FM-2:

FINANCIAL MARKET AND

SERVICES
FINANCIAL MARKET AND
SERVICES
Unit I: Overview of Indian Financial System
Indian Capital Market and Money Market, Foreign
Institutional Investors (FIIs)-Portfolio Management
Schemes of Indian Institutional Investors, Global
Capital Flows - Hedge Funds, Private Equity. ADR
and GDR.

Unit II: Indian Capital Market

Primary and Secondary Capital Markets in India-
Market for Stocks and Bonds, Market for Derivative
Instruments (Financial and Commodities), Over the
Counter Markets (OCTEI), NCDEX, MCX. Markets for
Government Securities, Mock Exercises in Online
Stock Market Operations on Sensex and Nifty.
Unit III: Banking in India
Meaning of Bank, types of banks, Current problems
of public sector banks, capital adequacy norms, Basel
norms, NPA problem, corporate debt restructuring,
and securitization of debt and asset reconstruction
companies, the new Insolvency and bankruptcy code

Unit IV: Merchant Banking and Credit Rating

Introduction to merchant banking, merchant
bankers/lead managers, registration, obligation and
responsibilities, underwriters, bankers to an issue,
brokers to an issue. Issue management activities and
procedure pricing of issue, issue of debt instruments,
book building green shoe option, services of merchant
banks, Credit Rating - SEBI guidelines, limitations of
rating.
Unit V: Regulatory Mechanisms
The role of SEBI in regulating the Capital Market and
Stock Exchanges- Outlines of the SEBI Act and
Powers of SEBI- Important Cases dealt with by SEBI-
Sahara, NSEL, and Insider Trading Cases etc.
Investigation into Corporate Frauds under Companies
Act 2013, NFRA and IBBI

Related Topics
• Foreign Direct Investment (FDI)
• Call and Put options (basic theory)
• Short and Long (basic theory)
• Investment Banking
• Stock broker
• Microfinance banks
Practical component:

1.Prepare a report on capital market scams.

2.Visit stock broking firms and understand their

operations.

3.Visit any 5 retailers and collect the information

about cashless transaction (merchant banking).

4.Online share trading with virtual money.

Unit I: Overview of Indian Financial
System

Indian Capital Market and Money Market,

Foreign Institutional Investors (FIIs)-Portfolio
Management Schemes of Indian Institutional
Investors, Global Capital Flows - Hedge
Funds, Private Equity. ADR and GDR.
 FINANCIAL MARKETS

• Market: where entities can trade financial securities,

commodities, at prices that reflect supply and demand.

• Financial markets are the centers or arrangements that

provide facilities for buying and selling of financial
products & services.

• Financial Markets Performs an important function of

cancelling surplus funds from savers to those who are
short of funds, thereby contributing to higher production
& efficiency in the economy.
KINDS OF FINANCIAL MARKET
CLASSIFICATION OF FINANCIAL MARKET

Financial Markets

Capital Market Money Market

Unorganized
Organized Market Organized Market
Market

Money
Industrial Govt. Call Commercial Treasury
lenders,
Securities Securities Money Bill Market Bill
Indigenous
Market Market Market Market
bankers etc.

Primary Secondary
Market Market
 MONEY MARKET

As per RBI “A market for short terms financial

assets that are close substitute for money,
facilitates the exchange of money in primary and
secondary market”.

A mechanism through which short term funds

are loaned and borrowed and through which a
large part of the financial transactions of a country
are cleared.

A segment of the financial market in which

financial instruments with high liquidity and very
short maturities are traded.
 MONEY MARKET

Money Market

Organized Market Unorganized Market

Call Money
Money lenders
Market

Commercial Bill Indigenous

Market bankers

Treasury Bill Unregulated

Market Intermediaries
ORGANISED MONEY STRUCTURE
PARTICIPANTS:

 Reserve bank of India.

 DFHI Ltd (discount and finance house of

India)

 Commercial banks:-
(i)Public sector banks
(ii)Private banks

 Development bank
-- IDBI, ICICI, NABARD, LIC, etc.
 COMPOSITION OF MONEY MARKET
Money Market consists of a number of sub-markets which
collectively constitute the money market. They are:

 Call Money Market:

• The call money market (CMM) the market where

overnight (one day) loans can be availed by banks to
meet liquidity.

