

 A financial market is a market where financial

instruments are exchanged or traded.
 They are centers or arrangements that provide facilities
for buying and selling of financial claims (assets) and
services.
 They perform an important function of mobilization of
savings and channelizing them into the most productive
uses.
 Financial markets exists wherever financial transaction
takes place. There is no specific location or place to
indicate a financial market.
 
 They act has a link between different groups. It facilitates
this function by acting as an intermediary between the
borrowers and lenders of money.
 It consists of individual investors, financial institutions
and other intermediaries who are linked by formal
trading rules and communication network for trading the
various financial assets and credit instruments.
 Definition

 Financial Markets may be defined as a transmission
between investors and the borrowers through which
transfer of funds is facilitated.
 A financial market is a location where buyers and
sellers meet to exchange goods and services at prices
determined by the forces of supply and demand.
Participants of Financial Markets

 Public Investors
 Brokers
 Dealers
 Credit Rating Agencies
 Banking & Non Banking Institutions
 Foreign Institutional Investors
 Important Functions of
Financial Markets

1. Price Discovery
2. Liquidity
3. Reduction of transaction costs
4. Borrowing and Lending
5. Information Aggregation & Coordination
6. Risk Sharing
 Role of Financial
Markets

1. Promoting economic growth
2. Enhancing efficiency
3. Mobilizing domestic savings
4. Acts as a buffer against economic disturbances
5. Improve competition
6. Development of financial structure
Classification of Financial Markets

 There are different ways to classify Financial Markets
Internal Market is also called the National Market
or Domestic Market. It is where issuers domiciled in
the company issue securities and where those securities
are subsequently traded.
External Market is also called as Foreign Market
(International Market). It is where securities are sold
and traded outside the country of issuers
 It can also be classified on the basis of kinds of
instruments or products traded.

 Unorganised Financial Markets are from the times
when India did not have well developed financial system.
 This segment of the market is generally outside he preview of
the central regulators such as RBI and SEBI.
 This segment of the markets consists of money lenders, chit
funds and other constituents.
 A few chit funds are subject to state government regulation
for chit companies.
 The unorganised segment has slowly declined over the years
as formal means of finance have made greater in roads into
the Indian Economy.
 
Organised Financial Markets : It is that market
where there are a number of standardised rules and
regulations set up for dealing insecurities.
 This market is under supervision and control of SEBI,
RBI, IRDA and other regulatory bodies.
 
 Financial Markets are further divided into 4 areas
Capital Markets, Money Markets, Currency Markets
and Commodity Market.
Capital Market : It is a market that deals in
medium and long-term funds. It is an institutional
arrangement for borrowing medium and long-term
funds issued by corporations and government. Long
term refers to financial instruments having a
maturity of more than one year.
 
 Money Market : The money market is a market for short-
term funds, which deals in financial assets whose period of
maturity is one year or less at the time of issuance. These are
mainly wholesale markets. Commercial banks and cooperative
banks dominate the organised sector of the money market.
 Commodity Market : It is the market where a wide range of
products / commodities like precious metals, base metals, crude
oil, energy, palm oil, tea, coffee, gold etc. are traded.
 Currency Market : It is also called as Foreign Exchange
Market. A foreign exchange market refers to buying foreign
currencies with domestic currencies and selling foreign
currencies for domestic currencies.
 
 On the basis on the type of trading it can be further divided into
Primary Market and Secondary Market (under Capital Market)
 Primary Market : It is a market where new securities are
bought and sold for the first time. It is also called as New Issue
Market or the IPO market. This market arranges new capital for
corporate enterprises by attracting new investible resources
from the public and allocates it among alternative projects.
 Secondary Market : It is a market in which an investor
purchases a security from another investor rather then the
issuer , subsequent to the original issuance in the primary
market. The secondary market known as Stock Market Or Stock
Exchange. Here trading takes place between investors. It is
further classified into organised stock exchanges and OTC (over
the counter) markets.
 
Gilt Edged Market : It is the market in government securities
or securities guaranteed by the government.
 Govt securities include securities of the GOI and of the state
government. They are issued by local authorities like corporations,
municipalities, port trusts, state electricity boards etc.
 The term gilt-edged means ‘of the best quality”. They are highly
liquid and do not suffer from the risk of default.
 Depending upon the expiry date, they are divided into short term
and long term securities.
 Short term government securities are Treasury bills. They have a
maturity of less than one year. There are three main treasury bills
in India – 91 day, 182 day and 364 day.
 Long term government securities are known as Government
Bonds Or Dated Securities. They have a maturity period of five
years, ten years, fifteen years etc.
 
Debt Market : It is a market meant for trading (i.e.
buying or selling) fixed income instruments. Fixed income
instruments could be securities issued by Central and State
Governments, Municipal Corporations, Govt. Bodies or by
private entities like financial institutions, banks,
corporates, etc.
 Debt instruments represent contracts whereby one party
lends money to another for a fixed term and are
redeemable by the issuer at the end of that term with
interest.
 Debt market is also called Fixed Income Market.
Instruments traded in Debt Market

 
Equity Market : Financial markets in which equity
instruments are traded are known as equity market.
 This market is also referred as the Stock Market.
 Two types of securities are traded in an equity market
namely equity shares and preference shares.
 An important distinction between these two forms of
equity securities lies in the degree to which they may
participate in any distribution of earnings and capital and
the priority given to each in the distribution of earnings.
 
 Financial Markets can be classified in terms of :
Cash Market : it is also referred to as the Spot Market. It is
the market for the immediate purchase and sale of financial
instruments. Spot Markets are markets in which assets are
bought and sold for ‘on the spot’.
Futures Market : A contract holder has either the
obligation or the choice to buy or sell another something at
or by some future date is referred as Futures Market. Here
the participants agree today to buy or sell assets at some
future date. Ex ….
 
 A farmer may enter into a futures contract in which
he agrees today to sell 5000 tonnes of soybean 6
months from now at a price of Rs 500 a tonne . On
the other side an international food producer looking
to buy soybeans in the future may enter into a
futures contract in which it agrees to buy soybeans 6
from now.
 
Derivative Market : The something that is the subject
of the contract is called the Underlying Assets.
 The underlying asset can be a stock , bond, currency or a
commodity.
 But the prices of such contracts derive their value from
the value of the underlying assets, these contracts are
called Derivative Instruments and the market where they
are traded is called Derivative Market.
Constituents of Financial Markets
Segment
Capital Mkt
(Equity)
Instruments
Shares,
Warrants,
SEBI 
Regulator Issuers
Public Ltd
Companies
Investors
Retail
Investors,
Equity and HNIs,
Derivatives Corporates,
Intermediaries
Capital Mkt G Sec, T Bill, RBI Central & RBI, DFI,
(Debt- G Sec) State Govt Sec State govt Banks
Capital Mkt Debentures, SEBI RBI, DFI, Corporates,
(Debt- Banks, Banks, FII
Corporate ) Instruments, Corporates
Derivatives
Money Mkt T Bills, CDs, RBI Central & Banks,
Commercial state Govt, Corporates
Bills, MM Banks,
Derivatives Corporates
Segment Instruments 
Regulator Issuers Investors
Currency Mkt Currencies, SEBI Banks, Govt, banks,
currency Corporates, Corporates
derivatives Consumers ( consumers &
exporters & Travelers
travelers)
Commodity Agricultural, FMC Commercial Commercial
Mkt Metals, producers & producers and
Commodity traders consumers
Derivatives traders.

