Institutions and Instruments in Financial markets | CMA Inter Syllabus
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The financial system plays the key role in the economy by stimulating economic growth, influencing economic performance of the actors, affecting economic welfare. This is achieved by financial infrastructure, in which entities with funds allocate those funds to those who have potentially more productive ways to invest those funds. A financial system makes it possible a more efficient transfer of funds. As one party of the transaction may possess superior information than the other party, it can lead to the information asymmetry problem and inefficient allocation of financial resources. By overcoming asymmetry problem, the financial system facilitates balance between those with funds to invest and those needing funds.
According to the structural approach, the financial system of an economy consists of three main components:
Each of the components plays a specific role in the economy.
According to the functional approach, financial markets facilitate the flow of funds in order to finance investments by corporations, governments and individuals. Financial institutions are the key players in the financial markets as they perform the function of intermediation and thus determine the flow of funds. The financial regulators perform the role of monitoring and regulating the participants in the financial system.
Financial Institutions
Financial Institutions are the business organisations that act as mobilisers of savings, and as purveyors of credit or finance. They also provide various financial services to the community. These financial business organisations deal in financial assets such as deposits, loans, securities and so on. These assets can be seen on the asset side of the balance sheet of banks or any other financial institutions. The non-financial institutions are those business organisations, which deal in real assets such as machinery, equipment, stock of goods, real assets, etc. These assets can be seen on the asset side of the balance sheet of the manufacturing companies. The financial institutions are classified into banking institutions and non-banking institutions.
Non-banking financial institutions are those institutions which act as mere purveyors of credit and they will not create credit, e.g., LIC, UTI, IDBI.
According to Sayers, banking institutions are ‘creators’ of credit and NBFIs are mere “purveyors” of credit.
The financial institutions are also classified into financial intermediaries and non-financial intermediaries.
1.1 Reserve Bank of India
The Reserve Bank of India (RBI) is the nation’s central bank. Since 1935, RBI began operations, and stood at the centre of India’s financial system, with a fundamental commitment to maintaining the nation’s monetary and financial stability. From ensuring stability of interest and exchange rates to providing liquidity and an adequate supply of currency and credit for the real sector; from ensuring bank penetration and safety of depositors’ funds to promoting and developing financial institutions and markets, and maintaining the stability of the financial system through continued macro-financial surveillance, the Reserve Bank plays a crucial role in the economy. Decisions adopted by RBI touch the daily life of all Indians and help chart the country’s current and future economic and financial course.
The origin of the Reserve Bank can be traced to 1926, when the Royal Commission on Indian Currency and Finance—also known as the Hilton-Young Commission— recommended the creation of a central bank to separate the control of currency and credit from the government and to augment banking facilities throughout the country. The Reserve Bank of India Act of 1934 established the Reserve Bank as the banker to the central government and set in motion a series of actions culminating in the start of operations in 1935. Since then, the Reserve Bank’s role and functions have undergone numerous changes—as the nature of the Indian economy has changed. Today’s RBI bears some resemblance to the original institution, but the mission has expanded along with the deepened, broadened and increasingly globalised economy. Over the years, RBI’s specific roles and functions have evolved. However, there have been certain constraints, such as the integrity and professionalism with which the Reserve Bank discharges its mandate.
RBI at a Glance
A. Structure, Organisation and Governance of RBI
The Reserve Bank is wholly owned by the Government of India. The Central Board of Directors oversees the Reserve Bank’s business. The Central Board has primary authority for the oversight of the Reserve Bank. It dele- gates specific functions through its committees and sub-committees Central Board includes the Governor, Deputy Governors and a few Directors (of relevant local boards). The Central Board of Directors includes:
Official Directors
Committee of Central Board: Oversees the current business of the central bank and typically meets every week, on Wednesdays. The agenda focuses on current operations, including approval of the weekly statement of accounts related to the issue of Banking Departments.
Board of Financial Supervision: Regulates and supervises commercial banks, Non-Banking Finance Compa-
nies (NBFCs), development finance institutions, urban co-operative banks and primary dealers.
Board of Payment and Settlement Systems: Regulates and supervises the payment and settlement systems.
Sub-Committees of the Central Board: Includes those on Inspection and Audit; Staff; and Building. Focus of each sub-committee is on specific areas of operations.
Local Boards: In Chennai, Kolkata, Mumbai and New Delhi, representing the country’s four regions. Local Board members, appointed by the Central Government for four-year terms, represent regional and economic inter- ests and the interests of co-operative and indigenous banks.
B. Management and Structure
The Governor is the Reserve Bank’s Chief Executive. The Governor supervises and directs the affairs and busi- ness of the Reserve Bank. The management team also includes Deputy Governors and Executive Directors.
The RBI has the following Departments and sub-departments:
Management and Structure
| S1 No. | Departments | Sub-Deparments |
| 1 | Markets |
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| 2 | Research |
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| 3 | Regulation, Supervi- sion and Financial Sta- bility |
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| 4 | Services |
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| 5 | Support |
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Main Activities/Functions of RBI
The Reserve Bank is the umbrella network for numerous activities, all related to the nation’s financial sector, encompassing and extending beyond the functions of a typical central bank. Main activities or functions of Reserve Bank are:
i. Monetary Authority
The Reserve Bank of India controls the credit and formulates monetary policy. Monetary policy refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit.
The main objectives of monetary policy in India are:
The relative emphasis among the objectives varies from time to time, depending on evolving macroeconomic developments.