•Lending and borrowing transactions are carried out for

one day that may or may not be renewed the next day.

•Demand comes from commercial banks that need to

meet requirements of CRR and SLR, whereas supply
comes from commercial banks with excess funds.
 The Treasury Bill Market:
•It deals in Treasury Bills of short term duration: 14 days,182
days, 91 days, and 364 days.

•It is a promissory notes or finance bill issued by Government.

•The treasury bills facilitate the financing of Central

Government temporary deficits.

•There are 2 types of treasury bills;

i. Ordinary / Regular treasury bills.: These ordinary bills
are sold to the general public or banks. They are freely
marketable. Their buyers are almost entirely commercial
banks.
ii. Ad hoc treasury bills.: Ad hoc means ‘for the particular
case’. This ad hoc treasury bills are issued for providing
investment outlets to state governments, semi-
governments for their temporary surpluses. They are not
sold to the general public.
 The Commercial Bill Market:
•Deals in bills of exchange, a seller draws a
bill of exchange on the buyer to make
payment within a certain period of time.

•The bills can be domestic bills or foreign

bills of exchange.

•The commercial bills are purchased and

discounted by commercial banks, and are
rediscounted by FIs like EXIM Bank, IDBI,
etc.
 UNORGANISED SECTOR

 Indigenous Banks

 Money lenders

 Unregulated Intermediaries
 INDEGENEOUS BANKS
Private firms that receive deposits and give loans and
thereby operate as banks

Like banks, they are also financial intermediaries. They

should be distinguished as professional money lenders
whose primary business is not banking but money
lending.

As activities are not regulated properly ,they are

unorganized segment

Broadly classified into 4 groups- GUJRATI SHROFFS,

MULTANI SHROFFS, CHETTIARS AND MARWARI
KAYAS
 MONEYLENDERS

Broadly classified into 3 categories:

 PROFESSIONAL MONEYLENDERS

 ITINERANT MONEYLENDERS

 NON PROFESSIONAL MONEYLENDERS

 UNREGULATED
INTERMEDIARIES

1. CHIT FUNDS- are saving institutions

2. NIDHIS- operate in unregulated credit

market and provide kind of mutual
benefit funds
Importance of Money Market:

1. Development of trade and Industry.

The money market, through commercial
papers, finances the short term working
capital requirements of trade and industries
and facilitates the development of industry
and trade – both national and international.

2. Development of Capital Market.

The short term rates of interests and
conditions that prevail in the money market
influence the long-term interest as well as the
resource mobilization in capital market.
 Importance of Money Market:

3. Smooth functioning of commercial banks.

The money market provides the commercial
banks with the facilities for temporarily
employing their surplus funds in easily
realizable assets. The commercial banks gain
immensely by economizing on their cash balance
and also enables commercial banks to meet their
statutory requirements of CRR and SLR by
utilizing the money market mechanism.
Importance of Money Market:

4. Effective Central Bank Control.

The money market facilitates effective
implementation of the monetary policy of a
central bank. The central bank, through
money market, pumps new money into the
economy in slump, and siphons it off in the
boom. The central bank, thus, regulates the
flow of money so as to promote economic
growth with stability.
Importance of Money Market:

5. Non-Inflationary source of finance to

government.
A developed market helps the government to
raise short term funds through the treasury
bills floated in the market. In the absence of a
developed money market, the government
would be forced to print and issue more money
or borrow from the central bank. Both ways
would lead to an increase on prices and the
consequent inflationary trend in the economy.
 CAPITAL MARKET

 The capital market is a market for financial assets

which have a long or indefinite maturity.

 The market where investment instruments like

bonds, equities and mortgages are traded is
known as the capital market.

