: Various forms of Government Securities Centre for Distance and Online Education, AMU 26Financial Economics (ECM-506) M.A (lls Semester} Face Value Discount to Face Value, Face Value Calland Put Face Value Face Value but paid in Option Inatalments period fixed at the Do not carry fied atthe fixed asa This bond is fixed as 2 time of any interest time of percentage due for percentage Issuance, rate Issuance, over. redemption over the ‘and remains andremains predefined in 2012. and wholesale ‘constant tll Constant till benchmerk carries spice index redemption fedemption rate which coupon of at the time of the. ofthe. may be 67% of ieeuance security Security Treasury bill, bank rate ete atthe time Of suance Fined Fed Fined Fined ‘Thisbond Fixed has been priced inline with s year bonds ‘Atpar (face Atpar (face Atpar (face At par (face Thisbond The principal Value) on'its value) onits value) on ts value) onits hasbeen redemption ‘maturity maturity maturity maturity priced In line is linked to date date date date withS year the bonds, Wholesale Price Index The Government dated securities can be bought for a minimum sum of Rs. 10,000/- and the Treasury bills for a sum of Rs. 25,000/- & in multiples thereafter and the State Govt Securities may be bought fora min, sum of Rs.1, 000/-. Money at Call and Short Notice: Call money or call deposits is the amount of money that is advanced on condition to repay on call, Notice money indicates the money that is advanced and repaid on a certain day's notification from the lenders. There are various reasons for this borrow such as: to ‘maintain their CRR, heavy payments etc. Money at short notice is meant for a maturity of up to 14 days. RBI has permitted banks and all India FIs as the main participants. At least a sum of Rs.20 crores for every transaction allowed the participation of the corporate in the call money market. The DFHI upgraded the activity of Call Money Market and Short-term Deposit Market. It allowed lending and borrowing of funds. Banks are the essential borrowers. It can function outside the provision of the ceiling rates fixed by the Indian Banks Association, GIC, IDBI, NABARD etc are the various participants along with the private ‘Mutual Funds that lends fund in the market. The DFHI determines the settlement among the lender and the borrower about the accessibility of funds and the sum required for exchanges. It also provides an advice regarding the interest rates appropriate to them. Here, the call rates Centre for Distance and Online Education, AMU 27Financial Economics (BCM-506} M.A (lls Semester} are highly unstable as they are estimated by the demand and supply of funds in the market which is based on the maintenance of CRR by the banks. There are 2 call rates sustained in of DFHI. India namely Inter-bank call rate & the lending rat Bills Rediscounting Scheme: Under this scheme the banks may advance funds by issue of issuance from issuing notes in appropriate lots and maturities matching the authentic trade bills discounted by them, It promotes liquidity in the market, Here the seller draws a BoE and the buyer accepts it Suppose, Mr.X(seller) sells on credit and he wants money in the meantime, he may approach the bank for discounting the bill and he acquires the money. Now, the bank who has discounted the bill may need to get it ‘redi counted’ with some other bank to acquire the funds. This is referred to as “bill rediscounting’. The bank can rediscount the bills with the RBI and other sanctioned institutions like LIC, GIC, ete. Inter-Bank Participation Certificate: These are allotted by scheduled commercial banks only to increase funds or to deploy short term surplus. It is issued as per the RBI guidelines on 2 basis: a. on risk sharing basis b. without risk sharing Under risk sharing, the lender bank shares losses with the borrowing banks by conjointly assessing the interest rate. The tenure in this case may be for 90 to 180 days. There is a tenure of 90 days in case of Inter-Bank Participation without risk sharing where the issuing bank is borrowing and the sum is lent by the participating banks. Money Market Mutual Funds (MMMFs): MMMEFs gather the small savings of a large no. of savers and invest them in the capital market to provide safety, liquidity and return. This concept is prolonged to money market. Hence, the MMMF are coming up. The managing principle on MMMFs are revised from time to time by SEBI relating to maximum limit of investment. Treasury Bill: ‘A treasury bill is a promissory note issued by the RBI to meet the short-term requirement of funds. Treasury bills are highly liquid instruments that means, at any time the holder of treasury bills can transfer of or get it discounted from RBI. These bills are normally issued at a price less than their face value; and redeemed at face value, So the difference between the issue price and the face value of the Treasury bill represents the interest on the investment. These bills are secured instruments and are issued for a period of not exceeding 364 days. Banks, inancial institutions and corporations normally play major role in the Treasury bill market. Centre for Distance and Online Education, AMU 28Financial Economics (BCM-506} M.A (ill! Semester) Certificates of Deposits: This is issued as per the guidelines of the RBI in dematerialized form or Promissory Note for the funds deposited at a bank or other financial institution. This is a negotiable instrument where the deposit should be at least of Rs.1 lakh and in the multiples of Rs. 1 lakh thereafter, The maturity period should not be less than 15 days and exceed 1 year. But, for the financial institution it should not be less than | year and not more than 3 years, Inter-Corporate Deposits: These are unsecured loan lent by | of the corporate to another. As the cost of funds for a corporate is higher than a bank, the rates in this market are higher than those in the other market. Call Money Market: The call money market is a market for extremely short period loans say one day to fourteen days. So, it is highly liquid. The loans are repayable on demand at the option of either the lender or the borrower. In India, call money markets are associated with the presence of stock exchanges and hence, they are located in major industrial towns like Mumbai, Kolkata, Chennai, Delhi, Ahmedabad, etc. The special feature of this market is that the interest rate varies from day-to-day and even from hour-to-hour and centre-to-centre. It is very sensitive to changes in demand and supply of call loans. Commercial Bills Market: It is a market for bills of exchange arising out of genuine trade transactions. In the case of credit sale, the seller may draw a bill of exchange on the buyer. The buyer accepts such a bill, promising to pay at a later date the amount specified in the bill. The seller need not wait until the due date of the bill. Instead, he can get immediate payment by discounting the bill. In India, the bill market is underdeveloped. The RBI has taken many steps to develop The a sound bill market. The RBI has enlarged the list of participants in the bill market. Discount and Finance House of India was set-up in 1988 to promote secondary market in bills. In spite of all these, the growth of the bill market is slow in India, There are no specialised agencies for discounting bills, The commercial banks play a significant role in this market, Gilt-edged (Government) Securities: These securities have huge demand by the banks to maintain the Net Demand & Time Liquidities (NDTL) through its buying and selling. Governments such as Central & State Centre for Distance and Online Education, AMU 29Financial Economics (BCM-506} M.A (lls Semester} Governments, Semi-Govemmment Authorities, and Municipalities ete. issues these securities which are dated long before and are with RBI. These issues are notified a few days before opening for subscription and offer remains open for two to three days. The rate of interest is lower but itis payable on semi-annually basis. Repo Market This tool helps in collateralised short- term borrowing & lending through purchase or sale operation in debt instruments. The securities here are sold by the holders to the investors with a promise to buy them again at a pre-fixed rate and date. Alternatively, under the reverse repo transactions, the securities are bought with a promise to resell them at a pre-set rate and date. Treasury Bills Market: It is a market for