The Reserve Bank’s Monetary Policy Department (MPD) formulates monetary policy. The Financial Mar- kets Department (FMD) handles day-to-day liquidity management operations. There are several direct and indirect instruments that are used in the formulation and implementation of monetary policy.
The instruments are discussed in detail hereunder:
ii. Issuer of Currency
The Reserve Bank is the nation’s sole note issuing authority. Along with the Government of India, RBI is responsible for the design and production and overall management of the nation’s currency, with the goal of ensuring an adequate supply of clean and genuine notes. The Department of Currency Management at Central Office, Mumbai, in cooperation with the Issue Departments of the Reserve Bank’s Regional Offices across India oversees currency management. The function includes supplying and distributing adequate quantity of currency throughout the country and ensuring the quality of banknotes in circulation by continu- ous supply of clean notes and timely withdrawal of soiled notes. Indirect Instrument.
Four printing presses actively print notes: Dewas in Madhya Pradesh, Nasik in Maharashtra, Mysore in Karnataka, and Salboni in West Bengal. The presses in Madhya Pradesh and Maharashtra are owned by the Security Printing and Minting Corporation of India (SPMCIL), a wholly owned company of the Government of India. The presses in Karnataka and West Bengal are set up by Bharatiya Reserve Bank Note Mudran Private Limited (BRBNMPL), a wholly owned subsidiary of the Reserve Bank. Coins are minted by the Government of India. RBI is the agent of the Government for distribution, issue and handling of coins. Four mints are in operation: Mumbai, Noida in Uttar Pradesh, Kolkata, and Hyderabad.
iii. Banker and Debt Manager to Goverment
Managing the government’s banking transactions is a key role of RBI. Like individuals, businesses and banks, governments need a banker to carry out their financial transactions in an efficient and effective manner, including the raising of resources from the public. As a banker to the central government, the Reserve Bank maintains its accounts, receives money into and makes payments out of these accounts and facilitates the transfer of government funds. RBI also act as the banker to those state governments that has entered into an agreement.
The role as banker and debt manager to government includes several distinct functions:
At the end of each day, RBI’s electronic system automatically consolidates all of the government’s transac- tions to determine the net final position. If the balance in the government’s account shows a negative posi- tion, RBI extends a short-term, interest-bearing advance, called a Ways and Means Advance-WMA-the limit or amount for which is set at the beginning of each financial year in April.
iv. Banker to Banks
Banks are required to maintain a portion of their demand and time liabilities as cash reserves with the Reserve Bank. For this purpose, they need to maintain current account with the Reserve Bank. The current account of the banks is opened by the Banking Departments of the Reserve Bank’s Regional offices.
The current accounts of individual banks are being opened in e-Kuber (CBS of RBI) by Banking Departments of the Regional Offices. These current accounts are also maintained for participation in Centralised and Decentralised Payment Systems and are used for settling inter-bank obligations, such as clearing transactions or clearing money market transactions between two banks, buying and selling securities and foreign currencies. Thus, Reserve Bank acts as a common banker, known as ‘Banker to Banks’ function, the operational instructions for which are issued by concerned central office departments of the Reserve Bank.
As Banker to banks, the Reserve Bank provides short-term loans and advances to select banks, when necessary, to facilitate lending to specific sectors and for specific purposes.
As the banker to banks, RBI focus on:
The Reserve Bank provides products and services for the nation’s banks similar to what banks offer their own customers.
v. Regulator of the Banking System
The RBI has a critical role to play in ensuring the safety and soundness of the banking system—and in maintaining financial stability and public confidence in this system. As the regulator and supervisor of the banking system, the Reserve Bank protects the interests of depositors, ensures a framework for orderly development and conduct of banking operations conducive to customer interests and maintains overall financial stability through preventive and corrective measures.
The Reserve Bank regulates and supervises the nation’s financial system. Different departments of the Reserve Bank oversee the various entities that comprise India’s financial infrastructure. RBI oversees:
The Reserve Bank makes use of several supervisory tools:
The Board for Financial Supervision oversees the Reserve Bank’s regulatory and supervisory responsibilities. Consumer confidence and trust are fundamental to the proper functioning of the banking system. RBI’s supervision and regulation help ensure that banks are stable and that the system functions smoothly.
As the nation’s financial regulator, the Reserve Bank handles a range of activities, including:
vi. Foreign Exchange Management
With the transition to a market-based system for determining the external value of the Indian rupee, the foreign exchange market in India gained importance in the early reform period. In recent years, with increasing integration of the Indian economy with the global economy arising from greater trade and capital flows, the foreign exchange market has evolved as a key segment of the Indian financial market.
The Reserve Bank plays a key role in the regulation and development of the foreign exchange market and assumes three broad roles relating to foreign exchange:
The Reserve Bank is responsible for administration of the Foreign Exchange Management Act, 1999 and regulates the market by issuing licences to banks and other select institutions to act as Authorised Dealers in foreign exchange. The Foreign Exchange Department (FED) is responsible for the regulation and development of the market.
On a given day, the foreign exchange rate reflects the demand for and supply of foreign exchange arising from trade and capital transactions. The RBI’s Financial Markets Department (FMD) participates in the foreign exchange market by undertaking sales / purchases of foreign currency to ease volatility in periods of excess demand for/supply of foreign currency.
The Department of External Investments and Operations (DEIO) invests the country’s foreign exchange reserves built up by purchase of foreign currency from the market. In investing its foreign assets, the Reserve Bank is guided by three principles: safety, liquidity and return.
vii. Regulator and Supervisor of Payment and Settlement Systems
Payment and settlement systems play an important role in improving overall economic efficiency. They consist of all the diverse arrangements that we use to systematically transfer money - currency, paper instruments such as cheques, and various electronic channels.
