Types of Financial Markets.pptx

8/10/2019 Types of Financial Markets.pptx

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Types of Financial Markets


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DEBT MARKET


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Role

Efficient Mobilization and Allocation ofResources

Financing the Development Activities of the

Govt Transmitting Signals for implementation of

Monetary Policy

Facilitating Liquidity Management

Pricing of non-govt securities in financialmarkets


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Regulator

Broadly,

Govt securities and Money Market- RBI

Corporate Debt Market- SEBI

Both NSE and BSE have started debt market

segment


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Participants in Debt Market

Central and State Govts

Primary Dealers

PSUs

Corporates

Banks

Mutual Funds

Insurance Companies

FIIs Provident and Pension Funds

Charitable Institutions and Trusts


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Primary and Secondary market

Primary market

Issues through public prospectus, rights issue or

pvt placement

Secondary market

Trading on OTCEI, BSE and NSE

Negotiated Dealing System- RBI-operated

electronic trading system, facilitates exchange ofgovernment securities and other money market

instruments


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Debt Market

Private Corporate debt Market

Public Sector Undertaking Bond Markets

Government Securities Market


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Private Corporate Debt Market

Role

Provides LT capital

Supplements banking system

Reduces cost of capital

Fosters market discipline and credit culture

Enables investors to hold diversified portfolio

Enables better asset-liability management forbanks and corporates


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Private Corporate Debt Market

Problems:

Needs market makers like primary dealers in govt securitiesmarket

Provident funds etc. being risk-averse have kept away from

private sector bonds Small investor base who only invest on highly rated

corporate debt

Banks prefer to lend to corporates than subscribe to theircorporate issues

Few firms willing to underwrite issues given low investordemand

Lack of investor awareness about advantages of investing inrated debt rather then unrated deposits


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PSU Bond Market

Started in 1980s when central govt stopped

funding through general budget

Mostly privately placed with banks or private

investors

Bonds can be of 2 types

Taxable (after govt. approval)

Non-taxable


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Govt Securities Market

Govt securities are referred to as SLR securities or

Gilt-edged securities

Significance

Principal segment of debt market

Acts as benchmark for providing debt securities

Plays crucial role in monetary policy transmission

Facilitates govt borrowing at reasonable cost


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Govt Securities Market

Largest players are banks, FIs, insurance

companies, primary dealers and mutual funds

Standard lots of trade- Rs.1 cr

Trade done through Subsidiary General ledger

(SGL)


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MONEY MARKET


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Money Market

Market for overnight to short-term funds that

have maturity of less than one year

Not a physical market, but conducted over

telephone


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Characteristics

Collection of markets for several instruments

Wholesale market

Demand and supply of money shape themarket

Creditworthiness of participants important

Main Players- RBI, SBI DFHI, MFs, InsuranceCos, Banks, NBFCs, PFs, Primary Dealers, STCI,

Corporate Investors etc.


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Functions

1. Balancing Mechanism to even out demand for andsupply of short-term funds

Development of non-bank intermediaries

Wide array of savings instruments

2. Focal point for central bank intervention forinfluencing liquidity and interest rates

3. Access to short-term funds to meet borrowing andinvestment requirements at efficient market clearingprice

Stable Source of funds to banks to manage risk

4. Facilitates development of market for longer-termsecurities


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RBI

Most important constituent because market

comes under direct purview of its regulations

Role

Liquidity and interest rates maintained at

certain levels

Ensure adequate flow of credit

Bring order in forex market


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Steps to Develop MM in India

Till 80s characterized by lack of depth, small no.of instruments and strict regulation on interestrates

In the 1980s DFHI was set up in 1988

182-day T-bill, Certificates of Deposit,Commercial Paper introduced

Interest rate ceiling on call money, interbank termmoney etc. was freed in stages from 1988


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Steps to Develop MM in India

In the 1990s

STCI was setup to provide active secondary market

Barriers to entry into money markets were eased

Setting up of primary and satellite dealers

Relaxing issuance restrictions

Increasing no. of participants by allowing entry of FIIs, MFs and

NBFCs

Financial innovation in instruments and methods eg. T-bills of

varying maturities, Repos, Interest rate swaps, LAF, forward rateagreements, Collateralized Borrowing and Lending Operations etc.