treasury bills which have ‘short-term’ maturity. A treasury bill is a promissory note or a finance bill issued by the Government. It is highly liquid because its repayment is guaranteed by the Government. It is an important instrument for short-term borrowing of the Government. There are two types of treasury bills namely: (i) Ordinary or Regular and (ii) ad hoe treasury bills popularly known as ‘ad hoes’. Ordinary treasury bills are issued to the public, banks and other financial institutions with a view to raising resources for the Central Government to meet its short-term financial needs. Ad hoc treasury bills are issued in favour of the RBI only. They are not sold through tender or auction. They can be purchased by the RBI only. Ad hoes are not marketable in India but holders of these bills can sell them back to RBI. Treasury bills have a maturity period of 91 days or 182 days or 364 days only. Financial intermediaries can park their ‘temporary surpluses in these instruments and earn income. Short-term loan market: It is a market where short-term loans are given to corporate customers for meeting their working capital requirements, Commercial banks play a significant role in this market. Commercial banks provide short-term loans in the form of cash credit and overdrafi Overdraft facility is mainly given to business people, whereas cash credit is given to industrialists. Overdraft is purely a temporary accommodation and it is given in the current account itself. But, cash credit is for a period of one year and it is sanctioned in a separate account. 1.8 Capital Market Centre for Distance and Online Education, AMU 30Financial Economics (BCM-506} M.A (lls Semester} Capital Market may be defined as a market dealing in medium and long-term funds. It is an institutional arrangement for borrowing medium and long-term funds and which provides facilities for marketing and trading of securities. So it constitutes all long-term borrowings from banks and financial institutions, borrowings from foreign markets and raising of capital by issue various securities such as shares debentures, bonds, ete, The market where securities are traded known as Securities market. It consists of two different segments namely primary and secondary market. The primary market deals with new or fresh issue of securities and is, therefore, also known as new issue market; whereas the secondary market provides a place for purchase and sale of existing securities and is often termed as stock market or stock exchange. Components of Capital Market Equity or Ordinary Shares: It represents the ownership capital. It is of several types: Authorized equity share capital: The maximum sum of share capital that a company can raise is its authorized share capital. Issued capital: It is that portion of the capital which offered by the company to the investors. Subscribed capital: It is the part of issued capital which is subscribed by the investors. Paid-up capital: It is the capital that paid by the shareholders. The main features include limited liability, residual claim to income, right to control, pre= emptive rights. Preference Shares: It has certain characters of equity share and debentures. It has a fixed rate of interest. It has preferential right to get dividend in comparison to equity share. The preference shareholders can get cumulative dividends i.e. all unpaid dividend are payable. They have no voting right. But, if the preference shares are not paid for more than 2 years with regard to cumulative shares, the preference shareholders permitted to vote. Debentures or Bonds or Note ‘The debenture holders are long-term creditors. The debenture holders get a predetermined rate of interest and the principal sum is refunded at specified time. Three types of debentures are found presently in India as: © Convertible debenture after 36 months ‘* Optionally convertible debenture within 36 months © Compulsorily convertible with 18 months Innovative Debt or Instrument: The debenture may be compulsorily, optional or convertible, Call option gives a chance to the company to redeem the bonds prematurely. The firms issue su0236590¢214\7Sh bonds and in favourable condition, they refund it, A warrant gives the right to subscribe the equity shares at a certain period. The zero coupon bonds do Centre for Distance and Online Education, AMU 31Financial Economics (BCM-506} M.A (lls Semester} not cary any coupon rate and sold at discount from their maturity value. The deep discount bond issued at discount over its face value far below the yield to maturity. Floating rate bonds are bonds whose interes rates are not predetermined and it is the percentage point more than the benchmark rate. The benchmark rate is interest rate on treasury bills, bank rate, and ‘maximum rate on term deposit. Forward Contraets: It is the contract based on specified price to buy or sale at a definite future date of an asset. The buyer assumes a long position and decides to buy at a definite future date at a definite price to buy and the other party gets short position to sell the asset on the same date at specified price. These are traded outside the stock exchange. Futures or Future Contracts: It is a contract between 2 parties to buy or sale an asset at a definite time in the future, at a definite price. It solves the different issues related to the forward market. It reduces the counter party risk as seen in forward contract. The future contracts are traded in an organized stock market while forward contract are traded in or SEL The future contracts are standardized contract which follow daily settlement. The forward contracts are customized contract terms and settlement done at the conclusion of the period. Options or Option Contracts: In forward contract and future contract, the parties dedicated themselves to do something whereas in case of option contract the parties get option the right to do something. The forward contract and future contract does involve any charge any cost. But the option contract requires an up-front payment. The option contracts are of two types, call option and put option. In case of call option the holder get the right not obligation to buy an asset by a definite date for a definite price. In case of put option the holder gets the right not the commitment to sell an asset on a pre-set date for a pre-set price. Importance of Capital Market Absence of capital market acts as a deterrent factor to capital formation and economic ‘growth, Resources would remain idle if finances are not funneled through the capital market The importance of capital market can be briefly summarised as follows: © The capital market for the productive use of the srves a an important sour economy's savings. It mobilises the savings of the people for further investment and thus, avoids their wastage in unproductive uses, ‘+ It provides incentives to saving and facilitates capital formation by offering suitable rates of interest as the price of capital. Centre for Distance and Online Education, AMU 32‘nancial Economics (ECM M.A (lls Semester) ‘© It provides an avenue for investors, particularly the household sector to invest in financial assets which are more productive than physical assets ‘© It facilitates increase in production and productivity in the economy and thus, enhances the economic welfare of the society. Thus, it facilitates ‘the movement of stream of command over capital to the point of highest yield’ towards those who can apply them productively and profitably to enhance the national income in the aggregate, ‘+ A healthy capital market consisting of expert intermediaries promotes stability in values of securities representing capital funds. ‘* Moreover, it serves as an important source for technological upgradation in the industrial sector by utilising the funds invested by the public, Thus, a capital market serves as an important link between those who save and those who aspire to invest their savings. The operations of different institutions in the capital market induce economic growth. They give quantitative and qualitative directions to the flow of funds and bring about rational allocation of scarce resources. 