The Payment and Settlement Systems Act of 2007 (PSS Act) gives the Reserve Bank oversight authority, including regulation and supervision, for the payment and settlement systems in the country. In this role, RBI focus on the development and functioning of safe, secure and efficient payment and settlement mechanisms.
The Reserve Bank has a two-tiered structure. The first tier provides the basic framework for our payment systems. The second-tier focusses on supervision of this framework. As part of the basic framework, the Reserve Bank’s network of secure systems handles various types of payment and settlement activities. Most operate on the security platform of the Indian Financial Network (INFINET), using digital signatures for further security of transactions. The various systems used are as follows:
These include:
viii. Maintaining Financial Stability
Pursuit of financial stability has emerged as a key critical policy objective for the central banks in the wake of the recent global financial crisis. Central banks have a critical role to play in achieving this objective. Though financial stability is not an explicit objective of the Reserve Bank in terms of the Reserve Bank of India Act, 1935, it has been an explicit objective of the Reserve Bank since the early 2000s.
In 2009, the Reserve Bank set up a dedicated Financial Stability Unit mainly to, put in place a system of continuous monitoring of the macro financial system. The department’s activities include:
Following the establishment of the Financial Stability Unit, the Reserve Bank started publishing periodic financial stability reports, with the first Financial Stability Report (FSR) being published in March 2010.
FSRs are now being published on a half yearly basis - in June and December every year. Internally, quarterly Systemic Risk Monitors and monthly Market Monitors are prepared to place before the Bank’s Top Manage- ment a more frequent assessment of the risks to systemic stability of the economy.
ix. Financial Inclusion and Development Role
This role includes ensuring credit availability to the productive sectors of the economy, establishing in- stitutions designed to build the country’s financial infrastructure, expanding access to affordable financial services and promoting financial education and literacy.
Over the years, the Reserve Bank has added new institutions as the economy has evolved. Some of the insti- tutions established by the RBI include:
Industrial Development Bank of India (1964), a development finance institution for industry.
The Reserve Bank continues its developmental role, while specifically focusing on financial inclusion. Key tools in this on-going effort include:
1.2 Commercial Banks
Commercial banks are a part of an organized money market in India. Commercial banks are joint stock compa- nies dealing in money and credit that accept demand deposits from public which are withdraw able by cheques and use these deposits for lending to others. Deposits are accepted from large group of people in forms of money and deposits are withdrawable on demand. Commercial banks mobilize savings in urban and rural areas and make them available to large and small industrial units and trading units mainly for working capital requirements. Commercial banks provide various types of financial services to customers in return of fees.
Types of Commercial Banks
Commercial banks are classified into:
A. Scheduled Commercial Banks
A scheduled bank is so called because it has been included in the Schedule-II of the Reserve Bank of India Act, 1934. To be eligible for this inclusion, a bank must satisfy the following three conditions: -
Scheduled banks enjoy certain advantages: - (i) Free / concessional remittance facilities through the offices of the RBI and its agents. (ii) Borrowings facilities from the RBI by depositing necessary documents. In return, the scheduled banks are under obligation to: -
All commercial banks such as Indian, foreign, regional rural banks and state co-operative banks are scheduled banks.
It comprises of Public Sector Banks, Regional Rural Banks, Private Sector Banks, Small Finance Banks (SFBs), Scheduled Payments Banks and Foreign Banks.
As on 31st March 2019 (Source: RBI)
| Type of Bank | No. of Banks with branches | No. of Branches |
| Public Sector Banks | 20 | 87,860 |
| Private Sector Banks | 22 | 32,375 |
| Regional Rural Banks | 43 | 22,042 |
| Foreign Banks | 46 | 300 |
Presently, 12 Small Finance Banks (SFBs) and 4 Scheduled Payments Banks are operating in India.
B. Non-scheduled Banks
Non-scheduled banks are also subject to the statutory cash reserve requirement. But they are not required to keep them with the RBI; they may keep these balances with themselves. They are not entitled to borrow from the RBI for normal banking purposes, though they may approach the RBI for accommodation under abnormal circumstances.
Commercial banks may be classified as (a) Indian and (b) foreign banks.
Both types of banks will have to maintain cash reserves with the RBI at rates stipulated by it. Besides, RBI can supervise over working of foreign banks operating in India.
Commercial banks may also be classified as (a) Private and (b) Public sector bank.
Functions of Commercial Banks
Functions of commercial banks can be divided in two groups–banking functions (primary functions) and non-banking functions (secondary functions).
A. Banking Functions (primary functions): Most of banking functions are: –
a. Acceptance of Deposits from Public: - Bank accepts following deposits from publics: -
b. Advancing Loans: It extends loans and advances out of money deposited by public to various business units and to consumers against some approved. Usually, banks grant short-term or medium-term loans to meet requirements of working capital of industrial units and trading units. Banks discourage loans for consumption Loans may be secured or unsecured. Banks do not give loan in form of cash. They make the customer open account and transfer loan amount in the customer’s account.
Banks grant loan in following ways: –
c. Credit Creation:- Credit creation is another banking function of commercial i.e., it manufactures money.
d. Use of Cheque System: - Banks have introduced the cheque system for withdrawal of
There are two types of cheques – bearer & cross cheque. A bearer cheque is encashable immediately at the bank by its possessor. A crossed cheque is not encashable immediately.