Negotiated Dealing System and Clearing Corporation of India were

introduced to strengthen payment system infrastructure


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Money Market Instruments

Treasury Bills

Call/ Notice Money

Commercial Paper Certificate of Deposit

Commercial Bills

Collateralized Borrowing and LendingObligation


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T-BILLS


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Purpose

ST instruments used by RBI to raise to raise ST

funds on behalf of govt

Required to bridge seasonal or temporary

gaps

Repaid at par on maturity


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Features

Negotiable Securities

Highly liquid, included in SLR securities

No default risk Purchase and Sale through Subsidiary General

Ledger account and not in form of scrip

Minimum investment amount of Rs.25,000and multiples


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Types

On tap Bills Bought from RBI anytime at fixed yield

Discontinued from April97

Ad hoc Bills Whenever cash balance of govt fell below certain

amount replenishment by creation of ad hoc bills

Automatic monetization of govtsbudget deficit

In 70s and 80s ad hocs were converted into long-term

securities (funding) Discontinued from April97

System of Ways and Means Advances was introduced


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Types

Auctioned T-Bills

Most active MM instrument

Introduced in April92

RBI receives bids in auction and issues subject to

cut-offs

Yield is thus market determined

3 maturities available on T-bills currently- 91, 182and 364 days


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Sale of T-Bills

Through auction which helps in price discovery

and determines cut-off yield

Competitive Bid

Bids submitted to RBI determine allotment

Participants- Banks, corporates, primary dealers, MFs

Non-competitive Bid

Allotment at weighted average price determined incompetitive bidding

Participants- State Govts, Non-govt PFs etc


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Types of Auctions

1. Multiple Price Auction

Each winning bidder pays the price it bid

2. Uniform Price Auction

Each winning bidder pays uniform price decided

by RBI

Introduced in Nov98 for 91-day T-bills


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Types

91-day

364-day

182-day 14-day- discontinued


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COMMERCIAL PAPER


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Commercial Paper

Unsecured short term, promissory note issuedat a discount for a fixed maturity period

Issued by creditworthy corporates, primary

dealers and all-India financial institutions tomeet their working capital requirements

Finance paper

Industrial paper

Corporate paper

Introduced by RBI in Jan 1990


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Issue of CP

Issued to

Individuals, banks, companies etc

NRIs on non-transferable basis

FIIs within set limits

Usually privately placed with investors, eitherthrough banks or merchant bankers

Discount is freely determined by market forces No RBI approval required and no underwriting

to be done


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Resolution

Passed by Board of Directors

Relevant documents executed as required by RBI

IssueRating

By credit rating agency in2-3 weeks

IPA

Issuing and Paying Agent is selected

Verifies all documents

Dealers

Merchant bankers, brokers, and banks can be dealers

Have to complete placement within 2 weeks of opening


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Guidelines for Issuance

Eligibility for Issue

For corporates minimum net worth of Rs.4 crore and

sanctioned working capital limit from bank

Rating Minimum credit rating of P2 by CRISIL and equivalent

Maturity

Revised from 3-6 months to 7days-1 year

Denomination

Multiples of Rs.5 lakh and thereof


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Limits Can be issued as standalone product

Banks, FIs can fix working capital limits according to resourcepattern

Issuing and Paying Agent Scheduled commercial banks

Verifies and holds custody of all important documents

Issues IPA certificate to all subscribers and reports issue

Mode of Issuance

Demat mode or promissory note Every issue, including renewal is a fresh issue

Standby Facility Not obligatory for banks to provide standby facility


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Secondary Market

Very little activity till some years back

Now developing, active players are

Foreign and pvt sector banks, mutual funds


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Factors Inhibiting Growth

Retail investors have not invested even thoughminimum investment size is Rs.5 lakh

Non-bank institutional investors (LIC etc) have RBIdirectives limiting ST investments to T-bills

No active secondary market for CPs Stamp duty differential for banks and non-bank

institutions for subscribing to a CP

CP issues involve complex administrative and

procedural formalities Corporates could borrow at sub-PLR rates from banks

making CPs unattractive


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COMMERCIAL BILLS


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Commercial Bills

Bills of exchange are negotiable instrumentsdrawn by seller (drawer) on buyer (drawee) forvalue of goods delivered, also called trade bills