1.8.1 Government Securities Market It is otherwise called Gilt-edged securities market. It is a market where Government Securities are traded. In India, there are many kinds of Government securities — short-term and long-term. Long-term securities are traded in this market while short-term securities are traded in the money market, Securities issued by the Central Government, State Governments, Semi-government authorities like City Corporations, Port Trusts, etc. iancial institutions Improvement Trusts, State Electricity Boards, All India and State level fi and public sector enterprises are dealt in this market. Government Securities are issued in denominations of * 100, Interest is payable half- yearly and they carry tax exemptions also. The role of brokers in marketing these securities is practically very limited and the major participant in this market is the ‘commercial banks’ because they hold a very substantial portion of these securities to satisfy their SLR requirements. The secondary market for these securities is narrow since, most of the institutional investors tend to retain these securities unti] maturity. The Government Securities are in many forms. These are generally: (i) Stock certificates or inscribed stock. (ii) Promissory notes. (iii) Bearer bonds which can be discounted. Centre for Distance and Online Education, AMU 33Financial Economics (BCM-506} M.A (ill! Semester) Government Securities are sold through the Public Debt Office of the RBI while Treasury Bills (short-term securities) are sold through auctions, Government Securities offer a good source of raising inexpensive finance for the Government exchequer and the interest on these securities influences the prices and yields in this market. Hence, this market also plays a vital role in monetary management. STRIPS — Separate Trading of Registered Interest and Principal of Securities With a view to improving liquidity and widening the investor base of the Government Securities market, stripping and reconstitution of Government Securities have been permitted under the Government Securities Act, 2006. Stripping is nothing but the process of separating a standard coupon leaving bond into its constituent interest and principal components. For example, st ping a 15-year security would yield 30 coupon securities (generally coupon payments are made on Jan 2 and July 2) maturing on the respective coupon dates and one principal security representing the principal amount maturing on the redemption date of the 15-year security. All the 30 coupon securities and the principal security would thereafter become zero coupon bonds. The reverse of stripping in called reconstitution, That is, when all the coupon STRIPS and the principal STRIPS are reassembled into the original Government Security, it is called reconstitution. The special feature of STRIPS is that the coupon STRIPS of the same date, though from different stocks are exchangeable since they are identical by their maturity dates. STRIPS provide additional instruments to institutional investors for their asset-liability management. Again, STRIPS have zero investment risk (discounted instruments with no periodic interest payment). Stripping/Reconstitution can be done at the option of the holder at any time from the date of issues of a Government Security till its maturity. The minimum amount of securities that needs to the submitted for Stripping/Reconstitution will be * 1 crore (ace value) and multiples thereof. 1.8.2 Corporate Security Market Corporate bonds are medium or long-term securities of private sector companies which obligate the issuer to pay interest and redeem the principal at maturity. Corporate bonds that are not backed by a specific asset are called debentures. Debentures are medium or long term, interest-bearing bonds issued by private sector companies, banks and other financial institutions that are backed only by the general credit of the issuer. Debentures are usually issued by large, well-established institutions. The holders Centre for Distance and Online Education, AMU 34Financial Economics (BCM-506} M.A (lls Semester} of debentures are considered creditors and are entitled to payment before shareholders in the event of the liquidation of the issuing company. Convertible Debentures are debentures issued with an option to debenture holders to convert them into shares after a fixed period. A convertible debenture is a type of debenture or commercial loan that gives the choice to the lender to take stock or shares in the company, as an alternative to taking the repayment of a loan. It is any form of debenture which can be converted into some other kind of security like shares or Common Stocks. Convertible debentures are either partially or fully convertible. In case of partially convertible debentures, part of the instrument i redeemed and part of it is converted into shares and in case of fully convertible debentures, the full value of the debenture is converted into equity. Convertible debentures are generally issued to prevent sudden outflow of the capital at the time of maturity of the instrument, which may cause liquidity problems. The conversion ratio, which is the number of equity shares exchanged per unit of the convertible debenture is clearly stated when the instrument is issued. Usually, Convertible Debentures offer more safety to the investor compared to Common Shares or Preference Shares. They are suitable for investors who look for potential increases in asset value (appreciation) compared to that yielded by Bonds, and more earnings than Common Stocks provide. Non-convertible Debentures are debentures issued without conversion option, The total amount of the debenture will be redeemed by the issuing company at the end of the specific period. 1.8.3 Primary and Secondary Market for Securities Primary Market Primary market is a market for new issues or new financial claims. Hence, it is also called New Issue Market. The primary market deals with those securities which are issued to the public for the first time. In the primary market, borrowers exchange new financial securities for long-term funds. Thus, primary market facilitates capital formation. There are three ways by which a company may raise capital in a primary market. They are: (i) Public sue. (ii) Rights issue. (iii) Private placement. The most common method of raising capital by new companies is through sale of securities to the public. It is called public issue. When an existing company wants to raise additional capital, securities are first offered to the existing shareholders on a pre-emptive basis. It is called rights issue. Private placement is a way of selling securities privately to a small group of investors. ies Primary Market Intermedi Centre for Distance and Online Education, AMU 35Financial Economics (BCM-506} M.A (ills Semester) ‘Merchant Banker or Lead Managers: Merchant bankers are corporate body who involve in issue of securities. It acts as manager or advisor or consultant to issuing company. A merchant banker needs a mandatory registration under the regulation 3 of SEBI (Merchant Bankers) Regulations, 1992. These activities broadly involves defining the composition of capital structure, compliance with procedural formalities , appointment of registration , listing of securities, organisation of underwriting , selection of brokers & bankers, publicity & advertisement agent , private placement of securities, advisory services, etc. The merchant bankers are responsible to make all attempts to safeguard the interest of investors, Due diligence, high standards of integrity, dignity has to be applied by the merchant bankers. The merchant bankers are also accountable in giving sufficient information without misleading about the applicable regulations and guidelines. Now, it is obligatory for all public issues to ‘be managed by merchant bankers working as the leading managers. Underwriter: An underwriter may be an individual, broker, merchant banker, financial institution or banks. The underwriting is an arrangement among the issuing company & the assuring party via an agreement to take up shares or debentures or other securities to a definite extent in case public subscription does not amount to the expected level. Thus, in case of any shortage, it has to be made sufficient by underwriting arrangements by the underwriter as per the agreement. Debenture Trustees: The issuing company has to make appropriate arrangements and fulfil the legal necessities for the investor. The company provides these amenities to the investors for a fee under a plan implementing as trust deed with the trustee who are mainly banks and financial institutions and file the similar with the Registrar of Companies. The chief responsibility