It has to be deposited only in the payee’s account. It is not negotiable.
e. Remittance of Funds: - Banks provides facilities to remit funds from one place to another for their cutomers by issuing bank drafts, mail transfer etc.
B. Non-Banking functions (secondary functions): Non-banking functions are (a) Agency services (b) General utility services
1.3 Non-Banking Financial Companies (NBFCs)
Definition of Non-Banking Financial Companies (NBFCs)
A non-banking financial company has been defined vide clause (b) of Section 45–1 of Chapter IIIB of the Re- serve Bank of India Act, 1934, as (i) a financial institution, which is a company; (ii) a non-banking institution, which is a company and which has as its principal business the receiving of deposits under any scheme or arrange- ment or in any other manner or lending in any manner; (iii) such other non-banking institutions or class of such institutions, as the bank may with the previous approval of the central government and by notification in the official gazette, specify.
NBFC has been defined under Clause (xi) of Paragraph 2(1) of Non-Banking Financial Companies Accep- tance of Public Deposits (Reserve Bank) Directions, 1998, as: ‘non-banking financial company’ means only the non-banking institution which is a loan company or an investment company or a hire purchase finance company or an equipment leasing company or a mutual benefit finance company.
A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/ securities issued by Govern- ment or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construc- tion of immovable property.
Different Types/Categories of NBFCs registered with RBI
NBFCs are categorized a) in terms of the type of liabilities into Deposit and Non-Deposit accepting NBFCs, b) non deposit taking NBFCs by their size into systemically important and other non-deposit holding companies (NBFC-NDSI and NBFC-ND) and c) by the kind of activity they conduct.
Within this broad categorization the different types of NBFCs are as follows:
Regulatory Objectives of NBFCs
The Reserve Bank of India is entrusted with the responsibility of regulating and supervising the Non-Banking Financial Companies by virtue of powers vested in Chapter III B of the Reserve Bank of India Act, 1934. The regulatory and supervisory objective is to: (a) ensure healthy growth of the financial companies; (b) ensure that these companies function as a part of the financial system within the policy framework, in such a manner that their existence and functioning do not lead to systemic aberrations; and that (c) the quality of surveillance and supervision exercised by the Bank over the NBFCs is sustained by keeping pace with the developments that take place in this sector of the financial system. It has been felt necessary to explain the rationale underlying the regulatory changes and provide clarification on certain operational matters for the benefit of the NBFCs, members of public, rating agencies, Chartered Accountants etc. To meet this need, the clarifications in the form of questions and answers, is being brought out by the Reserve Bank of India (Department of Non-Banking Supervision) with the hope that it will provide better understanding of the regulatory framework. The information given below is of general nature for the benefit of depositors/public and the clarifications given do not substitute the extant regulatory directions/instructions issued by the Bank to the NBFCs.
Diffrence between Banks & NBFCs
NBFCs lend and make investments and hence their activities are akin to that of banks; however, there are a few differences as given below:
Registration requirement of NBFCs
In terms of Section 45-IA of the RBI Act, 1934, no Non-banking Financial Company can commence or carry-on business of a non-banking financial institution without a) obtaining a certificate of registration from the Bank and without having a Net Owned Funds of ₹ 25 lakhs (rupees two crores since April 1999). However, in terms of the powers given to the Bank. to obviate dual regulation, certain categories of NBFCs which are regulated by other regulators are exempted from the requirement of registration with RBI viz. Venture Capital Fund/Merchant Bank- ing companies/Stock broking companies registered with SEBI, Insurance Company holding a valid Certificate of Registration issued by IRDA, Nidhi companies as notified under Section 620A of the Companies Act, 1956, Chit companies as defined in clause (b) of Section 2 of the Chit Funds Act, 1982, Housing Finance Companies regulated by National Housing Bank, Stock Exchange or a Mutual Benefit company.
NBFCs- Exempted from Registration
Housing Finance Companies, Merchant Banking Companies, Stock Exchanges, Companies engaged in the busi- ness of stock-broking/sub-broking, Venture Capital Fund Companies, Nidhi Companies, Insurance companies and Chit Fund Companies are NBFCs but they have been exempted from the requirement of registration under Section 45-IA of the RBI Act,1934 subject to certain conditions.
Housing Finance Companies are regulated by National Housing Bank, Merchant Banker/Venture Capital Fund Company/stock-exchanges/stock brokers/sub-brokers are regulated by Securities and Exchange Board of India, and Insurance companies are regulated by Insurance Regulatory and Development Authority. Similarly, Chit Fund Companies are regulated by the respective State Governments and Nidhi Companies are regulated by Ministry of Corporate Affairs, Government of India.
It may also be mentioned that Mortgage Guarantee Companies have been notified as Non-Banking Financial Companies under Section 45 I(f)(iii) of the RBI Act, 1934.
Residuary Non-Banking Company (RNBC)
Residuary Non-Banking Company is a class of NBFC which is a company and has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner and not being Investment, Asset Financing, Loan Company. These companies are required to maintain investments as per directions of RBI, in ad- dition to liquid assets. The functioning of these companies is different from those of NBFCs in terms of method of mobilization of deposits and requirement of deployment of depositors’ funds as per Directions. Besides, Prudential Norms Directions are applicable to these companies also.