Money Market

 
 Money Market is a mechanism that deals with the lending and
borrowing of short term funds.
 It is a centre in which financial institutions join together for the
purpose of dealing in financial or monetary assets, which are of
short term maturity.
 Money market is a market for short term financial assets that are
close substitute of money.
 Close substitute of money denotes any financial asset, which can
be quickly converted into money with the minimum transaction
cost and without a loss.
 In short money market is a market where money is bought and
sold.
 The short term debt and securities sold in the money market are
also known as Money market instruments and have a maturity
ranging from one day to one year and are extremely liquid.
Features of Money Market

1. Money Market specializes in very short term debt securities.
2. Money market deals with securities which are highly liquid.
3. It deals with securities which are readily transferable.
4. Most of the transactions in money market have a maturity
period of overnight to one week.
5. It is a heterogeneous market with several sub markets. Each sub
market deals with specific short term credit instruments.
6. It is wholesale market.
7. The role of individuals in money market is not significant.
8. Money market does not refer to any specific place where
borrowers and lenders meet each other.
9.

Borrowing and lending in money market is in high volume.
10. Due to high volumes, transaction cost is high.
11. Money Market securities offer lower rate of returns than
most other securities.
12. The risk of investment is very low.
13. Money market is a dealers market i.e. securities are bought
and sold in their own account.
14. Money market is regulated by RBI.
15. Money Markets are generally associated with important
places. In India it is located in major cities like Delhi,
Mumbai, Chennai, Kolkata etc.
Functions of Money Market

1. Development of Trade & Industry
2. Development of Capital Market
3. Formulation of suitable Monetary Policy
4. Helpful to the Government
5. Helpful to Commercial Banks
Development of Trade & Industry

 Trade and Industry are the key factors which lead to the
economic development of a country They ensure production
of goods, availability of services, generation of employment
to the human resources, earnings in foreign currencies
among various advantages to the financial system.
 At such a time money market plays a crucial role of making
liquidity available at the requisite time to the corporate for
the smooth conduct of the business.
 Trade financing as well as working capital requirements of
the business are duly met of through money market. Thereby
the money market facilities both the trade and the industry
ultimately resulting in the development of the country.
Development of Capital Market

 The money market rates provides an opportunity to the
RBI to influence the volume and the cost of liquidity on a
short term basis.
 Changes in the short term policy rate provide signals to
financial markets, whereby different segments of the
financial system respond by adjusting their rates of return
on various instruments. This in turn affects the long term
interest rates as well as pattern of financing for the
business.
 This may require firms to change their proportion of debt
or equity depending on the financing cost i.e. the cost of
capital. Thus leading to the development of the capital
market.
Formulation of Suitable Monetary Policy

 Monetary policy is the adjustment of the supply of money
in the economy to achieve some combination of inflation
and output stabilization.
 The money market indicates the central bank and the
government the true state of the economy thru the
prevailing short term interest rates.
 Based on these inputs a suitable and sufficient monetary
policy is then framed by the RBI.
 Helpful to the Government

 A developed money market helps the government to
raise short term funds thru the Treasury Bill floated in
the market.
 In the absence of a developed money market, the
government would be forced to issue more currency
notes or borrow from the central bank.
 This will raise the money supply over and above the
needs of the economy and the general price level will
go up.
 In short , money market is a device to the government
to balance its cash inflows and outflows.
 Helpful to Commercial Banks

 Money Markets helps commercial banks for investing
their surplus funds in easily realisable assets.
 The banks get back the funds quickly in times of need.
 This facility is provided by money market.
 Further the money market enables commercial banks to
meet the statutory requirements of CRR and SLR.
 In short, money market provides a stable source of funds
in addition to deposits.
 Organised &
Unorganised Money
Market

 Organised Sector

 The sector is one which has proper rules , regulations
and guidelines mentioned as well as followed by all
the participants or the stakeholders is the organised
sector.
 The government of India thru the RBI regulates the
organised sector of the money market.
 Unorganized Sector

 The economy on one hand performs thru organised
sector and on the other hand in rural areas there is
continuance of unorganised, informal and
indigenous sector.
 The unorganised money market mostly finances
short term financial needs of farmers and small
businessmen. The main constituents of unorganised
money market are : Indigenous Bankers,
Money Lenders, Chit Funds, Nidhi’s.
 1. Indigenous Bankers (IBs)

Indigenous bankers are individuals or private firms who
receive deposits and give loans and thereby operate as
banks.
IBs accept deposits as well as lend money. They mostly
operate in urban areas, especially in western and
southern regions of the country.
The volume of their credit operations is however not
known. Further their lending operations are completely
unsupervised and unregulated.
Over the years, the significance of IBs has declined due to
growing organised banking sector.
 2. Money Lenders (MLs)

 They are those whose primary business is money lending.
 Money lending in India is very popular both in urban and
rural areas.
 Interest rates are generally high. Large amount of loans are
given for unproductive purposes.
 The operations of money lenders are prompt, informal and
flexible.
 The borrowers are mostly poor farmers, artisans, petty
traders and manual workers.
 Over the years the role of money lenders has declined due to
the growing importance of organised banking sector.
 Chit Funds

 Chit funds are savings institutions.
 It has regular members who make periodic
subscriptions to the fund.
 The beneficiary may be selected by drawing of lots.
 Chit fund is more popular in Kerala and Tamil
Nadu.
 RBI has no control over the lending activities of chit
funds.
 Nidhi’s :

 Nidhi’s operate as a kind of mutual benefit for their
members only.
 The loans are given to members at a reasonable rate
of interest.
 Nidhi’s operate particularly in South India
Loan or Finance Companies

 Loan companies are found in all parts of the country.
Their total capital consists of borrowing, deposits
and owned funds .
 They give loans to retailers, wholesalers, artisans and
self employed persons.
 They offer a high rate of interest along with other
incentives to attract deposits.
 They charge high rate of interest varying from 36%
to 48%p.a.
 
Money
Market
Instruments
 Call / Notice Money

 It forms an important segment of the Indian Money
Market.
 It is the money borrowed or lent on demand for a very
short period.
 It is a market where short term surplus funds of
commercial banks & other institutions are traded.
 The maturities of these loans varies between 1 day to 2
weeks.
 
 Call money is required mostly by banks . Commercial
banks borrow money without any collateral from other
banks to maintain a minimum cash balance known as
CRR.
 This interbank borrowing is led to the development of call
money market.
 Under call money market funds are transacted on
overnight basis. Since the participants are only banks. It is
called Inter Bank Money Market.
 RBI has converted the call money market completely into
an Inter Bank Market. Hence Non Banks entities are not
allowed to access this market for their short term liquidity
requirements.
 
Notice Money Market funds are transacted for 2
days and 14 days period. The lender issues a notice
to the borrower 2 to 3 days before the funds are to be
paid. On receipt of the notice the borrower has to
repay the funds.
 The participants in this market are commercial
banks, cooperative banks, foreign banks, non
banking financial institutions like LIC, GIC, UTI,
NABARD etc.
 
 Call Money : When money is borrowed or lent for a
day, it is called Call Money (overnight) intervening
holidays or Sundays are excluded for this purpose.
Thus money borrowed on a day & repaid on next
working day is called Call Money.
 Notice Money : When money is borrowed or lent for
more than a day & up to 14 days it is called Notice
Money.
 