 The primal role of this market is to make

investment from investors who have surplus funds
to the ones who are running a deficit.
 CAPITAL MARKET
Capital Market

Organized Market

Industrial Securities Govt. Securities

Long Term Loan
Market Market

Primary Market Primary Market

Secondary Market Secondary Market

 CAPITAL MARKET
 Capital market maybe further divided into;

 Industrial Securities market

 Government Securities
 Long-term loans Market
 INDUSTRIAL SECURITIES MARKET
• It is a market for industrial securities namely:
i. Equity shares or ordinary shares.
ii. Preference shares.
iii. Debentures or bonds.

• It is a market where securities issued by firms

can be bought and sold freely in the market.

• It consist of
 The new issues market
 The stock exchange
 THE NEW ISSUE MARKET
 It is related with issue of new securities. Hence it
is also called as Primary market.

 The public limited companies often raise funds

through primary market for setting up or
expanding their business.

 Following are the methods of raising capital in

the primary market:
i) Public issue
ii) Private Placement
iii) Right Issue
 THE STOCK EXCHANGE
 The stock exchange 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. Hence it is also called as
Secondary Market.

 The stock exchange market is a highly

organized market for the purchase and sale of
second-hand quoted or listed securities.
 Government Securities Market

• It is also called as Gilt-edged securities market

• Risk-free market.
• Government securities market consist of short
term and long term.
• Long – term securities are traded in capital
market. Whereas the short – term securities are
traded in money markets.
• The major participant in this market is the
commercial banks, because, they hold these
securities to satisfy their SLR requirements.
• Government Securities consist of;
• Primary market: where the initial issue of
securities happens.
• Secondary market: where the original investors
trades their holdings to others.

• There are 3 forms in which government securities are

held:
• Stock or Book Debt
• Promissory Notes
• Bearer Bonds
 LONG – TERM LOANS MARKET

• Development banks and commercial banks

play a significant role in the market by
supplying long-term loans to corporate
customers.

• It can be further classified into;

• Term loans market
• Mortgages market
• Financial guarantees market
ROLE OF CAPITAL MARKET IN INDIA’S
INDUSTRIAL GROWTH
• Financing Five Year Plans
• Mobilization of savings and acceleration of
capital formation.
• Promotion of industrial growth.
• Raising long-term capital.
• Ready and continuous market.
• Proper channelization of funds.
• Provision of a variety of services.
FACTORS CONTRIBUTING TO THE GROWTH
OF CAPITAL MARKET IN INDIA

• Establishment of development banks and

industrial financing institutions.
• Legislative measures.
• Growth of underwriting business.
• Growing public confidence.
• Increasing awareness of investment
opportunities.
• Mutual funds.
• Credit rating agencies.
 PROBLEMS OF THE INDIAN CAPITAL
MARKET : THE PRE-REFORM PHASE
EQUITY MARKET
• As of 1992, BSE was a monopoly, so it
had high cost of intermediation.
• “Open outcry”, brokers used to charge the
investors a much higher price.
• No price-time priority.
• Manipulative practices prevailed.
• Retail investors were dependent on sub-
brokers.
• Inefficiency of the exchange for the
below largest 100 stocks.

• Future-style settlement

• Order execution was unreliable and

costly.

• Share certificates were printed on paper.

 STRENGTHENING THE CAPITAL
MARKET: THE POST-REFORM PHASE
GOVERNMENT SECURITIES MARKET
 The auction system for the sale of
government of India medium and long-
term securities was introduced from June
3, 1992.
 The government of India set up the Securities
trading corporation of India.
 Scheme of 14-day intermediate treasury
bills was introduced.
 A system of primary dealers was
established in 1995.
 Market orientation to issues of government
securities paved the way for the RBI to
activate the open market operation as a
tool of market intervention.
 Improvement were brought in
transparency of operations and data
dissemination.
 A practise of pre-announcing a calendar of
treasury bills was introduced.
 Foreign institutional investors were
allowed to set up 100per cent debt funds
to invest in government securities.
 Retail trading in government securities
commenced in 2003.
SECURITIES AND EXCHANGE BOARD
OF INDIA (SEBI)
SEBI set up in 1988 was given statutory
recognition in 1992 on recommendations of
the Narasimham Committee.