The insurance companies are financial intermediaries as they collect and invest large amounts of premiums. They offer protection to the investors, provide means for accumulating savings, and channelise funds to the government, and other sectors. They are contractual saving agencies which receive, mostly without fail, steady inflow of funds in the form of premiums or regular contributions to pension plans. They are also in a position to predict, relatively accurately, when what amounts of insurance or pension benefits have to be paid. Further, their liabilities in most cases are long-term liabilities, for many life policies are held for 30 or 40, or 50 or even more years. As a result, the liquidity is not a problem for them, and their major activity is in the field of long-term investments. Since they offer life-cover to the investors, the guaranteed rate of return specified in insurance policies is relatively low.
Therefore, they do not need to seek high rates of return on their investments.
The insurance companies are active in the following fields among other—life, health, and general, and they have begun to operate the pension schemes and mutual funds also. Insurance business consists of spreading risks over time and sharing them between persons and organisations. The major part of insurance business is life insurance, the operations of which depend on the laws of mortality.
The distinction between life and general insurance business is that with regard to the former, the claim is fixed and certain, but in the case of the latter, the claim is uncertain i.e., the amount of claim is variable and it is ascertainable only sometime after the event. Pension business is a specialised form of life assurance.
Insurance Sector Reforms
The insurance sector in India has gone through the process of reforms following these recommendations. The Insurance Regulatory & Development Authority (IRDA) Bill was passed by the Indian Parliament in December 1999. The IRDA became a statutory body in April, 2000 and has been framing regulations and registering the private sector insurance companies. The insurance sector was opened upto the private sector in August 2000. Consequently, some Indian and foreign private companies have entered the insurance business now. There are about 31 general insurance and 24 life insurance companies operating in the private sector in India, early in 2022.
Statutory Functions of IRDA:
List of Life Insurance Companies in India
| 1 | Life Insurance Corporation of India |
| 2 | HDFC Life Insurance Co. Ltd. |
| 3 | Max Life Insurance Co. Ltd. |
| 4 | ICICI Prudential Life Insurance Co. Ltd. |
| 5 | Kotak Mahindra Life Insurance Co. Ltd. |
| 6 | Aditya Birla SunLife Insurance Co. Ltd. |
| 7 | TATA AIA Life Insurance Co. Ltd. |
| 8 | SBI Life Insurance Co. Ltd. |
| 9 | Exide Life Insurance Co. Ltd. |
| 10 | Bajaj Alliance Life Insurance Co. Ltd. |
| 11 | PNB MetLife India Insurance Co. Ltd. |
| 12 | Reliance Nippon Life Insurance Company Limited |
| 13 | Aviva Life Insurance Company Ltd. |
| 14 | Shara India Life Insurance Co. Ltd. |
| 15 | Shriram Life Insurance Co. Ltd. |
| 16 | Bharti AXA Life Insurance Company Ltd. |
| 17 | Future Generali India Life Insurance Company Ltd. |
| 18 | Ageas Federal Life Insurance Company Ltd. |
| 19 | Canara HSBC Oriental Bank of Commerce Life Insurance Company Ltd. |
| 20 | Aegon Life Insurance Company Ltd. |
| 21 | Pramerica Life Insurance Co. Ltd. |
| 22 | Star Union Dai-Ichi Life Insurance Co. Ltd. |
| 23 | IndiaFirst Life Insurance Company Ltd. |
| 24 | Edelweiss Tokio Life Insurance Company Limited |
List of Non-Life Insurance Companies in India
| 1 | Acko General Insurance Ltd. |
| 2 | Aditya Birla Health Insurance Co. Ltd. |
| 3 | Agriculture Insurance Company of India Ltd. |
| 4 | Bajaj Allianz General Insurance Co. Ltd. |
| 5 | Bharti AXA General Insurance Co. Ltd. |
| 6 | Care Health Insurance Ltd |
| 7 | Cholamadalam MS General Insurance Co. Ltd. |
| 8 | ECGC Ltd. |
| 9 | Edelweiss General Insurance Co. Ltd. |
| 10 | Future Generali India Insurance Co. Ltd. |
| 11 | Go Digit General Insurance Ltd. |
| 12 | HDFC ERGO General Insurance Co. Ltd. |
| 13 | ICICI LOMBARD General Insurance Co. Ltd. |
| 14 | IFFCO TOKIO General Insurance Co. Ltd. |
| 15 | Kotak Mahindra General Insurance Co. Ltd. |
| 16 | Liberty General Insurance Ltd. |
| 17 | Magma HDI General Insurance Co. Ltd. |
| 18 | Manipal Cigna Helath Insurance Company Limited |
| 19 | Niva Nupa Health Insurance Co. Ltd. |
| 20 | National Insurance Co. Ltd. |
| 21 | Navi General Insurance Ltd. |
| 22 | Raheja QBE General Insurance Co. Ltd. |
| 23 | Relaince General Insurance Co. Ltd. |
| 24 | Royal Sundaram General Insurance Co. Ltd. |
| 25 | SBI General Insurance Co. Ltd. |
| 26 | Shriram General Insurance Co. Ltd. |
| 27 | Star Health & Allied Insurance Co. Ltd. |
| 28 | Tata AIG General Insurance Co. Ltd. |
| 29 | The New India Assurance Co. Ltd. |
| 30 | The Oriental Insurance Co. Ltd. |
| 31 | United India Insurance Co. Ltd. |
| 32 | Universal Sompo General Insurance Co. Ltd. |
1.5 Pension Funds
Pension Funds (PNFs) have grown rapidly to become the primary vehicle of retirement benefit or retirement saving, and retirement income in many countries. A Pension Plan (PP) is an arrangement to provide income to participants in the plan when they retire. PPs are generally sponsored by private employers, government as an employer, and labour unions. They may be Funded Pension Plans (FPPs) or Unfunded Pension Plans (UPPs). If the benefits promised by the PP are secured by assets specifically dedicated for that purpose, it is called a FPP. If the fulfilment of the promised benefits by the sponsor depends on the general credit and not by any specific contribution to be made year after year, it is called an UPP. There may also be Individual Retirement Pension Plans (IRPPs).