 The interest rate in the call & Notice Money Market are
market determined.
 The interest rates in this market are highly sensitive to
demand and supply factors.
 In view of the short term tenure of such transaction both
the borrowers and the lenders are required to have
current a/c with RBI.
 This will facilitate quick and timely debit and credit
operations.
 Commercial Bills

 Commercial bill is a short term, negotiable, and self-
liquidating instrument with low risk. It enhances the
liability to make payment within a fixed date when goods
are bought on credit.
 Bills of exchange are negotiable instruments drawn by the
seller (drawer) on the buyer (drawee) or the value of the
goods delivered to him. Such bills are called Trade Bills.
 Bill of Exchange is an instrument in writing containing an
unconditional order signed by the drawer directing a
person to pay a certain sum of money only to the order of a
certain person or to the bearer of the instrument.
 Since the drawer gives some period for payment, the bill
would be payable only at a future date.
 
 Either the seller may retain the bill till the due date or if the
seller is in need of funds he gets it discounted from some
bank and gets cash immediately.
 When trade bills are accepted by commercial banks, they are
called Commercial Bills. The bank discount this bill by
keeping a certain margin and credits the proceeds.
 In the meanwhile if the bank is in needs of funds it can
rediscount the bills already discounted by the commercial
banks.
 Banks can also get such bills rediscounted by financial
institutions such as LIC, UTI, GIC, ICICI and IRBI.
 The maturity period of the bills varies from 30 days, 60 days
or 90 days, depending on the credit extended in the industry.
Features of Commercial Bills

1. These are negotiable instruments.
2. These are generally issued for 30 days to 120 days. Thus these
are short term credit instruments.
3. These are self liquidating instruments with low risk.
4. These can be discounted with a bank. When a bill is
discounted with a bank, the holder gets immediate cash. This
means bank provide credit to the customers. The credit is
repayable on maturity of the bill. In case of need the banks can
rediscount the bill in the money market and get ready money.
5. These are used for settling payments in the domestic and
foreign trade.
6. The creditor who draws the bill is called drawer and the
debtor who accepts the bill is called drawee.
 Treasury Bills (T-Bills)

 Treasury Bill Market is a market which deals in Treasury Bills. In
this market, treasury bills are bought and sold.
 It is an important instrument of short term borrowing by the
government.
 These are promissory notes or a kind of finance bill issued by the
government for a fixed period not extending beyond one year.
 It is used by the government to raise short term funds for
meeting temporary government deficits.
 The Central Government issues T-Bills at a price less than their
face value and the difference between the buy price and the
maturity value is the interest earned by the buyer of the
instrument.
 At present, the Government of India issues three types of
treasury bills through auctions, namely, 91-day, 182-day and
364-day.
 Features of T Bill

 Form : T bills are issued in the form of a promissory note
in physical form or by credit to Subsidiary General
Ledger account or Gilt Account in Demat Form.
 Minimum Amount of Bids : Bids for T Bills are to be
made for a minimum amount of Rs 25000/- only and in
multiples thereof.
 Eligibility : All entities registered in India like Banks,
financial institutions, primary dealers, firms, companies,
mutual funds, provident funds, trusts etc.
 
 Repayment : the T bills are repaid at par on the expiry of
their tenure at the office of RBI.
 Availability : all the T bills are highly liquid instruments
available both in the primary and secondary market.
 Day Count : for T bills the day count is taken as 365 days
for a year.
 Advantages

1. The government can raise short term funds for
meeting temporary budget deficit
2. The government can absorb excess liquidity in the
economy thru the issue of T bills in the market.
3. No tax is deducted at source
4. Zero default risk
5. Highly liquid money market instrument
6. Better returns in short term period
7. Simplified settlement
 MONEY MARKET MUTUAL
FUNDS(MMMFs)

 A money market fund is a mutual fund that invests solely in
money market instruments.
 Money market instruments are forms of debt that mature in less
than one year and are very liquid.
 Treasury bills make up the bulk of the money market
instruments.
 Securities in the money market are relatively risk-free.
 Money market funds are generally the safest and most secure of
mutual fund investments.
 The goal of a money-market fund is to preserve principal while
yielding a modest return by investing in safe and stable
instruments issued by governments, banks and corporations
etc.
 Advantages of MMMFs

 These enable small investors to participate in the
money market.
 The investor gets higher return.
 These are highly liquid.
 These facilitate the development of money market.
Certificate of Deposits (CDs)

 They are termed as Deposit Certificates.
 They are issued by Commercial Banks and Financial
Institutions at discount from Face Value with the
maturity period ranging from 7 days to 1 year.
 It was introduced by RBI in the year 1989 to enable the
banking system to mobilize bulk deposits from the
market which can have competitive rates of interest.
 They are negotiable Money Market instruments issued in
Demat Form.
 
 They are like Bank Term Deposits.
 They are freely negotiable and are often referred to as
negotiable certificate of deposits.
 The return on it is higher then the Treasury Bills because it
assumes a higher level of risk.
 Features of Certificate of
Deposits

1. CD’s can be issued by trusts, associations banks,
corporations, financial Institutions etc.
2. All scheduled Commercial banks except Regional Rural
Banks & Cooperative Banks are allowed to issue CD’s
without any ceiling.
3. CD’s are highly liquid & marketable.
4. They issued at discount on Face Value.
5. Maturity period ranges from 7 days to 1 year.
6. They are freely transferable by endorsement and
delivery.
 
7. CD’s may or may not be credit rated.
8. The minimum size of issue of a single deposit is 1
lakh.
9. They are repayable on a fixed date.
10. Duplicate CD’s can be issued by giving public
notice & obtaining indemnity.
11. Loans against collateral of CD’s is not permitted.
 Advantages of CDs

1. It enables the depositors to earn higher return on
their short term surplus.
2. The market provides maximum liquidity.
3. The bank can raise money in times of need. This will
improve their lending capacity.
4. The market provides an opportunity for banks to
invest their surplus funds.
5. The transaction cost of CDs is lower.
GILT EDGED GOVERNMENT SECURITIES


 These are issued by governments such as Central Government,
State Government, Semi Government authorities, City
Corporations, Municipalities, Port trust, State Electricity Board,
Housing boards etc.
 The gilt-edged market refers to the market for Government and
semi-government securities, backed by the Reserve Bank of
India(RBI).
 Government securities are tradable debt instruments issued by
the Government for meeting its financial requirements.
 The term gilt-edged means 'of the best quality'.
 This is because the Government securities do not suffer from risk
of default and are highly liquid (as they can be easily sold in the
market at their current price).
 The open market operations of the RBI are also conducted in such
securities.
 Repo & Reverse Repo

 Repo was introduced in December 1992.
 A Repo or Repurchase agreement is an instrument used in
Money Market. It is short term & safe as a secured
instrument.
 A Repurchase agreement is an agreement b/w 2 parties
whereby one party sells the other a security at a specified
price with a commitment to buy the security back at a
later date for another specified price.
 
 In simple terms it is recognised as Buy Back Arrangement.
 In order words a Repo is a combination of an outright
purchase & later an outright sale.
 Repo is a collateralized lending by which commercial
banks borrow money from the RBI to meet their short term
needs. They are usually for overnight borrowing.
 Repo / reverse Repo transactions can be done only
between the parties approved by RBI and in RBI approved
securities i.e. GOI and State securities, T bills, PSU bonds,
corporate bonds etc.
 
 The party who sells & later repurchases the security is
said to perform a Repo.
 Similarly the buyer purchases the security with an
agreement to resell the same to the seller on an agreed
date in future at a prefixed price. The party who
purchases and later resells the security is said to perform
a Reverse Repo.
 A transaction is called Repo when viewed from the
perspective of the seller of the securities.
 A transaction is called Reverse Repo when the
transaction is viewed from the buyer of the securities.
 