of the debenture trustees is mainly the ownership of trust property in agreement with the trust deed, taking periodical report from the body corporate, enforce security of interest, protection of the debenture holders, inspect books of a/c, notify SEBI if any breach of trust deed ete, Registrars and Share Transfer Agents: These are very significant intermediaries in for the organizing new capital, keeping records, determining the basis of allotment et investors. They are very suitable in case of share transfer, sale, as it supports in liquidity to the investors of their investment, They also offer this service to the existing companies. But this responsibility decreases as depository system comes into play. But the share transfer agents will have to work unless the old system is entirely abolished and the shareholding completely switch over to dematerialized system, The ‘Registrar to an issue means, any Centre for Distance and Online Education, AMU 36Financial Economics (BCM-506} M.A (ill! Semester) individual appointed by the company or group of individuals transmit out such activities on its behalf ic. collecting applications, maintaining records, determining the basic for allotment of securities, finalizing the list from the same, process & dispatch of allotment letters etc. The “Share Transfer Agents’ means, any person who keep records of holder of securities on behalf of any corporate, They manage all matters linked with it, like redemption, transfer of securities ete, It can be a unit of a body corporate performing the activities at any time the total no, of holders of its securities issued is greater than one lakh, Bankers to Issue: The Chapter I of SEBI (Bankers to an Issue) Regulations, 1994, deals with Banker to an issue, The Banker to issue means a schedule bank performing on all or any of the following activities: Acceptance of application and application money Acceptance of allotment or call money. Refund of application money. Payment of dividend or interest warrant. Secondary Market Secondary market is a market for secondary sale of securities. In other words, securities which have already passed through the new issue market are traded in this market. Generally, such securities are quoted in the Stock Exchange and it provides a continuous and regular market for buying and selling of securities. This market consists of all stock exchanges recognised by the Government of India. The stock exchanges in India are regulated under the Securities Contracts (Regulation) Act, 1956. The Bombay Stock Exchange is the principal stock exchange in India which sets the tone of the other stock markets Secondary Market Intermediaries The trading of securities that are initially offered is dealt by the secondary market. ‘The below mentioned are the secondary market intermediaries: Portfolio Manager: The word ‘portfolio’ refers to the total sum of holdings of securities owned by any person and the portfolio manager is the person who under an arrangement with the client, instructs or guides the management and administration of such portfolio of securities. The portfolio manager has to move into an agreement on behalf of a client and it contains: 1. the investment objectives, 2. Area of investment, 3. Type of instrument, 4. Custody of securities, 5. Procedure of client’s account ete. Centre for Distance and Online Education, AMU 37Financial Economics (BCM-506} M.A (ill! Semester) Stock Brokers: Stock brokers are members of known stock exchanges who buy and sell or deals in securities. For a broker to transact in the securities on a recognized stock exchange, it is mandatory that he must be registered as a stock broker with SEBI. They simplifies transaction of securities in the secondary market. The stock broker has to engage into an agreement with his client before buying & selling of securities. Person should have a client account with a registered broker or sub-broker to buy or sell securities and will have to do the transaction through such broker or sub-broker. A brokerage commission is charged by the broker or sub-broker for enabling transaction. Custodian: It means any individual who delivers custodial services with respect to securities of a client or safe keeping of gold or gold related instrument. They run their purpose by opening custodial account which is an account of a client preserved by a custodian of securities. Any individual who recommends to move such business as custodian of securities will have to give an application to SEBI for grant of a certificate for registration. The applicant satisfies the capital requirement specified under regulation 7(1), a net worth of at least rupees 50 crore. The applicant should have the essential infrastructures and should follow all rules and regulation approved under any law for the time being in force relating to securities, gold or gold related instrument. The applicant should be skilled person and the grant of certificate is in the interest of investor. Custodian has the duty to examine their affairs through the inspecting officer such as books, securities ete 1.11 Analysis of Financial Markets Every time we purchase a good in the market, we want to have more benefit from that product than the price we have to pay for that product. The type of benefit varies with the type of product. But it is sure that whenever we buy anything we want that return from that particular thing should be more than the amount we have to pay for that. Similarly when we buy a share we want to know how much benefit we will derive from that as against the current value of that share, Fundamental analysis is a one such technique. 1.11.1 Fundamental Analysis Fundamental analysis is a method that attempts to predict the intrinsic value or True value of an investment, Intrinsic value refers to the true value of the share. This true value can be found by an investor by discounting the future dividends and expected market price of share by his required rate of return, In case this true value or intrinsic value is more than the current market price than the investor will desirous to buy that share otherwise not. Fundamental Analysis is based on the theory that the market price of an asset tends to move Centre for Distance and Online Education, AMU 38Financial Economics (ECM-506) M.A (ills Semester) towards its ‘real value’ or ‘intrinsic value’. In fundamental analysis an investor makes an altempt to study everything that can affect the share price. One tries to find out all the quantitative and the qualitative factors that he finds to be important for his study. He can look for information about the economy, industry and the company so that he can find a right security to invest in, The ultimate aim of doing fundamental analysis is to find a value that an investor can compare with the security’s current price and on basis of his comparison he finally decides whether to buy an under-priced security or to sell an overpriced security. All this decision is based on the assumption that ultimately a security’s price will reach to its intrinsic value or true value. Why to Study Fundamental Anal Before understanding about how to do fundamental analysis one should understand why he should do fundamental analysis. The answer to this question lies in the fact the all of us are rational consumers, We want more satisfaction for every rupee spent. E eryone wants to maximize his benefit. For example many times when we are at a shop to buy a product we ofien say to the shopkeeper to tell us the final price of the product at which he is ready to sell as the price told by him earlier are not according to the worth of the product for us. The same concept applies here, When we buy a share we are offered with various shares from various companies. Here again the question arises that whether the market price of share is a true reflector of its actual worth or not. Thus fundamental analysis helps hereby doing fundamental analysis one can calculate the intrinsic value of the share and then compare it with its market price. If intrinsic value is greater than he buys the shares and if it is lesser then he sells the shares (if he is holding some previously purchased shares). How to do Fundamental Analysis: It is a fact that it is not easily possible for an investor to find the intrinsic value of each and every stock present in the stock market and then decide on what to buy. Even if someone does so it will takes him years and finally when he will