Classification of Pension Plans - The financial intermediary, or an organisation, or an institution, or a trust that manages the assets and pays the benefits to the old and retirees is called a Pension Fund (PNF). Some pension plans are said to be insured i.e., in such cases, the sponsor pays premiums to a life insurance company in exchange for a group annuity that would pay retirement benefits to the participants.
Another classification of PPs is:
These are discussed below:
i. Defined Benefits Pension Plan (DBPP)
Under DBPP, the final pension is pre-defined based on the final salary and the period of service. Most of the pension plans offered by public sector enterprises and the government as employer in India are of DBPP variety. This type ensures a predictable amount of pension to the employees for all the years after their retirement and it is guaranteed by the State. DBPPs involve considerable cost to the employer. The firms with DBPP typically establish a legally separate trust fund, and the trustees invest employers’ contributions in shares and bonds.
ii. Defined Contribution Pension Plan (DCPPs)
It is popular in US, do not guarantee the amount of final benefit which the employees would get after they retire. In DCPP, the employee and employer make a pre-determined contribution each year, and these funds are invested over the period of time till the retirement of employee. Whatever the value of these investments at the time of retirement, the employee will get a certain amount which he would use to purchase an annuity. From the point of view of the employer. DCPP is also known as “money purchase pension plan”.
iii. Pay-As-You-Go-Pension Plan (PAYGPP)
In most European countries, including France and Germany, pensions are paid through PAYGPP, under which the current employees pay a percentage of their income to provide for the old, and, this, along with the contribution of the State, goes as a pension that sustains the older generation. In US, there has been a trend towards a decline in DBPPs and an increase in DCPPs.
Management of Pension Funds
Some sponsors of pension plans manage their pension funds themselves, but most of the sponsors appoint a trustee to do so on their behalf. This trustee is usually a trust department of a commercial bank, or an insurance company, or a mutual fund. The trustee manager invests contributions provided by the sponsor and pays benefits to the retired persons.
In case of DBPPs, the assets of the PNF remain the property of the sponsor, who sets general investment policy in respect of portfolio composition, target return, quality of securities, etc. The fund manager takes day-today decisions on buying or selling specific assets. Some large sponsors may divide the management of their PNFs among several trustee-managers.
There are certain advantages in managing PNFs by outside trustees: (a) Transaction costs are lower. The trustee has greater expertise and he possesses all the necessary personnel, equipment, and expertise in regulatory requirements, (b) It enhances the credibility of the pension plan.
Pension System in India
In India, the pension system coverage is very small at present. The pension market in India is highly unorganised which covers hardly three per cent of the Indian population. The Employees’ Provident Fund (EPF), Employees’ Pension Scheme (EPS), and the PPF are the only schemes, which cover the pension market in India. The regular salaried employees in the organised sector have been relatively better off in that public policy provided vehicles for compulsory savings and old age provisions. It is estimated that, around 23% of people employed in the government sector were the beneficiaries of the government’s ‘defined benefit pension scheme’, and 49 per cent of people employed in the private sector were covered by the mandatory employee provident fund.
Last seven years, from 2000 to 2007, have seen a marked shift in pension policy in India through introduction of a new pension system. OASIS committee has recommended two major pension reforms for the government employees and the unorganised sector respectively. These efforts culminated in setting up of the Pension Fund Regulatory and Development Authority in October 2003.
The Pension Fund Regulatory and Development Authority (PFRDA) was established by the Government of India on August 23, 2003 to promote old age income security by establishing, developing and regulating pension funds, to protect the interests of subscribers to schemes of pension funds and for matters connected therewith or incidental thereto. The authority consists of a Chairperson and not more than five members, of whom at least three shall be whole-time members, to be appointed by the Central Government.
The pension schemes in operation in India currently can broadly be divided into the following categories:
(1) Civil Services Pension Schemes (Pay as- you-go), (2) Employees’ Provident Fund (EPF), (3) Employees’ Pension Scheme (EPS). (4) New Pension Scheme (NPS), (5) Voluntary Pension Schemes under which two schemes are in operation such as (i) Personal / Group Pension Plans, (ii) Public Provident Fund.
Current Pension Schemes
Some of the pension schemes available in India at present are:
i. Government Employees’ Pension Scheme: The Government Employees’ Pension Scheme (GEPS), which has been made mandatory from 1995. It is a subset of Employees’ Provident Fund (EPF). It provides (a) superannuation pension, (b) retirement pension, (c) permanent total disability pension, (d) widow or widower’s pension, and (e) orphan pension. It is essentially a defined-contribution and defined benefit pay- as-you-go scheme, which is financed by diverting 8.33 per cent of the employers’ existing share of PF
The Central government contributes an amount equivalent to 1.16 percent of a worker’s salary. The scheme provides a minimum pension of ₹ 500 per month and a maximum pension of 60 per cent of the salary. All assets and liabilities of the erstwhile Family Pension Fund Scheme, 1971 have been transferred to this GEPS, 1995 scheme. After the introduction of this scheme, the employees who had enrolled in the LIC pension schemes will also obtain pension benefits from GEPS, which is also known as Employees Pension Scheme (EPS), 1995. However, only the scheme (Pension and Provident Fund Scheme for employees of establishments covered under the Employees Provident Fund Act, 1952) run by Central Provident Fund Commissioner (CPFC) is eligible for the government contribution of 1.16 per cent of salary, thereby discouraging establishments to seek exemption from running their own schemes. The employers who want to be exempted have to contribute the balance 1.16 per cent of the salary, thereby ensuring that a contribution rate of 9.5 per cent is maintained for both exempted and non-exempted schemes. All benefits from exempted schemes have to be at least equal to those provided under the EPS 1995. Employers who do not wish to contribute to centrally administered EPF can set up their own trustee managed funds and seek the same exemption from Employees’ Provident Fund Organisation.