 Reverse Repo is a term used to describe the opposite
side of a Repo transaction.
 Repo and Reverse Repo are exactly the same kind of
transaction just described from opposite view points.
 In November 1996, RBI introduced Reverse Repo.
 Features of Repo

1. Banks and primary Dealers are allowed to undertake both
Repo and Reverse Repo transaction.
2. It is collateralised short term lending and borrowing
agreement.
3. It serves as an outlet for deploying funds on short term
basis.
4. The interest rates depends on the demand and supply of
the short term surplus amongst the interbank players.
 Commercial Papers (CPs)

 Commercial Paper is the short term unsecured promissory
note issued by only large, well known credit worthy
companies, at a discounted value on face value.
 They come with fixed maturity period ranging from 1 day
to 270 days.
 These are issued for the purpose of financing of accounts
receivables, inventories and meeting short term liabilities.
 The return on commercial papers is higher as compared to
T-Bills so as the risk as they are less secure in comparison
to these bills.
 It is easy to find buyers for the firms with high credit
ratings.
 They can be issued to banks, companies, individuals and
other registered Indian Corporate bodies.
 
 Chances of default are almost negligible but are not
zero risk instruments.
 Since commercial papers are instruments not backed
by any collateral, only firms with high credit ratings
will find buyer easily.
 Since they are actively traded in the secondary
market, they are issued in the form of a promissory
notes and are freely transferable in Demat form.
 Advantages of CPs

1. These are simple to issue.
2. The issuers can issue CPs with maturities according
to their cash flow.
3. The image of the issuing company in the capital
market will improve. This makes easy to raise long
term capital.
4. The investors get higher returns.
5. These facilitate securitization of loans. This will
create a secondary market for CP.
 Credit
Obligors Enhancement
Providers
2 Collections 3 Credit enhancement
Original 6. Issue of securities
1 Cash flows
Loan
9 10 Servicing
Collection SPV of securities Investors
Sale of
Agent asset 5
4 Rating 7. Subscription to securities
Originator 8
Purchase
consideration Rating Agency Merchant
Bankers

Contracts
Ongoing cash flows
Initial cash flows
 Disadvantages of CPs

1. It cannot be repaid before maturity.
2. It can be issued only by large financially strong
firms.
 Bankers Acceptance

 It is a short-term credit investment created by a non
financial firm and guaranteed by a bank to make payment.
 It is simply a bill of exchange drawn by a person and
accepted by a bank.
 It is a buyer’s promise to pay to the seller a certain specified
amount at certain date.
 The same is guaranteed by the banker of the buyer in
exchange for a claim on the goods as collateral.
 The person drawing the bill must have good credit rating
otherwise the banker’s acceptance will not be tradable.
 The most common term for these instruments is 90 days.
However they can vary from 30days to 180 days.
 
 For corporations it acts as a negotiable time draft for
financing imports, exports and other transactions in
goods and is highly useful when the credit
worthiness of the foreign party is unknown.
 The seller need not hold it until maturity and can sell
off the same in secondary market at discount from
the face value to liquidate its receivables.
 Collateral Loan Market

 Collateral Loan Market is another important sector of the
money market.
 The collateral loan market is a market which deals with
collateral loans.
 Collateral means anything pledged as security for
repayment of a loan. Thus collateral loans are loans backed
by collateral securities such as bonds, stock etc.
 The collateral loans are given for a few months.
 The collateral security is returned to the borrower when the
loan is repaid.
 When the borrower is not able to repay the loan, the
collateral becomes the property of the lender.
 Inter Bank Participation
Certificates (IBPCs)

 IBPCs are instruments issued by scheduled commercial
banks only to raise funds or to deploy short term surplus.
 IBPCs are of 2 types – with risk sharing & without risk
sharing.
 The minimum period shall be 91 days and maximum
period 180 days in case of IBPCs in risk sharing basis and
in case of IBPCs under non risk sharing basis the total
period is limited to 90 days.
 IBPCs are not transferable and cannot be redeemed before
due date.
Defects of the Money Market

1. Presence of unorganised segment
2. Absence of Integration
3. Difference in Interest Rates
4. Seasonal Diversity of Money Market
5. Absence of Bill Market
6. Limited Instruments
7. Limited no of Participants
8. No contact with Foreign Money Market
Discount Finance House of India (DFHI)

 It was set up in April 1988 to develop the money market
and to provide liquidity to money market instruments.
 It was set up as per the recommendations of Vaghul
Working Group.
 It was given the specific task of widening and deepening
the money market.
 It was set up jointly by RBI, public sector banks and
financial institutions.
 
 DFHI was accredited as a Primary Dealer in Feb 1996.
 DFHI has opened its branches at Ahmedabad, Bangalore,
Calcutta, Chennai, New Delhi and very recently at
Hyderabad with a view to catering to the requirements of
the small and medium sized institutions operating at
these centres and at the same time integrating the markets
at these regional centres with main money market at
Mumbai.
 Objectives of DFHI

1. To provide liquidity to money market instruments.
2. To provide safe and risk free short term investment
avenues to institutions.
3. To facilitate money market transactions of small and
medium sized institutions that are not regular
participants in the market.
4. To integrate various segments of the market.
5. To develop a secondary market for money market
instruments.
6. To integrate markets at regional centres with the main
market at Mumbai, through its network.
 Function & Role of DFHI

1. To discount, rediscount, purchase and sell treasury bills,
trade bills of exchange, commercial bills and commercial
papers.
2. To play an important role as a lender, borrower or broker in
the interbank call money market.
3. To promote and support company funds, trusts and other
organisations for the development of short term money
market.
4. To advise governments, banks and other financial
institutions for the growth and development of money
market.
5. To undertake buyback arrangements in trade bills, T bills
and other instruments.
Capital Market

 
 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, etc.
 
 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.
 The secondary market provides a place for purchase and
sale of existing securities and is often termed as stock
market or stock exchange.
 
Functions of the Capital
Market
 1. Link between Savers
and Investors:

 The capital market functions as a link between savers
and investors.
 It plays an important role in mobilising the savings
and diverting them in productive investment.
 In this way, capital market plays a vital role in
transferring the financial resources from surplus and
wasteful areas to deficit and productive areas, thus
increasing the productivity and prosperity of the
country.
 2. Encouragement to
Saving:

 With the development of capital, market, the
banking and non-banking institutions provide
facilities, which encourage people to save more.
 In the less- developed countries, in the absence of a
capital market, there are very little savings and those
who save often invest their savings in unproductive
and wasteful directions, i.e., in real estate (like land,
gold, and jewellery) and conspicuous consumption.
 3. Encouragement to
Investment:

 The capital market facilitates lending to the
businessmen and the government and thus encourages
investment.
 It provides facilities through banks and nonbank
financial institutions.
 Various financial assets, e.g., shares, securities, bonds,
etc., induce savers to lend to the government or invest
in industry.
 With the development of financial institutions, capital
becomes more mobile, interest rate falls and investment
increases.
 4. Promotes Economic
Growth:

 The capital market not only reflects the general
condition of the economy, but also smoothens and
accelerates the process of economic growth.
 Various institutions of the capital market, like
nonbank financial intermediaries, allocate the
resources rationally in accordance with the
development needs of the country.
 The proper allocation of resources results in the
expansion of trade and industry in both public and
private sectors, thus promoting balanced economic
growth in the country.
 5. Stability in Security
Prices:

 The capital market tends to stabilise the values of
stocks and securities and reduce the fluctuations in
the prices to the minimum.
 The process of stabilisation is facilitated by
providing capital to the borrowers at a lower interest
rate and reducing the speculative and unproductive
activities.
 6. Benefits to Investors:

 The credit market helps the investors, i.e., those who have
funds to invest in long-term financial assets, in many
ways:
 (a) It brings together the buyers and sellers of securities
and thus ensure the marketability of investments,
 (b) By advertising security prices, the Stock Exchange
enables the investors to keep track of their investments
and channelize them into most profitable lines,
 (c) It safeguards the interests of the investors by
compensating them from the Stock Exchange
Compensating Fund in the event of fraud and default.
Difference b/w Money Market
& Capital Market

 Refer to word doc
Capital Market Instruments

Equity Shares : Commonly referred to as
Ordinary Shares also represent the form of fractional
ownership in which a shareholder, as a fractional
owner, undertakes the maximum entrepreneurial
risk associated with a business venture.
 Characteristics

1. They have voting rights at all general meetings of the
company.
2. These votes have the effect of the controlling
management of the company.
3. They have the right to share the profits of the company
in the form of dividend and bonus shares.
4. When the company is wound up, payment towards
the equity share capital will be made only after
payment of the claims of all creditors and the
preference share holders.
 Sweat Equity Shares

 Sweat equity shares refers to equity shares given to the company’s
employees on favorable terms, in recognition of their work.
 It is one of the modes of making share based payments to
employees of the company.
 The issue of sweat equity allows the company to retain the
employees by rewarding them for their services.
 Sweat equity rewards the beneficiaries by giving them incentives
in lieu of their contribution towards the development of the
company.
 Further, it enables greater employee stake and interest in the
growth of an organization as it encourages the employees to
contribute more towards the company in which they feel they
have a stake.
Global Depository Receipts

 They are also known as GDRs.
 They are internationally traded equity instruments
issued against equity shares.
 They are issued by international depository and
denominated in US dollars.
 They are negotiable certificates and they are freely
traded in the overseas financial markets including
Europe and USA.
 American Depository
Receipts

 They are popularly known as ADR’s.
 They are traded in US markets mostly.
 They are denominated in US dollars.
 ADR’s are an easy and cost effective way to buy shares
in a foreign company.
 They save money by reducing administration costs and
avoiding foreign taxes on each transaction.
 Investors gains the potential to capitalize on emerging
economies by investing in different countries.
 2. Preference Shares

 They are the shareholders who assume only limited
risks and entitled to a predetermined dividend.
 They have no voting rights.
 Holders of preference shares enjoy the preference to
receive their capital over the equity shareholders.
 These instruments are issued when there is need for
long term funds and at the same time shareholders
do not want to dilute the ownership in the company.
 Though these types of shares are marketable, they
are not widely traded on account of fixed dividend.
Types of Preference Shares

1. Cumulative Preference Shares
2. Non Cumulative Preference Shares
3. Convertible Preference Shares
4. Redeemable Preference Shares
 Primary Market

 It is a market where new securities are bought and sold
for the first time. It is also called as New Issue Market or
the IPO market.
 In other words, the first public offering of equity shares
or convertible securities by a company , which is
followed by the listing of company’s shares on a stock
exchange is known as Initial Public Offering.
 The Primary market also includes issue of further capital
by the company whose shares are already listed on the
stock exchange
 
 There are different type of intermediaries operating
in the capital market.
 They play a crucial role in the development of capital
market by providing various services.
 These intermediaries i.e. merchant bankers , brokers,
bankers to issues, portfolio managers, registrars to
issues etc. are regulated by SEBI.
Modes of Primary Market Issuance

 Public Issue – IPO & FPO
 Rights Issue
 Bonus Issue
 Private Placements
 Secondary Market

 It is a market in which an investor purchases a security
from another investor rather then the issuer , subsequent
to the original issuance in the primary market.
 The secondary market known as Stock Market or Stock
Exchange.
 It provides a place where these securities can be encashed
without any difficulty and delay.
 It is an organised market where shares, and debentures
are traded regularly with high degree of transparency
and security.
 
 In fact, an active secondary market facilitates the growth
of primary market as the investors in the primary market
are assured of a continuous market for liquidity of their
holdings.
 It plays an equally important role in mobilizing long-
term funds by providing the necessary liquidity to
holdings in shares and debentures.
Characteristics of a Stock Market

1. It is an organized market.
2. It provides a place where existing and approved
securities can be bought and sold easily.
3. In a stock exchange, transactions take place b/w its
members or their authorized agents
4. All transactions are regulated by rules and by laws
of the concerned stock exchange.
5. It makes complete information available to public in
regard to prices and volumes of transactions taking
place every day.
 
6. It may be noted that all securities are not permitted
to be traded on a recognised stock exchange. It is
allowed only in those securities that have been duly
approved for the purpose by the stock exchange
authorities.
7. Due to the availability of on line trading facility
transactions are quite fast as it takes a few minutes
to strike a deal.
DISTINCTION BETWEEN PRIMARY
AND SECONDARY MARKET

 1. Function : While the main function of primary market is
to raise long-term funds through fresh issue of securities,
the main function of secondary market is to provide
continuous and ready market for the existing long-term
securities.
 2. Participants: While the major players in the primary
market are financial institutions, mutual funds,
underwriters and individual investors, the major players
in secondary market are all of these and the stockbrokers
who are members of the stock exchange.
 
 3. Listing Requirement: While only those securities can be
dealt within the secondary market, which have been
approved for the purpose (listed), there is no such
requirement in case of primary market.
 4. Determination of prices: In case of primary market, the
prices are determined by the management with due
compliance with SEBI requirement for new issue of
securities. But in case of secondary market, the price of the
securities is determined by forces of demand and supply of
the market and keeps on fluctuating.
 Functions of the Secondary
Market / Stock Exchange

 Refer to the text book
Mutual Funds

 Definition

A Mutual Fund is made up of money that is pooled
together by a large number of investors who give
their money to a fund manager to invest in a
large portfolio of stocks and / or bonds.

A Mutual Fund is a financial services organization

that receives money from unit holders, invest it,
earns returns on it, attempts to make it grow and
agrees to pay shareholders cash on demand for
the current value of his investment.

 
 The money thus collected is then invested in capital
market and money market instruments such as shares,
debentures etc.
 Investors invest money and get the units as per the unit
value which we call as NAV (net assets value)
 Mutual fund is the most suitable investment for the
common man as it offers an opportunity to invest in
diversified portfolio management, good research team,
professionally managed Indian stock as well as the foreign
market.
 The main aim of the fund manager is to take the scrip that
have under value and whose future value would be rising,
then fund manager sells out the stock.
 
An investor can lose money in a mutual fund.
This is because mutual funds invest in securities
whose value may rise and fall.
Though regulations ensure disciplined
investments and ceilings on expenses that are
charged to the unit holders, unit holders assume
investment risk, including loss of principal.
There is an upside to investment risk, greater is
the potential reward.
 Advantages of Mutual Funds
1.

Portfolio Diversification : Mutual funds invest in a well
diversified portfolio of securities which enables investor
to hold a diversified investment portfolio , whether the
amount of investment is big or small.
2. Professional management : Fund manager undergoes
thru various research works and has better investment
management skills which ensures higher returns to the
investor than what he can manage on his own.
3. Tax Benefit : Specific schemes of mutual funds give
investors the benefit of deduction of the amount invested
from their income that is liable to tax. This reduces their
taxable income and therefore the tax liability.
 