When trade bills are accepted by commercialbanks for discounting, they are called commercialbills

Banks initially provide credit by discounting bills

Traded by offering bills for rediscounting Hence, CBs are short term, negotiable, self-

liquidating instrument with low risk


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Types of T-Bills

1. Demand or Usance Bill

2. Clean or Documentary Bill

3. Inland or Foreign Bill

4. Hundi


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CB Rediscounting

To facilitate multiple rediscounting RBI

introduced Derivative Usance Promissory

Notes

Backed by CBs for usance upto 90 days

No stamp duty on rediscounting

For rediscounting bill should arise out of a genuine

commercial transaction


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Measures to Develop CB Market

Setting up DFHI RBI sanctioned limit for discounting

Interest rate ceiling of 12.5% on rediscountingwas withdrawn in 1989

During 1995-97, various mutual funds andprimary dealers were allowed to participate inthe rediscounting market as borrowers andlenders

RBI advised banks in 1997 that at least 25% ofinland credit purchases of borrowers be throughbills


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Reasons for Underdevelopment

Though a refinance facility is available to the DFHI, itconcentrates more on other instruments like call moneyand treasury bills

Funds under bill rediscounting scheme were put on adiscretionary basis in beginning of 1980s and stopped later

Mostly foreign trade is financed through the bills market;share of foreign trade in national income of India is small

Large part of bills discounted are not genuine; created byconverting CC or overdraft accounts of customers

System of CC and overdraft is often cheaper and moreconvenient than complex procedures for rediscounting

Declining popularity of Hundi as a credit instrument


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CERTIFICATE OF DEPOSIT


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Certificate of Deposit

Unsecured, negotiable, short-term instruments

Issued by commercial banks and financial

institutions at discount to face value

No ceiling on amounts raised by banks

FIs can issue within umbrella limit set by RBI

Similar to time deposits (FDs), but being in bearer

form, are transferable and tradable Issued to individuals, companies, NRIs, trusts,

funds etc.


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Certificate of Deposit

Issued during periods of tight liquidity, at highinterest rates

Can also be issued at floating interest rates

In 1992, IDBI, IFCI, SIDBI, IRBI, EXIM Bank werealso allowed to issue CDs

From 1993, limits on amount and interest rate

ceilings were removed from CDs Issued by banks on a discretionary basis to

high net-worth clients


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Minimum Size of Issue

Minimum amount- Rs.1 lakh and multiples

Maturity

7 days- 1 year (for banks)

1 year- 3 years (for FIs)

Discount Rate

Interest rate is freely determined

Can also be at floating interest rate, given thatmethodology for calculation is objective, transparentand market-based


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Reserve Requirements

CRR and SLR have to be maintained on the issue price

of CDs

Loans/ Buy backs Banks cant give loans against CDs nor buy them back

Format

Can only be issued in demat form Investors though can seek a physical certificate

Issue of CDs attracts stamp duties


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Secondary Market

Has been dormant

Investors usually hold these high yielding

instruments till maturity

2-way quotations are also offered by DFHI


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Factors inhibiting growth of CDs

CDs form only 2% of the aggregate deposits of

banks

Interest rates are high and CDs are not listed

Secondary market has not developed

No facility for lending by banks against CDs

nor can they be bought back

High minimum investment amount


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CALL/ NOTICE MONEY MARKET


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Meaning

Call Money- Funds transacted on an overnightbasis

Notice Money- Funds borrowed/lent for a

period from 2-14 days Banks funds are transacted and no collateral

required

Accounts for major part of total turnover ofmoney market

Is extremely volatile


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Participants

In 1971 UTI, LIC were allowed to participate In 1990s, DFHI, STCI, GIC, NABARD, IDBI, money

market MFs, corporates etc were allowed aslenders

In 1996 primary dealers were allowed as lendersand borrowers

From 2005, it is a pure inter-bank money market Eligible participants are only banks and primary

dealers

Minimum size of transactions reduced to Rs.3crore


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Reporting

Mandatory reporting of transactions within 15

minutes on NDS

Screen based quote driven system for dealings

in call/ notice money market called NDS-CALL

was launched in Sep 2006

NDS-CALL accounts for >75% of total call-

notice transactions


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Purpose

Developed because of inter-bank borrowing to

maintain minimum cash balances (CRR)