reach to @ conclusion that the result will be outdated as many new developments must have been taken place during the time he was analyzing. So this makes it essential for an investor to find a certain technique to short down a list of share to be studied. As everyone knows that the price of a share is affected by the performance of a company and the company’s performance is dependent upon the changes taking place in Industry and Economy. Thus it is important for us to make an analysis about economy, Industry and company. The logic for this three tier analysis is that the company performance depends not only on its own efforts, but also on the general Centre for Distance and Online Education, AMU 39Financial Economics (BCM-506} M.A (lls Semester} industry and economy factors. A company can be from any industry. For example a Reliance Infocom, IDEA etc. are companies that come under telecom industry. Thus these companies will be affected by any policy changes or any matter related to this industry. And this industry operates in an economy thus this industry will be affected by the changes in the economy. Thus the factors that affect a company can be broadly classified as: + Economic factors like rate of growth of the economy, exchange rates ete, ‘* Industry factors like demand and supply in the industry, competitors in the industry et. ‘© Company related factors like image of the company and its managers, profitability ete So Fundamental Analysis involves the following three analysis: © Economic Analysis © Industry Analysis * Company Analysis It can be done in two ways: top down approach and bottom up approach. If we start from economic analysis and then industry analysis and company analysis is performed it is called as top down approach. On the opposite side one can go by studying about the company first, then its industry analysis and then economic analysis then it is called as bottom up approach. Economic Analy: Economie Analysis relates to the analysis of the economy. If the economy is booming and growing then this will also have a positive attitude for the industries and hence the companies. For instance in current scenario of Indian economy when India is increasing its goodwill and building a positive identity internationally it has led to an increase in investors’ confidence in the economy and in industries. The initiatives like 'Make in India’ is increasing and attracting the attention of investors towards this developing and growing economy. Thus investors attitude are shaped by economic conditions prevailing in a country. They understand whether the economic climate is conducive or not for the growth of the business in general. There are many factors that can be studied for analyzing the economy like gap, rate of inflation, fiscal and monetary policy ete. Industry Analysis A good and booming economy gives positive outlook to investors but not for every industry. Thus it is important to study about the particular industry in which the investor is Centre for Distance and Online Education, AMU 40Financial Economics (BCM-506} M.A (lls Semester) interested. He should make a detailed study about the future of the industry and its prospect. It is often said that a weak stock in a strong industry is preferable to a strong stock in a weak industry. One should make a study whether the industry is struggling or not. A study about past performance of the industry along with its future prospects must be done. One should know about the phase with which an industry is going. Generally industry goes through for phases .They are pioneering, Expansion, Stagnation and decline. It is more beneficial to buy stock of a company when it is pioneering and expansion stage as one can foresee a good return in future. Various other factors shall also be kept in consideration like labor conditions, government's attitude and policies towards an industry, competitive conditions, technological changes ete. Company Analysis The final analysis after economic and industry is of company. Once an investor has selected the industry, he should then look for the company in which he wants to invest. There are various sources to study about a company like balance sheet income statement cash flow statement etc, varius ratios can be calculated like retum on equity, earning per share ,price earnings ratio etc. these information helps the analyst to make a projection about the future of the company and its growth, When performing ratio analysis on a company, the ratios should ‘be compared to other companies within the same or similar industry to make a good decision. S. Kevin suggested that in this era of globalization one may add one more circle to the diagram to represent the international economy. 1.11.2 Technical Analysis In any stock market an investor does a number of analysis before buying a stock. Sometimes they hire professionals to guide them and analyses about which stocks to be bought and sold. Among various methods of analyzing stock, one is Technical Analysis. Technical Analysis is concerned with the study of the past price behaviour of shares as well as volume of shares being traded in the past.one can study daily or weekly price and volume data of index comprising several stocks like SENSEX or NIFTY. A method of valuing securities by considering data produced by market movement, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity. Analysts who are using technical analysis believe that the historical performance of stocks and markets are indicators of future performance Centre for Distance and Online Education, AMU 41Financial Economics (BCM-506} M.A (ill! Semester) Technical analysis is all about studying stock price graphs and a few momentum oscillators derived thereof. It must be understood that technical studies are based entirely on prices and do not include balance sheets, P&L accounts (fundamental analysis). In technical analysis it is being assumed that the markets are totally efficient and all the possible price sensitive information regarding a stock or shares are built into the graph of price of the concerned security / index. Therefore, technical analysis supports the efficient market theory as against the “random walk theory" which supports the belief that stocks can be bought / sold on random events, Technical analysis is not dependent on corporate events like quarterly results and special announcements like earnings guidance and policy changes in operations to generate a buy / sell recommendation. Principles of Technical Analysis It is generally recognized that there are three basic principles of technical analysis. ‘The three principles are as follows’ ‘© Market discounts everything ‘© The Market Exhibits Trends ‘© History repeats itself Market Discounts Everything The first is that the action of the market reflects everything. This is extremely important, because underpinning technical analysis is the concept that just by studying market action we can get a good idea of future movements, There are many things that can affect the price. These include: «Fundamental factors, such as how fine products are selling and what profit margin can be achieved; Political or corporate factors, such as legislation; ‘© The putting in place of a new CEO or changes in working practices; «Psychological factors, such as whether the latest garment will attract the attention of people or not, or the Blackberry becomes a must-have for business reasons; ‘© By cutting across this, and declaring that all these factors which may or may not be knowable become included in the price by market action, the technical analyst can focus on the market alone, and doesn’t need a squad of research assistants. ieved that all the above factors ar In technical analysis it is bel incorporated in the prices of the securities, If a person has positive attitude towards a security then there will be Centre for Distance and Online Education, AMU 42Financial Economics (BCM-506} M.A (ll! Semester) an increase in the demand of that security. On the other hand if there is a negative attitude of people regarding a security then there will be a fall in the demand for buying that share and increase in selling of such shares. In economics we have already studied that the supply and demand for any product set its price. If demand is more than the supply, then in time the price of shares are increasing then for a commodity will rise. If this happens for a share i.e. pris we call ita bullish