 Low Transaction Cost : Since the fund managers have a
large amount of funds at their disposal for the purpose of
investments, they enjoy the benefits of scale in brokerage,
custodial and other fees which translate into lower costs for
investors. Thus Mutual Funds area relatively less expensive
way to invest.
 Liquidity : An investor can sell of this units easily in the
market without any loss of time.
 Choices of Schemes : Mutual funds provide investors with
various schemes with different investment objectives.
Investors have the option of investing in a scheme having a
correlation b/w its investment objectives and their own
financial goals.
 
 Well Regulated : All Mutual Funds are registered with
SEBI and they function within the provisions of strict
regulations designed to protect the interest of investors.
The operations of MF are regularly monitored by SEBI.
 Transparency : Regular information in the value of the
MF investment in addition to disclosure on the specific
investments made by the scheme is mandatory as per
SEBIs regulations. The proportion of funds invested in
each class of assets and the fund manager’s investment
strategy and outlook can be checked by the investors to
confirm whether they have been as per the disclosure
norms or not.
 Disadvantages of MFs

1. Cost control not in the hands of an investor
2. No interference in the decision making process
3. Difficulty in selecting a suitable fund scheme
 Mutual Fund Schemes

1. Open ended schemes
2. Close ended schemes
3. Interval Funds
4. Equity Funds – Sector funds, ELSS, diversified
equity funds
5. Debt Funds – Gilt funds, diversified debt funds,
money market funds.
Debt Market

 
 Debt market is used by both firms and governments to
raise funds for long term purposes, though most
investments by firm is financed by retained profits.
 Bonds are long term borrowing instruments for the
issuer.
 These are fixed interest bearing instruments.
 Some corporate bonds are secured against assets of the
company that issues them, other bonds are unsecured.
 Bonds secured on the assets of the issuing company are
known as Debentures.
 Bonds that are not secured are referred as Loan Stock.
Characteristics of Debt Market

1. Bonds are classified into :
Short term - up to 5yrs,
Medium term - 5yrs to 15yrs and
Long term - over 15 yrs
2. They pay a fixed rate of interest called coupon. It is
normally made into 2 installments, at 6 monthly
intervals, each equal to half the rate specified in the
bond’s coupon.
3. Liquidity is one of the key characteristics of the
bond market.
Debt Market
Instruments

1. Government Securities

 G Sec are issued by RBI on behalf of the Government
of India.
 Normally the dated government securities have a
period of 1 yr to 30 yrs.
 These are fixed interest bearing instruments with
interest payable semi annually.
 They consists of promissory notes, bearer bonds, T
bills etc.
 Features of Government
Securities

1. Issued at par value.
2. No default risk as the securities carry sovereign
guarantee.
3. Ample liquidity as the investor can sell the security in the
secondary market.
4. Interest payment on a half yearly basis on face value.
5. No tax deducted at source
6. Can be held in Demat form
7. Rate of interest and tenor of the security is fixed at the
time of issuance and is not subject to change.
8. Maturity ranges from 1 – 30 yrs
 Corporate Bonds

 Corporate bonds are issued by public sector
undertakings and private corporations for a wide range
of tenors normally up to 15 yrs.
 Compared to government bonds, corporate bonds
generally have a higher risk of default.
 This risk depends, of course upon the particular
corporation issuing the bond, the current market
conditions, the industry in which it is operating and the
rating of the company.
 Corporate bond holders are compensated for this risk
by receiving a higher yield than government bonds.
 Debentures

 If a company needs funds for extension and development
purpose without increasing its share capital, it can borrow
from the general public by issuing certificates for a fixed
period of time and at a fixed rate of interest.
 Such a Loan Certificate is called a Debenture. Debentures
are offered to the public for subscription in the same way
as for issue of equity shares.
 Debenture is issued under the common seal of the
company acknowledging the receipt of money.
 Features of Debentures

1. Debenture is an instrument of loan.
2. Interest is paid at fixed rate every year and debentures is
known as "fixed cost bearing capital".
3.Debenture has common seal of the company.
4. Debenture is redeemable at a fixed and specified time.
5. Debenture-holders are the creditors of company not
owners.
6. Debenture is a form of long-term borrowed capital.
7. Debenture-holders have no right to cast vote in company's
general meting.
8. At the time of liquidation, first priority is given to
debenture-holders at the time of repayment.
 Types of Debentures

 Secured Debentures: These instruments are secured
by a charge on the fixed assets of the issuer
company. So if the issuer fails on payment of either
the principal or interest amount, his assets can be
sold to repay the liability to the investors
 Unsecured Debentures: These instrument are
unsecured in the sense that if the issuer defaults on
payment of the interest or principal amount, the
investor has to be along with other unsecured
creditors of the company.
 
 Irredeemable Debenture: Such debentures are
generally not redeemed during the lifetime of the
company. So, it is also termed as perpetual debt.
Repayment of such debenture takes place at the time
of liquidation of the company.
 Redeemable Debentures: Redeemable debenture is
a debenture which is redeemed/repaid on a prede-
termined date and at predetermined price.
 
 Registered Debentures: Registered debentures are
those debentures where names, address, serial num-
ber, etc., of the debenture holders are recorded in the
register book of the company. Such debentures
cannot be easily transferred to another person.
 Unregistered Debentures: Unregistered debentures (
Bearer Debentures) may be referred to those
debentures which are not recorded in the company’s
register book. Such a type of debenture is also
known as bearer debenture and this can be easily
transferred to any other person.
Commodity Market

 
 A market place where consumers and producers meet to buy
and sell commodities is known as Commodity Market.
 Commodity market is a place where trading in commodities
takes place. It is similar to an equity market, but instead of
buying or selling shares one buys or sells commodities.
 Trading in commodities include physical trading and
derivative trading using forwards, futures and options on
futures.
 It is in fact the oldest market in the Indian Economic system.
 The demand and supply factors determine the mechanics of
the commodity markets and therefore of commodity prices.
Types of Commodities Traded

 Precious Metals: Gold, Silver, Platinum, etc.
 Other Metals: Nickel, Aluminum, Copper, etc.
 Agro-Based Commodities: Wheat, Corn, Cotton,
Oils, Oilseeds, etc.
 Soft Commodities: Coffee, Cocoa, Sugar, etc.
 Live-Stock: Live Cattle, Pork Bellies, etc.
 Energy: Crude Oil, Natural Gas, Gasoline, etc.
 Participants

 Hedgers :
Hedger is a person who basically wants to avoid risk
and enters into a contract with speculator. Hedgers is a
user of the market, who enters into futures contract to
manage the risk of adverse price fluctuation in respect
of his existing or future assets. Hedgers are those who
hedge to insure themselves against adverse price
fluctuations. Ex exporters, producers etc. it reduces or
limits risks associated with unpredictable changes in
prices.
 
 Speculator :
A Trader, who trades or takes position without having
exposure in the physical market, with the sole intention
of earning profit is a speculator. Speculators are those
who may not have an interest in the ready contracts etc.
but see an opportunity of price movement favorable to
them. A speculator is one who enters the market to
profit from the future price movements.
 