The Aims of SEBI are:

 Regulating the business in stock market
and other security market.
 Registering and regulating the working
of stock brokers.
 Registering and regulating the working
of investment schemes.
The Aims of SEBI are:

 Promoting and regulating the self-

regulatory organizations.

 Prohibiting fraudulent and unfair trade

practices.

 Prohibiting insider trading.

 Regulating substantial acquisition of shares

and takeover of companies.
NATIONAL STOCK EXCHANGE OF INDIA

• NSE is a securities exchange set up in 1992.

• It is a limited liability company.
• The physical floor was replaced by
anonymous, computerized order-matching
with strict price-time priority.
• Satellite communication removed the
limitation of physical place.
• Transparency.
FOREIGN INSTITUTIONAL
INVESTMENTS
FOREIGN INSTITUTIONAL INVESTMENTS
(FII)
•A foreign institutional investor (FII) is an investor or investment fund
registered in a country outside of the one in which it is investing.

• Institutional investors most notably include insurance companies,

pension funds and mutual funds.

• FII is defined as an institution organized outside of India for the

purpose of making investments into the Indian securities market
under the regulations prescribed by SEBI.

• FII include “Overseas pension funds, mutual funds, investment trust,

asset management company, nominee company, bank, institutional
portfolio manager, university funds, endowments, foundations,
charitable trusts, charitable societies, a trustee or power of attorney
holder” incorporated or established outside India proposing to make
proprietary investments or investments on behalf of a broad-based
fund.
FII In
• The Union Government allowed the entry of FIIs in order
India
to encourage the capital market and attract foreign funds
to India.

• FIIs are permitted to invest in all securities traded on the

primary and secondary markets, including equity shares
and other securities listed or to be listed on the stock
exchanges.

• The overall investment for foreign institutional investors is

only 24% of the paid up capital of the Indian companies.

• In the case of public sectors the limit is 20% paid up

capital.
BENEFITS OF
FII
ENHANCED FLOWS OF EQUITY
CAPITAL
• FIIs are well known for a greater appetite for
equity than debt in their asset structure.

• Thus, opening up the economy to FIIs is in line

with the accepted preference for non-debt
creating foreign inflows over foreign debt.
IMPROVING CAPITAL
MARKETS
• FIIs as professional bodies of asset managers and
financial analyst’s, enhance competition and efficiency of
financial markets.

• Equity market development aids economic development

by increasing the availability of riskier long term capital
for projects.

• The increasing role of institutional investors has brought

both quantitative and qualitative developments in the
stock markets viz., expansion of securities business,
increased depth and breadth of the market.
IMPROVED CORPORATE
GOVERNANCE
• Good corporate governance is essential to
overcome the principal – agent problem between
shareholders and management.

• Bad corporate governance makes equity finance

a costly option.

• FIIs constitute professional bodies of asset

managers and financial analysts, who, by
contributing to better understanding of firms’
operations, improve corporate governance.
MANAGING UNCERTAINTY AND
CONTROLLING RISKS
• Institutional investors promote financial innovation
and development of hedging instruments.

• Institutions in general and FIIs in particular are

known to have good information and low
transaction costs. By aligning asset prices closer
to fundamentals, they stabilize markets.
KNOWLEDGE
FLOWS
• The activities of international institutional
investors help strengthen Indian finance.

• FIIs advocate modern ideas in market design,

promote innovation development of sophisticated
products such as financial derivatives, enhance
competition in financial intermediation, and lead
to spillovers of human capital by exposing Indian
participants to modern financial techniques, and
international best practices and systems.
IMPROVEMENTS TO MARKET
EFFICIENCY
• A significant presence of FIIs in India can improve
market efficiency. when adverse macro economic
news, such as bad monsoons, unsettles many
domestic investors, it may be easier for a globally
diversified portfolio manager to be more
dispassionate about India’s prospects and
engage in stabilizing trades.
DISADVANTAGES OF FII
• Problems of Inflation:
• Huge amounts of FII fund inflow into the country creates too much
of circulation of rupee, resulting in inflation.