Banks thus trade positions to maintain

reserves

It is an OTC market without intermediation of

brokers


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Call Rate

It is the interest rate paid on call loans Presently freely determined by market forces

Reference rate in overall call money market hasnow emerged through NSE and Reuters NSE launched MIBOR and MIBID; based on

representative panel of 31 banks/ primary dealers

Quotes processed daily for overnight, 14 day, 1month, and 24 month rates

Reuters MIBOR (Mumbai Interbank OvernightAverage) based on weighted average of rates of 22banks/ institutions


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Link between Call and other Rates

Call Rate and Rate on CD

Call Rate and issue of G-secs

Call Rate and rise in CRR

Call Rate and decline in repo rate


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Factors influencing Call Rates

Liquidity conditions

Supply and demand for money governed by

deposit mobilisation, govt borrowings program,

credit offtake etc

Reserve Requirement

CRR rates

Liquidity Changes in forex markets Funding of foreign currency purchases


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Measures for Curbing Excess Volatility

Through Repos Repos and reverse repos to provide reasonable floor

to call rates and inject or remove liquidity from system

Freeing Inter-bank liabilities from ReserveRequirements

To generate smooth yield curve and reduce call ratevolatility

Size of call money market Increase in no. of players owing to reform measures

Growth in primary dealers activities


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Term Money

Maturity ranging from 3 months-1 yr

Turnover is little since low participation from

banks or other large players

RBI allowed IDBI, IFCI, NABARD, SIDBI, EXIM Banketc. to borrow from term money market

Banks were exempted from maintenance of CRR

and SLR on inter-bank liabilities in this market Despite of these measures the market is shallow


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FOREX MARKET


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Forex Market

Oldest, biggest, most extensive, fastestgrowing and most liquid market in the world

Electronically linked network of big banks,

forex dealers Leading financial centers for foreign exchange

are London, Paris, Zurich, Tokyo, Frankfurt etc.

Trading is done 24 hrs a day by telephones,display monitors, satellite communicationnetwork called SWIFT etc


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Structure

ForexMarket

Retail Wholesale

Inter-bankCentral

Bank


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Structure

Retail Travelers, tourists and people who are in need of

foreign currency carry out small permittedtransactions

Wholesale

Interbank- Major banks deal directly

Small banks have a credit line with the largest

banks Market operates from major centres- Mumbai,

Delhi, Kolkatta, Chennai, Bangalore etc


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Players

Authorized Dealers

Mostly banks who are authorized to deal in forex

Forex brokers

Act as intermediaries between ADs and customers

Customers- Individuals, corporates etc

Need forex for their transactions

Central Bank

Intervenes to influence currency rates


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Forex Trading

Spot Exchange Rate Current exchange rate for immediate delivery of

foreign exchange

Dealers continuously offer bid-ask rates eg. INR/USD

48.50 bid / 48.75 ask In interbank market, funds are received 2 working

days after the transaction

Forward Rates

Contracts available for 1-12 months delivery To cover risks faced by parties


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FEM Trading Platform

FX CLEAR by CCIL- Most widely used

FX Direct by IBS Forex Ltd

D2 Platform and Reuters Market Data System

by Reuters

Above platforms provide transactions in major

currencies like USD/INR, EUR/USD, USD/JPY,

GBP/USD etc.


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Deficiencies in Indian FEM

Dominated by merchant flows and not financiallydriven

Forward rates reflect demand supply conditions

rather than interest rate differentials Not integrated with the money markets

Cross currency market has not developed

Free access to hedging products like swaps,

forward rate agreements, currency futures andoptions is not available


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Efficiency of FEM

Determined by the bid-ask spread 3 sources of the spread

Order processing costs

Inventory holding costs

Information costs of market making

Low and stable bid-ask spread indicates marketefficiency with low volatility, high liquidity andless information asymmetry