 Arbitrageurs :
It refers to the simultaneous purchase and sale in 2
markets so that the selling price is higher than the
buying price by more than the transaction cost,
resulting in the risk less profit to the arbitrageur.
Arbitrage is making purchases and sales
simultaneously in 2 different markets to profit from the
price differences prevailing in those markets.
 Commodity exchanges
in India

 There are more than 20 recognised commodity futures
exchanges in India under the purview of the forward
Markets commission (FMC).
 There are six exchange at the national level ;
1. National Commodity & Derivative exchange of India
(NCDEX)
2. National Multi Commodity Exchange of India (NMCE)
3. Multi Commodity Exchange of India Ltd (MCX)
4. Indian Commodity Exchange Ltd (ICEX)
5. Ace Derivatives and Commodity Exchange Ltd
6. Universal Commodity Exchange Ltd.
 Names of Exchanges

 New York Mercantile Exchange (NYMEX)
 Chicago Board of Trade (CBOT)
 London Metals Exchange (LME)
 Chicago Board Options Exchange (CBOE)
 Tokyo Commodity Exchange (TCE)
 Malaysian Derivatives Exchange (MDEX)
 Commodities Exchange (COMEX)
 Multi Commodity Exchange (MCX)
 National Commodity & Derivative Exchange (NCDEX)
Derivative Market

 
 All investors have the opportunity to invest in either real
assets or financial assets.
 Real assets are assets such as land, buildings, precious
metals & machinery. An investor would get the return
from the investment on the basis of the changes in the
price of these assets.
 Financial Assets on the other hand, is a claim on an issuer
of financial security. Ex: bonds or equities.
 
 A derivative security on the other hand, realizes its value
from the value of the asset, which forms the basis of the
derivative contract.
 The asset whose value determines the value of the
derivative contract is known as the underlying asset.
 The value of the derivative product will change depending
on the changes in the value of the underlying assets.
 
 Derivative contract can be written on real assets as
well as financial assets.

 The derivative products written on real assets are

called Commodity Derivatives whereas those written
on financial assets are called as Financial Derivatives.
 
 A derivative is an instrument which derives its value
from an underlying asset.
 They have no independent value, so its value depends on
the underlying asset.
 
 According to The Security Contracts (Regulation)
Act derivative is defined as follows “A derivative
includes :
a) a security derived from a debt instrument, share
loan, whether secured or unsecured, risk instrument
or contract for differences or any other form of
security
b) a contract which derives its value from the prices or
index of prices of underlying securities”.
 PARTICIPANTS OF
DERIVATIVE MARKET

 Hedgers :-
They participate in derivative market to lock the
prices at which they will be able to do a buy or sell
transaction in future. The transaction they undergo is
known as Hedging. They try to reduce or avoid price
risk by dealing in derivatives.
 
 Speculators:
Speculators are risk takers who want to take
advantage of future price movement of an asset.
They are ready to face what hedgers want to avoid.
They use derivatives to get extra leverage.
 
 Arbitrageurs :
They are interested in taking advantage of
discrepancy between the prices in two different
markets. Whenever they see a mismatch in prices of
two markets, they enter into a buy transaction in one
and a sell transaction in other market so as to enjoy
profit arising out of differences in prices.
 Derivatives

Forwards Futures Options Swap

Sell – purchase transactions could be:

 Cash transactions in which payment and delivery of
goods is done at the same time.
 In credit transactions, delivery of goods is before
payment.
 In advance payment transactions, payment is before and
delivery is in future.
 There is one more possibility.
 
 A forward contract is an agreement to buy or sell a specified
asset at a specified time in future for a specified price
agreed upon at the time of entering into the contract.
 In a forward contract, the parties just enter into an
agreement to exchange assets and cash at a mutually
agreeable price at the present time.
 The actual exchange of asset & cash takes place in the
future. Forward contracts came into existence because they
allowed for a reduction in the price risk faced by
individuals & businesses.
 They are conceived as a risk mitigation measure for both
buyer & seller.
 Type of Mutual Delivery of Payment by
Deal agreement on goods by buyer
rate & seller
quantity b/w
buyer &
seller
Cash Now Now Now

Credit Now Now At a future Date

Advance Now At a future date Now

Payment
Forwards Now At a Future Date At a Future Date
For Instance :
 A potato dealer in Byculla market has to get guaranteed
supply of potatoes at reasonable rates. So, he approaches a
farmer in the month of January. He offers to buy 10,000
kilos potatoes from him @ Rs 5/- per kilo, in May.
 The Farmer is also unsure of the rate he will get for
potatoes as it depends upon demand supply pressure in
the market. So, he gets comfort of assured sale and assured
rate.
 So both of them agree in Jan itself. But the actual delivery
of potatoes will be in May. Payment by dealer is also in
May.

This is a Legal Contract.

Hence it has to be honored by both of them.
 
 Notionally though, either of them would be a looser
in May. If wholesale market rate in May turns out to
be Rs 4/-(per kilo) then, dealer is at a loss.
 If the rate turns out to be Rs 6/- (per Kilo), then the
farmer is at a loss.
 But still both of them agree in January. They do not
want any open uncertainty and risk is eliminated.
 
 Thus a forward contract assures a price to both the
parties for a future transaction, however either party
could gain or lose from a forward contract becoz of the
movement in the underlying asset.
 It should be noted that the gain of party will result in a
loss of the same amount for another party.
 Characteristics of
Forwards Contracts

1) Forwards contracts are tailor made. Any quantity and
date is possible as these are negotiated contracts.
2) Buyer and seller know each other and bear a risk of
default on each other.
3) Settlement is by actual delivery of contracted underlying
asset and cash.
4) Difficult to cancel.
5) Forward contracts are not traded on exchanges and
hence lack liquidity feature.
 
 A futures contract is an agreement to buy or sell a
specified quantity of a specified asset at a certain time in
the future for a price that is agreed upon at a time of
entering into the contract.
 The specified asset is known as the Underlying Asset.
 The time at which the asset is bought or sold in the future
is known as the Expiry Date or the Maturity Date of the
future contract.
 The price at which the transaction will take place on the
expiry date that is determined at the current time is known
as the Futures price.
 
 Thus, futures contract are special forms of forward
contracts that are designed to reduce the disadvantages
associated with forward agreements.
 They are nothing more than forward contracts whose terms
have been standardized so they can be traded in public
marketplace, giving them liquidity.
 Standardized makes futures contract s less flexible than
forwards agreements, but it also makes them more liquid &
less vulnerable to credit (default) risk.
 Example

 Say in February, something happens in the life of a dealer
& he doesn’t want to remain in potato business any more.
He will hunt for another potato dealer in the market who
would like to buy potatoes in May. Good thing he
discovers is that, dealers are now willing to enter into
similar contract for Rs 6/- per kilo. So, his already signed
deal is more attractive.
 He will assign his contract to another dealer and will
demand Rs 6/- as per market rate. May be most of the
farmers have already signed such contracts in January and
the new dealer cannot find one for lesser rate. So he buys
contract from earlier dealer.
 Farmer will get Rs 5/- as contracted. The additional Rs. 1/-
is gain of the dealer who signed the original contract.
 
 Willing buyers of these contracts will have to make a big
hunt in the market to find a contract of desired quantity.
 Varied quantity in each contract is thus a hurdle in
liquidity market.
 To over come this hurdle and to maintain liquidity, a
systematic market of these contracts are developed on the
lines of stock market.
 
 Contracts in this market are listed & are of standard
quantity i.e. size. Thus these are standardized
forward contracts which are traded on an organized
exchange.
 Such standardized forwards contracts are called as
Futures.
 Futures are traded thru exchanges.
 Characteristics of Futures

1. Futures contracts are negotiable. This means that a party
that enters into a futures contract to buy an asset, at later
time, enter into a futures contract to sell the same asset
before the maturity of the contract.
2. Futures contracts are standardized in terms of the size,
date of maturity & details of delivery. This reduces the
flexibility.
3. Since futures contracts are traded on futures exchanges.
 