• Problems for small investor:

• The FIIs will profit from investing in emerging financial stock
markets. If the cap on FII is high then they can bring in huge
amounts of funds in the country’s stock markets and thus have
great influence on the way the stock markets behaves, going up or
down.
• The FII buying pushes the stocks up and their selling shows the
stock market the downward path. This creates problems for the
small retail investor, whose fortunes get driven by the actions of
the large FIIs.
• Adverse impact on Exports:
• FII flows leading to appreciation of the currency may lead to the
exports industry becoming uncompetitive due to the appreciation of
the rupee.

• Hot Money:
• “Hot money” refers to funds that are controlled by investors who
actively seek short-term returns. These investors scan the
market for short-term, high interest rate investment
opportunities.
• “Hot money” can have economic and financial repercussions on
countries and banks. When money is injected into a country, the
exchange rate for the country gaining the money strengthens,
while the exchange rate for the country losing the money
weakens. If money is withdrawn on short notice, the banking
institution will experience a shortage of funds.
Portfolio Management Schemes (PMS) of
Indian Institutional Investors
•Portfolio management scheme popularly known as PMS
are specialized investment vehicle for lump sum investments.

•The portfolio manager invests the money in shares and other

securities and manages the portfolio on behalf of the client.

•Portfolio Management Schemes (PMS) are ideal for large

investments Rs 25 lakh or more and carry higher degree of
risk.
•Mutual funds are simpler. You can start investing via
systematic investment plans (SIP), with just Rs 500. Mutual
funds are ideal for new investors looking for relatively stable
returns over longer tenures.
PRIVATE EQUITY
&
HEDGE FUNDS
What Is Privat
Equity e
 Private equity consists of investors and funds that
make investments directly into private companies
or conduct buyouts of public companies that result
in a delisting of public equity.
 Capital for private equity is raised from retail and
institutional investors, and can be used to fund new
technologies, expand working capital within an
owned company, make acquisitions, or to
strengthen a balance sheet.
 Types Of Private Equity
 Private equity can be broadly defined to include the following
different forms of investment:

1. Leveraged Buyout: Leveraged buyout (LBO) refers

to the purchase of all or most of a company or a
business unit by using equity from a small group of
investors in combination with a significant amount of
debt.
2. Growth Capital :- refers to equity investments, in
relatively mature companies that are looking for capital
to expand or restructure operations, enter new markets or
finance a major acquisition without a change of control
of the business.
 3. Distressed funding

• Also known as vulture financing, in this type of funding,

money is invested in troubled companies with
underperforming business units or assets.

• The intention is to turn them around by making necessary

changes to their management or operations or make a sale
of their assets for a profit.
 4. Real Estate Private Equity

• Typical areas where funds are deployed are

commercial real estate and real estate investment
trusts.

• Real estate funds require higher minimum capital for

investment as compared to other funding categories in
private equity.

• Investor funds are also locked away for several years

at a time in this type of funding.
 5. Fund of funds
• As the name denotes, this type of funding primarily focuses
on investing in other funds, primarily mutual funds and
hedge funds.

• They offer a backdoor entry to an investor who cannot

afford minimum capital requirements in such funds.
 6. Venture capital
• Venture capital refers to equity investments made, typically
in less mature companies, for the launch of a seed or start-
up company, early stage development, or expansion of a
business.

• Venture investment is most often found in the application

of new technology, new marketing concepts.

• Many entrepreneurs do not have sufficient funds to finance

projects themselves, and they must therefore seek outside
financing.
• Venture capital is most suitable for businesses with large up-
front capital requirements which cannot be financed by
cheaper alternatives such as debt.
 Role And Importance Of private
•
Equity
They help in growth of the Economy
• Helps the companies for expanding to international
markets
• Life Boat for the companies who have unfortunately
come under hard times and need a turnaround
• Expertise to lead them on a new and sustainable
path.
• Greater expansion of business create more
employment.
 Hedge Funds

• Hedge fund is an alternative investment that is designed to

protect investment portfolios from market uncertainty, while
generating absolute returns.

• A hedge fund's purpose is to maximize investor returns and

eliminate risk.
 Hedge Funds

• Hedge fund is an alternative investment that is designed to

protect investment portfolios from market uncertainty, while
generating absolute returns.