market. On the other hand, if demand for share is less than the supply then there will be a fall in the prices of such shares. The market for such shares is called as bearish market, Thus a technical analysts focuses only on the prices of security as every information regarding demand or supply of share is reflected in the prices of the security. Thus there is no need to focus on various factors like financial results, political situation, trends for a particular product of a company, seasonal factors etc. Only studying of trends in the movement of prices will give a good idea about them. The Market Exhibits Trends The second principle of technical analysis is that the prices of securities tend to move in trends. By this we mean that if the price is rising then it will in all likelihood continue to rise; and when falling then it will keep going down; and when hovering at about the same level, it will keep doing that. This sometimes is known as moving sideways. Of course, none of these things goes on forever, but it is generally predictable that a trend will go on for a though in the past changing. A lot of trading plans are based on this basis that ‘let the trend be your friend’, which means you should trade to follow the existing trend, It is assumed that if you are not following or going with a particular trend then it might expose you to more risk than you could have been to. The trends can be seen by drawing charts. Following is a chart that shows upward trend in the stock prices. PRICE ~ UPTREND Figure 4: Uptrend in Stock prices Centre for Distance and Online Education, AMU 43Financial Economics (BCM-506} M.A (ll! Semester) ‘Most charts you will use have the same basic layout. The time is along the horizontal, or X-axis, and the price is in the vertical or Y-axis. The time may show minutes or hours during the day, or days, weeks, or months or years. Commonly the analysts use charts with the time seale marked in days, and it is the custom to only include working days, five days a week. The chart that has been shown above shows an uptrend, with the price rising over time. One should keep it in mind that the trend usually does not go straight up or straight down, but goes up in a series of spurts, with what are called ‘retracements’ in between. This chart shows a fairly clear uptrend overall, Sometimes it helps to look at different time scales so you can identify which way the trend is going — for instance, if you looked at a chart of the same stock as shown above, but with a different timescale that only showed you a retracement, you might think the stock was in a downtrend. When trading with the trend, your task reduces to identifying the trend as soon as possible, so that you can enter the trade early, and keep on with it while waiting for until it shows signs of failing, or reversing. Many traders try to capture the greatest gain as much they can, while being confident enough that what they have identified is a real trend. History Repeats Itself The third principle of technical analysis is merely a statement that we don’t expect people to change their behaviour. In other words, we put our faith in on the fact ----history being repeating itself, with patterns and actions that have happened in the past leading to the same results when they happen in the future. Georg Hegel once said cynically that “We learn from history that we do not learn from history. ‘The task of the technical analyst is to learn what history has to teach. The psychology of traders and investors has not changed over decades, and this fact can be used to give advantage in the technical analysis.it is believed that traders mentality remain same. Therefore they behave in the same manner in similar situations as they did in the past. So if one can understand that how a person behaves then he can make gains in this market by analyzing the trends. This again is a central belief to trading using technical analysis. We rely on a study of history to tell us what normally happens in a certain set of circumstances, and then we expect that the same thing will happen again. The outcomes are seldom or never sure, but trading is a percentage game. We stack the odds in our good turn, and then use wise money management to make sure that the end result is a fully clad profit. Tools of Technical Analysis Centre for Distance and Online Education, AMU 44Financial Economics (BCM-506} M.A (lls Semester} ‘A technical analysts has and uses following tools for doing technical analysis. These tools are: © Charting © Market Indicators Charting Charting is the one of the crucial activity in technical analysis. Till now we have understood that basic motive in technical analysis is to identify the price trend. This trend is to be found by studying the past data about the price behaviour of a stock. And such past data helps to predict the future behaviour of stock. Thus the inputs for technical analysis is the price and volume data. Charts and graphs are the basic tools that are used in identifying the current trends in prices. These charts or graphs can be drawn either for a specific share or for the market as a whole. If one is concerned with the specific share then he is required to study the data for that particular share and in case he is doing the analysis of the market then he will look for the past behaviour of that market or an index. Since in charting we are concerned with finding out price trends therefore one should know what prices he has to look for. A security is traded at different price levels on any particular day. Out of these different price quotations, four prices are relevant and important. ‘These prices are as follows: © Opening price © Closing price © High price * Lowprice Opening price: As the stock exchange opens on a day, the first price at which the trade of a security takes place is called the opening price of the security. A security's opening price is an important indicator for that day's trading activity, especially for those interested in measuring short-term results, such as day traders. Closing price: Closing price is the last price at which the security was traded on a particular day before the stock market closes for that day. The closing price signifies the most up-to- date estimate of a security up to trading starts again on the next trading day. closing prices make available usefull marker for investors to measure changes in stock prices over time The closing price of one day can be compared to the previous closing price in order to measure market sentiment for a given security over a trading day. Stock indices for a day are also calculated on the basis of closing price of the constituent security. Centre for Distance and Online Education, AMU 45Financial Economics (BCM-506} M.A (lls Semester) Low Price: It is the lowest or the minimum price at which a particular stock was traded on a day. High Price: It is the highest or maximum price at which a particular share was traded on a day. Market Indicators Market indicators are quantitative in nature and seek to interpret stock or financial index data in an attempt to forecast market moves, Market indicators are a subset of technical indicators and are typically comprised of formulas and ratios. They aid investors! inve stment/trading decisions Market indicators are similar to technical indicators in that both apply a statistical formula to a series of data points to draw a conclusion. The difference is that market Often indicators use data points from multiple securities rather than just a single security times, market indicators are plotted on a separate chart rather than appearing above or below an index price chart. Most stock market indicators are created by analyzing the number of companies that have reached new highs relative to the number that created new lows, known as market breadth, since it shows where the overall trend is headed. ‘The two most common types of market indicators are: + Market Breadth indicators compare the number of stocks moving in the same direction as a larger trend. For example, the Advance-Decline Line looks at the number of advancing stocks versus the number of declining stocks. + Market Sentiment indicators compare price and volume to determine whether investors are bullish or bearish on the overall market. For example, the Put Call Ratio looks at the number of put options versus call options during a given period. Some of the most popular market indicators include: + Advance-Decline