4. Since futures are traded on exchanges, they have
developed a mechanism thru which non
compliance with the contractual obligations by
either party to the futures contract are eliminated.
This is accomplished thru clearing house. Thus
exchanges guarantees the performance of all futures
contracts.
5. In this contract the parties are asked to post a
margin, according to the rules of the exchange.
 Types of Futures
 Agricultural

1st type - Grains : Corn, Oats, Wheat.
2nd type - Oil & Meat : Soyaoil, sunflower oil, soya seed.
3rd type – Livestock : cattle
4th type – Forest Products : Plywood, wood.
5th type – Textiles : cotton.
6th type – Foodstuff : Cocoa, coffee, rice, sugar.
 
 Metallurgical – Metals & Petroleum.
 Interest Bearing Assets – Treasury bill, bonds
 Stock Futures – Stocks of Blue Chip companies
 Foreign Currencies – Dollar, Yen, Euro
 Miscellaneous – Insurance, Cheese, Fertilizer
Difference between Forward and
Futures
Features
Features
Future
Currency Future
Forward
Currency
Forward
Agreement standardized contract with fixed customized contract where
Agreement standardized contract
maturity date withquantity
and fixed customized contract
the parties can negotiate
fixed maturity
as defined by date and fixed where
the exchange the and
terms parties can
conditions
quantity as defined by the negotiate terms and
exchange conditions
Accessibility High Low
Accessibility
Channel of trade High
Exchange- traded contract thatLowTraded on OTC markets.
Channel of trade Exchange-
is availabletraded contract
for trading on Traded on OTC markets
that is available
recognized for trading
exchanges such as through authorized
onNSE
recognized
BSE and exchanges
MCX dealer network of RBI
such as NSE BSE and MCX such as scheduled banks
Default risk Risks is Low and Clearing or licensed Risk is foreign
High and the parties
house bears the risk bear the
exchange risk.
dealers.
Default risk
Counterparties Do not
Low andknow onehouse
Clearing another. HighInand
contact with one
the parties bearanother
Negotiation Hrs bears
Duringthe market
risk sessions. the risk.
As per convenience.
Guarantee Guarantee Deposit. No guarantee Deposit
 
 A swap is one of the most simple and successful
forms of OTC – Trades derivatives.
 It is cash settled contract b/w two parties to
exchange cash flow streams. It is simultaneous &
equivalent lending or borrowing.
 As long as the present value of the streams is equal
can entail almost any type of future cash flow.
 
 It is a combination of 2 forwards. Some what like a barter
with future date.
 A farmer wants to sell potatoes and buy cottonseed.
Another farmer wants to sell cottonseed and buy potatoes.
Both at a future date . In such case they will make each
other to exchange potatoes for cottonseed at a future date.
Quantity to be exchanged is decided now. This is a swap
contract.
 It looks very unlikely that such 2 farmers will meet and
enter into such agreement. Hence commodity swaps are
rare.
 
 An option contract conveys the right to buy or sell a
specified asset at a fixed price for a fixed length of time.
 The important thing in an option contract is that the
purchaser of the options contract has the right but not an
obligation, to sell or buy the asset.
 The holder of an options contract is not legally obliged to
take any further action.
 The holder of an option contract may wish to fulfill their
contractual right to buy or sell the asset only if it is
economically advantageous to do so.
 
 In forward or future contracts, it is commitment on both
buyer as well as seller.
 In option contract it’s a commitment on one side but
privilege or option on the other side. So, in buyers privilege
(Call option), buyer may or may not buy at a future date.
 But if buyer chooses to buy, then seller has to compulsorily
sell at the decided price, the contracted quantity.
 
 There could be seller’s privilege too (Put option). Seller
may or may not sell at decided price.
 But if he decides to sell , then the buyer has to
compulsorily but at that price, the contacted quantity.
 A particular option can be Put Option or Call Option, but
obviously it cannot be both at a time.
Currency Markets

 Currency Market

 It is also called as Foreign Exchange Market.
 A foreign exchange market refers to buying foreign
currencies with domestic currencies and selling foreign
currencies for domestic currencies.
 Thus it is a market in which the claims to foreign moneys
are bought and sold for domestic currency.
 Exporters sell foreign currencies for domestic currencies
and importers buy foreign currencies with domestic
currencies.
 
 The foreign exchange market is not limited by any
geographical boundaries. It does not have any days week
and regular market timings and operates 24 hours, 7 days
week and 365 days a year.
 The market has ever growing trading volume ranging
from institutional investor buying and selling millions of
dollars at one go to individuals buying and selling less
than one hundred dollars.
 
 The foreign currency market never closes. For instance,
when the currency markets open in Europe, its
counterpart in Asia will be winding down to close. As
the European market closes, the American market
becomes active and as the American Market closes, the
Japanese market begins.
 This trading cycle continues thru out the day making
the forex market the largest and the most active market
in the world.
 The major foreign exchange trading centres are in
London, New York, Tokyo, Zurich, Singapore and
Hong Kong.
Features of Foreign Exchange Market

1. It consists of trading one type of currency for
another.
2. It has no physical location and no central exchange.
3. It operates over the counter thru a global banks,
corporations and individuals trading one currency
for another.
4. It is the world’s largest financial market and
operates 24 hours, 7 days week and 365 days a year.
5. The market is deepest and most liquid.
 
6. Unlike other financial market, investors can respond to
currency fluctuations caused by economic, political and
social events at the time they occur, without having to
wait for exchanges to open.
7. It market primarily existed to provide for the
international movement of money and capital.
8. Foreign Exchange Market are present in every country
and therefore geographically they are located everywhere
in the world, which makes them quite unique.
Types of Foreign Exchange Market

1. Retail Market
The retail market is a secondary price maker. Here travelers,
tourists and people who are in need of foreign exchange for
permitted small transactions, exchange one currency for
another.
2. Wholesale Market
The wholesale market is also called interbank market. The
size of transactions in this market is very large. Dealers are
highly professionals and are primary price makers. The main
participants are Commercial banks, Business corporations
and Central banks. Multinational banks are mainly
responsible for determining exchange rate.
 Participants

1. Consumers & foreign Travelers:
They purchase goods in foreign currency either while traveling abroad or
shopping via the internet with their credit cards. They reach out to banks or
currency exchange bureaus to covert their local currency into foreign currency
in order to close the trade.
2. Commercial Banks :
Commercial banks carry out buy and sell orders from their retail clients and of
their own account. They deal with other commercial banks and also through
foreign exchange brokers.
3. Foreign Exchange Brokers & Dealers :
Each foreign exchange market centre has some authorized brokers. Brokers act
as intermediaries between buyers and sellers, mainly banks. Commercial banks
prefer brokers.
4. Central Banks:
Central banks are keepers of foreign exchange reserves and are often influential
in maintaining reserves volumes and stable exchange rates to meet certain
developmental goals.
 Types of Exchange Rate

 Floating Rate : a completely floating exchange rate is
one whose level is determined by the demand and
supply of the currencies. Euro
 Fixed rate : it the one in which case the government
guarantees a stable price for foreign currency this is
achieved thru interventions by central currency. Ex :
Kuwati Dinar
 Managed Float : it is a system where the authorities
manipulate the exchange rate to suit their own
objectives, sometimes intervening to fix the rate and
some times staying on the sidelines. Ex : Indian Rupee,
Yen
 Role & Functions

 Transfer Function
 Hedging Function
 Credit Function
Thank You