Spreads in Indian FEM have declined over theyears


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Role of RBI

Regulating transactions and facilitatingdevelopment

Managing foreign currency assets and gold

reserves of the country Ensuring smooth conduct in domestic foreign

exchange market

Thus deals on its own account and on behalf ofgovt. through authorized dealers


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RBI Intervention

To manage volatility

International capital movements increased

significantly over recent years

To protect currency form speculative attacks

To maintain export competitiveness

To influence trend movements if long-run

equilibrium values are perceived to bedifferent from actual values


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RBI Intervention

Sterilised Intervention Purchase or sale of foreign currency is offset by

corresponding sale or purchase of govt debt toeliminate effects on domestic money supply

Non-sterilised Intervention

Purchase or sale of currency without the offsettingeffects

Since 1993, RBIs policy is that of passiveinterventions, only to keep REER stable


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Exchange Rates

Managed Float System- followed by India

Modified Liberalised Exchange Rate

Management System (LERMS)

Earlier- Single Currency Peg, then Basket Peg,

the LERMS Dual rates in 1991, then Modified

LERMS with unified rate in 1993


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Types of Exchange Rates

NER (Nominal ER)

RER (Real ER)

Adjusted for inflation; indicates real purchasing

power of one currency relative to other NEER (Nominal Effective ER)

Is multilateral and not bilateral

Reflects weighted average against other majorcurrencies

REER (Real Effective ER)


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Currency Convertibility

Currency convertibility, refers to the ease with whichdomestic currency can be traded for foreign currency,for a particular usage and at a given exchange rate. Current account convertibility allows residents to make

and receive trade-related payments, i.e. receive foreign

currency for export of goods and services and pay foreigncurrency for import of goods and services like travels,medical treatment and studies abroad.

Capital account convertibility allows freedom to makeinvestment in foreign equity, extend loans to foreigners,

buy real estate in foreign lands and vice versa. India has full current account and partial capital

account convertibility


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PRIMARY MARKET


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Primary Market

Market for new issues

Methods- New Issue through Prospectus,

Rights Issue, Bonus Issue

Other Methods to raise capital- Offer for sale

and Private Placement

Participants- Issuers, investors and

Intermediaries (MB, Registrar, Bankers etc)


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Issue Pricing

Earlier fixed prices by Controller of Capital

Issues

Now Book Building- Demand and investor bids

determine price

k


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Primary Market

Online IPOs

GDR, ADR and IDR

ECB and FCCB

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Primary Market

k C


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Money Market Concepts

Open Market Operations

OMOs conducted by RBI involve sale/purchase of Government securities to/ from

the market Objective- to adjust the rupee liquidity

conditions

Excess liquidity (sell securities) and tightliquidity (buy securities)

M M k C


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Liquidity Adjustment Facility Tool for day-to-day liquidity management through repo

(8%) and reverse repo (7%) operations

Narsimham Committee on Banking sector reforms;

Interim LAF introduced in 1991

RBI moved from discriminatory price auctions to dailyfixed rate repo auction system in 1997

Repo/reverse repo auctions conducted everydayexcept Saturdays

LAF is different from market repos

M M k C


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Market Stabilization Scheme MoU between GoI and RBI in 2004

For issuance of G-secs with maturity less than 2 yrs andT-bills

Purpose: To absorb surplus liquidity arising out of significant forex

inflows

Reducing the burden of sterilisation on LAF window andOMOs

Proceeds from MSS go into a separate account of RBI Ceiling for outstanding balance under MSS has been

fixed at Rs.50,000 crore by RBI for 2012-13

M M k C


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Collateralized Borrowing and Lending Obligation Introduced in 2003 by CCIL to provide liquidity to non-bank

entities who have restrictions on access to call money market

Discounted instrument available in maturities from 1-90days

Membership to the CBLO segment is for RBI- NDS members(Banks, FIs, Insurance Companies, MFs, Primary Dealers, etc.

Non-NDS members can get associate membership

Members can borrow or lend funds against the collateral ofeligible securities. (Central Government securities includingTreasury Bills, other specified securities)

CCIL fixes borrowing limits on deposited securities, matchesorders and notifies members

M M k t C t


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Marginal Standing Facility

Introduced by RBI in 2011-12, under which

banks could borrow funds from RBI up to 1%

of their net demand and time liabilities

The MSF rate is pegged 100 basis points above

the repo rate.


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Documents

Types of Financial Markets.pptx