The EPF and EPS funds are invested mainly in government securities and government special deposit schemes, and individual employees do not have any say in the choice of investments.
ii. BEPS and IEPS: Bank Employees Pension Scheme (BEPS), 1993, and Insurance Employees Pension Scheme (IEPS), 1993 are for the benefit of the employees of public sector banks, and government owned insurance companies They are financed by the entire employer’s portion of the PF contribution which is 10% of the basic salary. The main benefit under these schemes (after superannuation at 60 years of age or after 33 years of service) is in the form of a pension of 50% of the average basic salary during the last 10 months of employment. An additional benefit of 50% of the average of the allowances which rank for the PF but not for DA during the last 10 months of service is also provided to the employees, and this amounts to 2-4% of the employee’s salary.
iii. Privately Administered Superannuation Fund: So far, the private sector has been kept out in respect of setting up and running of pension funds; they have been run by the government or semi-government If any employer sets up a privately administrated superannuation fund, it is stipulated that he can accumulate funds in the form of an irrevocable trust fund during the employment period of the employee concerned, but when the pension becomes payable, suitable annuities have to be purchased from the LIC.
Alternatively, the employer can have a superannuation scheme with the LIC and pay suitable contributions for the employees in service.
LIC has introduced 4 pension plans in the recent past:
1.6 Alternative Investment Funds (AIF): Angel Fund, Venture Capital Fund, Private Equity Fund and Hedge Funds
Alternative Investment Fund (AIF) means any fund established or incorporated in India which is a privately pooled investment vehicle which collects funds from sophisticated investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors.
AIF does not include funds covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999 or any other regulations of the SEBI to regulate fund management activities. Further, certain exemptions from registration are provided under the AIF Regulations to family trusts set up for the benefit of ‘relatives’ as defined under the Companies Act, 1956, employee welfare trusts or gratuity trusts set up for the benefit of employees, ‘holding companies’ within the meaning of Section 4 of the Companies Act, 1956 etc. [Ref. Regulation 2(1)(b) of the SEBI]
Categories of AIF
Category -I AIFs
AIFs which invest in start-up or early-stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds as may be specified. [Ref. Regulation 3(4)(a)]
Category -II AIFs
AIFs which do not fall in Category I and III and which do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in the SEBI (Alternative Investment Funds) Regulations, 2012. [Ref. Regulation 3(4)(b)] Various types of funds such as real estate funds, private equity funds (PE funds), funds for distressed assets, etc. are registered as Category II AIFs.
Category -III AIFs
AIFs which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. [Ref. Regulation 3(4)(c)] Various types of funds such as hedge funds, PIPE Funds, etc. are registered as Category III AIFs.
Angel Fund
“Angel fund” is a sub-category of Venture Capital Fund under Category I Alternative Investment Fund that raises funds from angel investors and invests in accordance with the provisions of Chapter III-A of AIF Regulations. In case of an angel fund, it shall only raise funds by way of issue of units to angel investors.
Angel funds shall accept, up to a maximum period of 3 years, an investment of not less than ₹ 25 lakh from an angel investor.
“Angel investor” means any person who proposes to invest in an angel fund and satisfies one of the following conditions, namely,
Investment in Angel Funds
Section 19D of the SEBI regulations state
Investment by Angel Funds
As per Section 19F of the SEBI regulations:
Angel funds shall invest only in venture capital undertakings which:
Explanation I: For the purpose of this clause, “industrial group” shall include a group of body corporates with the same promoter(s)/promoter group, a parent company and its subsidiaries, a group of body corporates in which the same person/ group of persons exercise control, and a group of body corporates comprised of associates/sub- sidiaries/holding companies.
Explanation II: For the purpose of this clause, “group turnover” shall mean combined total revenue of the in- dustrial group.
Provided that the compliance to this sub-regulation shall be ensured by the Angel Fund at the end of its tenure.
Venture Capital Fund
Venture Capital funding is different from traditional sources of financing. Venture capitalists finance innovation and ideas which have potential for high growth but with inherent uncertainties. This makes it a high-risk, high return investment. Apart from finance, venture capitalists provide networking, management and marketing support as well. In the broadest sense, therefore, venture capital connotes risk finance as well as managerial support. In the global venture capital industry, investors and investee firms work together closely in an enabling environment that allows entrepreneurs to focus on value creating ideas and venture capitalists to drive the industry through owner- ship of the levers of control in return for the provision of capital, skills, information and complementary resources. This very blend of risk financing and hand holding of entrepreneurs by venture capitalists creates an environment particularly suitable for knowledge and technology-based enterprises.