• A hedge fund's purpose is to maximize investor returns and

eliminate risk.
 Hedge Funds…
• Like a mutual fund, a hedge fund makes pooled investments
in various securities that are anticipated to increase in value.

• However, a hedge fund differs from a mutual fund in two

key respects.
• First, unlike mutual funds, hedge funds "hedge" their investments by
also making "short" investments that increase in value when a given
security declines in value.

• Second, unlike mutual funds, which are highly regulated and open
to all investors, hedge funds are unregulated and are open only to
what are termed "accredited investors." Typically, such investors are
defined as institutions (e.g., pension funds, banks) and high-net-
worth individuals.
 Hedge Fund Strategies

1. Long/Short:

• Using both the strategies, Say 70% of the stocks are long
traded and 30% are short sold.

• Then the difference between the two is 40%.

• This is called as the net exposure to markets.

 Market Neutral
• The concept is to reduce the net exposure to markets to zero

• Removes any impact of market movements

• Fund manager relies solely on his or her ability to pick

stocks

• Reducing beta of overall fund to zero achieved by Equal

investment in long and short strategies
 Quantitative Hedge Funds
• Quantitative hedge fund managers often employ computer
programmers who comb the statistical models and data
looking to find alpha that hide behind market abnormalities.

• This can be exploited by super high-frequency trading

programs that can buy and sell thousands of stocks or futures
instantly.

• Unfortunately, they do not always anticipate market

commentary.
ADR & GDR
 DEPOSITORY RECEIPTS
• Depository receipts are instruments issued by international
depositories, and they represent an interest in the underlying
shares held by them in the issuer company (Indian Company).

• The shares are usually held by a domestic custodian on behalf

of the depositories in turn issue the depository receipts,
which entitle the holder of the receipts to get the underlying
shares on demand.
• DRs are traded on Stock Exchanges in the US,
Singapore, Luxembourg, London, etc.

• DRs listed and traded in US markets are known as

American Depository Receipts (ADRs) and those listed and
traded elsewhere are known as Global Depository Receipts
(GDRs).

• In Indian context, DRs are treated as FDI

 INTERNATIONAL CAPITAL
MARKET

INTERNATIONAL BOND INTERNATIONAL EQUITY

MARKET MARKET

EURO FOREIG
GDR ADR
N
BON BOND
D
AMERICAN DEPOSITORY RECEIPTS
(ADR)
• ADR is a dollar-denominated negotiable certificate.

• It represents a non-US company’s publicly traded equity.

• Each ADR represents a specific number of shares (one or

more) in a foreign corporation
 How did ADRs start?

• Due to complexities involved in buying shares in foreign

countries

• These complexities involved trading at different prices and

differing currency values

• So, US banks (acting as depositories) simply purchase a bulk

lot of shares from the foreign company

• This bulk lot is then bundled into groups and re-issued on

NYSE, NASDAQ and AMEX.
 ADVANTAGES OF ADR/GDR
• Can be listed on any of the overseas stock exchanges.

• Freely transferable by non-resident.

• Diversification - Investor gains the potential to capitalize

on emerging economies by investing in different countries.
GLOBAL DEPOSITORY RECEIPTS
(GDR)
• A bank certificate issued in more than one country for shares
in a foreign company.

• The shares are held by a foreign branch of an international

bank. The shares trade as domestic shares, but are offered for
sale globally through the various bank branches.
 DIFFERNCE BETWEEN ADR & GDR
ADR
American depository receipt
(ADR) is compulsory for non –
US companies to trade in stock
market of USA.
ADRs can get from level 1 to level
III.
ADR is only negotiable in USA .
Investors of USA can buy ADRs
from New York stock exchange
(NYSE) or NASDAQ
GDR
Global depository receipt (GDR) is
compulsory for foreign company to
access in any other country’s share
market for dealing in stock.
GDRs are already equal to high
preference receipt of level II and
level III.
GDR is negotiable instrument all
over the world
Investors of UK can buy GDRs from
London stock exchange and
Luxemburg stock exchange and
invest in Indian companies without
any extra responsibilities .
END OF
UNIT-1