Issues - The ratio of advancing to declining securities at any given point in time, Since the indexes are weighted by market capitalization, this is helpful in determining true sentiment rather than just looking at the performance of the largest companics in a given index. Examples: SNYAD and SNAAD. + New Highs-New Lows - The ratio of new highs to new lows at any given point in time. ‘When there are many new highs, it's a sign that the market may be getting frothy, while many new lows suggest that a market may be bottoming out. Centre for Distance and Online Education, AMU 46Financial Economics (BCM-506} M.A (lls Semester} + McClellan Oscillator - This oscillator uses a moving average of highs and lows to help smooth out market breadth and make it easier to interpret rather than looking at choppy charts showing the raw numbers. It ranges from +150 to -150, + Moving Averages - Many market indicators look at the percentage of stocks above or below key moving averages, such as the 50- and 200-day moving averages $NYASO0, $NYA200, $NAASO, and S$NAA200. xamples: Fundamental ys. Technical Analysis: Technical analysis uses past data of a stock to predict future price movements, Fundamental analysis instead looks at economic and financial factors that influence a business. The major points of differences are: «The first step to technical analysis starts with charts, whereas in fundamental analysis it starts with the company’s financial statements. In fundamental analysis, you will have to determine a company’s intrinsic value by looking at its income statement, balance sheet and cash flow statement. Intrinsic value of a stock can be determined by discounting the value of future projected cash flows to the net present value. If the stock trades below the company’s intrinsic value, you can invest in it, But, technical analysts believe that a stock’s price already reflects everything that has or could affect a company. + The time horizon in fundamental analy is is often long-term, as opposed to a short-term approach taken by technical analysis. By the approach of fundamental anal you should wait for a long time before a company’s intrinsic value is reflected in the stock market. In technical analysis stock charts can be delimited in weeks, days, or even minutes. + Technical analysts and fundamental analysts have very different goals in their minds, Technical analysis will demand that you identify many short- to medium-term trades where you can eam a profit, whereas fundamental analysis demands you to make long- term investments, 1.12. Indicators of Financial Development Financial development of any economy depends upon its financial structure. Financial structure of any economy, in tum, depends upon the economic progress of the country. If the economy has a strong and sound stock market, debt market, insurance companies, pension funds, mutual funds, ete.ie. an effective non-banking financial sector, this shows a high level of financial development, Centre for Distance and Online Education, AMU 47Financial Economics (BCM-506} M.A (ll! Semester) Financial development of any economy can be judged by the presence or absence of the following indicators: «Finance ratio i.e. the ratio of total issue of primary and secondary claims to national income + Financial inter-relation ratio i.e. the ratio of financial assets to physical assets in the economy. + New issue ratio ie. the ratio of primary issues to the physical capital formation * Intermediation ratio ie. the ratio of secondary issues to primary issues. ‘The ratio of money to national income. + The proportion of current account deficit financed by market flows. + The level of imegration of domestic and international financial system, + The level of government intervention in credit allocation, Thus, the indicators given above can be analyzed to judge the extent of financial development of any economy. The greater the level of financial development, the higher would be the level of economic development, 1.13. Indian Stock Markets and Role of SEBI Stock exchange is the term commonly used for a secondary market, which provide aplace where different types of existing securities such as shares, debentures and bonds, government securities can be bought and sold on a regular basis. A stock exchange is generally organised as an association, a society or a company with a limited number of members. It is open only to these members who act as brokers for the buyers and sellers. The Securities Contract (Regulation) Act has defined stock exchange as “an association, organisation or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business of buying, selling and dealing in securities.” ‘The main characteristics of a stock exchange are: © Itis an organised market. ‘+ It provides a place where existing and approved securities can be bought and sold easily. © Ina stock exchange, transactions take place between its members or their authorised agents, ‘+ All transactions are regulated by rules and by laws of the concerned stock exchange. Centre for Distance and Online Education, AMU 48Financial Economics (BCM-506} M.A (ll! Semester) ‘© It makes complete information available to public in regard to prices and volume of transactions taking place every day. Stock Exchanges in India The first organised stock exchange in India wa: started in Mumbai known as Bombay Stock Exchange (BSE). It was followed by Ahmedabad Stock Exchange in 1894 and Kolkata Stock Exchange in 1908, The number of stock exchanges in India went up to 7 by 1939 and it increased to 21 by 1945 on account of heavy speculation activity during Second World War. A number of unorganised stock exchanges also functioned in the country without any formal set-up and were known as kerb market. The Security Contracts (Regulation) Act was passed in 1956 for recognition and regulation of Stock Exchanges in India, At present we have 23 stock exchanges in the country. Of these, the most prominent stock exchange that came up is ‘National Stock Exchange (NSE). It is also based in Mumbai and was promoted by the leading financial institutions in India. It was incorporated in 1992 and commenced operations in 1994, This stock exchange has a corporate structure, fully automated screen-based trading and nation-wide coverage. Another stock exchange that needs special mention is Over the Counter Exchange of India (OTCED. It was also promoted by the financial institutions like UTI, ICICI, IDBI, IF , LIC ete, in September 1992 specially to cater to small and medium sized companies with equity capital of more than Rs.30 lakh and less than Rs.25 crore. It helps entrepreneurs in raising finances for their new projects in a cost-effective manner. It provides for nationwide online ringless trading with 20 plus representative offices in all major cities of the country. On this stock exchange, securities of those companies can be traded which are exclusively listed on OTCEI only. In addition, certain shares and debentures listed with other stock exchanges in India and the units of UTI and other mutual funds are also allowed to be traded on OTCEI as permitted securities. It has been noticed that, of late, the tumover at this stock exchange has considerably reduced and steps have been afoot to revitalize it. In fact, as of now, BSE and NSE are the two Stock Exchanges, which enjoy nation-wide coverage and handle most of the business in securities in the country. Bombay Stock Exchange (BSE) Established in 1875, BSE (formerly known as Bombay Stock Exchange), is Asia's first & the Fastest Stock Exchange in world with the speed of 6 micro seconds and one of India's leading exchange groups. Over the past 143 years, BSE has facilitated the growth of the Indian corporate sector by providing it an efficient capital-raising platform. Popularly Centre for Distance and Online Education, AMU 49Financial Economics (BCM-506} M.A (ll! Semester) known as BSE, the bourse was established as ‘The Native Share & Stock Broker's Association’ in 1875. In 2017 BSE become the Ist listed stock exchange of India, Today BSE provides an efficient and transparent market for trading in equity, currencies, debt instruments, derivatives, mutual funds. BSE SME is India's largest SME platform which has listed over 250 companies and continues to grow at a steady pace. BSE STAR MF is India's largest online mutual fund platform which process over 27 lakh transactions per month and adds almost 2 lakh new SIPs ever month, BSE Bond, the transparent and efficient electronic book mechanism process for private placement of debt securities, is the market leader with more than Rs 2.09 lakh crore of fund raising from 530 issuances National Stock Exchange (NSE) The National Stock Exchange of India Ltd. (NSE) is the leading stock exchange in India and the second largest in the world by nos. of trades in equity shares from January to June2018, according to World Federation of Exchanges (WEE) report. NSE was incorporated in 1992. It was recognised as a stock exchange by SEBI in April 1993 and commenced operations in 1994 with the launch of the wholesale debt market, followed shortly after by the launch of the cash market segment. NSF's identity crafted in the nineties has for the last 25 years, stood for reliability, expertise, innovation and trust. In the last 25 years, the Indian economy and technology landscape has changed dramatically. And so has NSE. NSE was the first exchange in the country to provide a modern, fully automated sereen-based electronic trading system that offered easy trading facilities to investors spread across the length and breadth of the country. VikramLimaye is Managing Director & Chief Executive Officer of NSE. National Stock Exchange has a total market capitalization of more than USS3 trillion, 2021. ‘making it the world's 9th-largest stock exchange as of Regulations of Stock Exchanges The stock exchanges suffer from certain limitations and require strict control over their activities in order to ensure safety in dealings thereon. Hence, as early as 1956, the Securities Contracts (Regulation) Act was passed which provided for recognition of stock exchanges by the central Government. It has also the provision of framing of proper bylaws by every stock exchange for regulation and control of their functioning subject to the approval by the Government. All stock exchanges are required submit information relating to its affairs as required by the Government from time to time. The Government was given wide powers relating to listing of securities, make or amend bylaws, withdraw recognition to, or Centre for Distance and Online Education, AMU 50Financial Economics (BCM-506} M.A (ll! Semester) supersede the governing bodies of stock exchange in extraordinary/abnormal situations. Under the Act, the Government promulgated the Securities Regulations (Rules) 1957, which provided inter alia for the procedures to be followed for recognition of the stock exchanges, submission of periodical retums and annual returns by recognised stock exchanges, inquiry into the affairs of recognized stock exchanges and their members, and requirements for listing of securities. Securities and Exchange Board of India (SEBD) SEBI is a regulator for the securities market in India. It was established during the year 1988 and given statutory powers on 12th April 1992 through the SEBI Act. Objectives of SEBI ‘* To protect the interest of the investors ‘+ To regulate the securities market. ‘+ To promote efficient services by brokers, merchant bankers and other intermediaries. ‘+ To promote orderly and healthy growth of the securities market in India, >To create proper market environment. ‘+ To regulate the operations of financial intermediaries. * To provide suitable education and guidance to investors. Role of SEBI ‘As part of economic reforms programme started in June 1991, the Government of, India initiated several capital market reforms, which included the abolition of the office of the Controller of Capital Issues (CCI) and granting statutory recognition to Securities Exchange Board of India (SEBI) in 1992 for: (a) protecting the interest of investors in securities; (b) promoting the development of securities market; (c) regulating the securities market; and (d) matters connected there with or incidental thereto SEBI has been vested with necessary powers concerning various aspects of capital market, such as: «Regulating the business in stock exchanges and any other securities market; ‘« Registering and regulating the working of various intermediaries and mutual funds; ‘Promoting and regulating self-regulatory organisations; ‘+ Promoting investors education and training of intermediaries; Centre for Distance and Online Education, AMU 51Financial Economics (BCM-506} M.A (ll! Semester) «Prohibiting insider trading and unfair trade practices; ‘Regulating substantial acquisition of shares and takeover of companies; ‘Calling for information, undertaking inspection, conducting inquiries and audit of stock exchanges, and intermediaries and self-regulation organisations in the stock market; «Performing such functions and exercising such powers under the provisions of the Capital Issues (Control) Act, 1947 and the Securities Contracts (Regulation) Act, 1956 as may be delegated to it by the Central Government. As part of its efforts to protect investors’ interests, SEBI has initiated many primary market reforms, which include improved disclosure standards in public issue documents, introduction of prudential norms and simplification of issue procedures. Companies are now required to disclose all material facts and risk factors associated with their projects while making public issue. All issue documents are to be vetted by SEBI to ensure that the disclosures are not only adequate but also authentic and accurate, SEBI has also introduced a code of advertisement for public issues for ensuring fair and truthful disclosures. Merchant bankers and all mutual funds including UTI have been brought under the regulatory framework of SEBI. . A code of conduct has been issued specifying a high degree of responsibility towards investors in respect of pricing and premium fixation of issues. To reduce cost of issue, underwriting of issues has been made optional subject to the condition that the issue is not undersubscribed. In case the issue is under- subscribed ic,, it was not able to collect 90% of the amount offered to the public, the entire amount would be refunded to the investors. The practice of preferential allotment of shares to promoters at prices unrelated to the prevailing market prices has been stopped and private placements have been made more restrictive. All primary issues have now to be made through depository mode, The initial public offers (IPOs) can go for book building for which the price band and issue size have to be disclosed. Companies with dematerialized shares can alter the par value as and when they so desire. ‘As for measures in the secondary market, it should be noted that all statutory powers to regulate stock exchanges under the Securities Contracts (Regulation) Act have now been vested with SEBI through the passage of securities law (Amendment) Act in 1995. SEBI has duly notified rules and a code of conduct to regulate the activities of intermediaries in the securities market and then registration in the securities market and then registration with SEBI is made compulsory. It has issued guidelines for composition of the governing bodies of stock exchanges so as to include more public representatives. Corporate membership has Centre for Distance and Online Education, AMU 52Financial Economics (BCM-506} M.A (lls Semester) also been introduced at the stock exchanges. It has notified the regulations on insider trading to protect and preserve the integrity of stock markets and issued guidelines for mergers and acquisitions. SEBI has constantly reviewed the traditional trading systems of Indian stock exchanges and tried to simplify the procedure, achieve transparency in transactions and reduce their costs, To prevent excessive speculations and volatility in the market, it has done away with badla system, and introduced rolling settlement and trading in derivatives. All stock exchanges have been advised to set-up Clearing Corporation / settlement guarantee fund to ensure timely settlements. SEBI organises training programmes for intermediaries in the securities market and conferences for investor education all over the country from time to time 1.14 Answer the questions Examine the various components of the Indian financial system 2. What is a money market? 3. What is a capital market? 4, Distinguish between a primary market and a secondary market. 5. Differentiate between fundamental and technical analysis. 6. Explain the role of SEBI in the Indian stock market. 7. What are the different indicators of financial development? Centre for Distance and Online Education, AMU 53