As per the 2(1)(z) of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, “Venture Capital Fund” means an Alternative Investment Fund which invests primarily in unlisted securities of start-ups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based activities or a new business model and shall include an angel fund as defined under Chapter III-A of the SEBI regulations.
Minimum investment in a Venture Capital Fund
Private Equity Fund
As per the section 2(1)(r) of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, “private equity fund” means an Alternative Investment Fund which invests primarily in equity or equity linked instruments or partnership interests of investee companies according to the stated objective of the fund.
Hedge Funds
Hedge funds are private investment vehicles not open to the general investment public. Hedge funds face less regulation than publicly traded mutual funds, allowing them to hold substantial short positions to preserve capital during market downturns. Typically, hedge fund managers generate profit from both long as well as short positions. the private nature of hedge funds often suits both the needs of investors and managers.
Futures of Hedge fund
Hedging strategies adopted in case of hedge Funds
Benefits of Hedge Funds
1.7 SEBI regulations (including AIF Circulars)
The Securities and Exchange Board of India was established on April 12, 1992 in accordance with the provisions of the Securities and Exchange Board of India Act, 1992.
The Preamble of the Securities and Exchange Board of India describes the basic functions of the Securities and Exchange Board of India as “...to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto”.
Role of SEBI or Steps taken by SEBI for the Development of Capital Markets in India
To introduce improved practices and greater transparency in the capital markets and for capital market develop- ment, the roles of SEBI are:
structural change which will ensure qualitative improvement in the functioning of the mutual funds and require that the AMCs have a minimum net worth of ₹ 6 crores of which the sponsors must contribute at least 40 percent. The SEBS (Mutual Fund) Regulations also provide for an approval of the offer documents of schemes by SEBI. The regulations are intended to ensure that the mutual funds grow on healthy lines and investors’ interest is protected.
Since inception, SEBI issued time to time Acts, Rules, Regulations, Guidelines, Master Circulars, General Orders and Circulars
SEBI Regulations
Capital market is a market for equity shares and long-term debt. In this market, the capital funds comprising of both equity and debt are issued and traded. This also includes private placement sources of debt and equity as well as organized markets like stock exchanges. Capital market includes financial instruments with more than one year maturity. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets (e.g., the money market). The capital market is characterized by a large variety of financial instruments: equity and preference shares, fully convertible debentures (FCDs), non-convertible debentures (NCDs) and partly convertible debentures (PCDs) currently dominate the capital market. However new instruments are being introduced such as debentures bundled with warrants, participating preference shares, zero-coupon bonds, secured premium notes, etc.
Functions of Capital Market
The capital market is an important constituent of the financial system. The functions of an efficient capital market are as follows:
The following are the consituents of capital market:
2.1 Primary and Secondary Markets and its Instruments
Classification of Capital Market
Primary Market
The primary market is a market for new issues. Hence it is also known as new issue market. This refers to the long-term flow of funds from the surplus sector to the government and corporate sector through primary issues and to banks and non-bank financial intermediaries through secondary issues. Funds are mobilized in the primary market through prospectus, rights issues, and private placement.
Types of Issues or Methods of rising Funds in Primary Market
| Public Issue | Rights Issue | Bonus Issue | Private Placement | Bought out deals | Depository Receipts |
|
Initial Public offering (IPO)- this is the offer of sale of securities of an unlisted company for the first time. Follow-on Public Offering (FPO)-This is the offer of sale of securities by listed company |
If a company issue share in the market to raise additional capital, the existing members are given the first preference to apply for new shares in proportion to their existing share holdings. this is known as right issue mentioned in sec 62(1) of companies act 2013. |
Bonus issues are made by the company when it has huge amount of accumulated reserves and wants to capitalize the reserves. Bonus shares are issued on fully paid up shares only, to the existing sharehold- ers free of cost. sec 63 of com- panies act states this. |
|
When the new issued shares of an unlisted company is bought large by investor or by small investors in group it is known as the bought out deal. |
Issue of negotiable equity instruments by Indian companies for rising capital from the international capital market. Example- ADRs, GDRs. |
Participants in the Primary Market:
Procedure of selling securities:
Secondary Market
The secondary market is a market in which existing securities are resold or traded. This market is also known as the stock market. It is a market where buying, selling of those securities which have been granted the stock exchange quotation takes place. In India, the secondary market consists of recognized stock exchanges operating under rules, by-laws and regulations duly approved by the government.
Bombay Stock Exchange (BSE) was established in 1875, it is the oldest stock exchange in India. Subsequently other stock exchanges like in Ahmedabad, Kolkata were established. At present, in India there are 7 stock exchanges operating.
Functions of the Secondary Market
The Indian secondary market can be segregated into two:
The main participants in the secondary market for government securities are entities like primary dealers, banks, financial institutions, and mutual funds.
Difference between Primary and Secondary Market
| Basis | Primary Market | Secondary Market |
| Nature of Securities | It deals with new securities, i.e. securi- ties which were not previously avail- able, and are offered for the first time to the investors. | It is a market for old securities which have been issued already and granted stock exchange quotation. |
| Sale/purchase | Securities are acquired from issuing companies themselves. | Securities are purchased and sold by the investors without any involvement of the companies. |
| Nature of financing | It provides funds to new enterprises & also for expansion and diversification of the existing one and its contribution to company financing is direct. | It does not supply additional funds to com- pany since the company is not involved in transaction. |
| Liquidity | It does not lend any liquidity to the securities. | The secondary market provides facilities for the continuous purchase and sale of securities, thus lending liquidity and mar- ketability to the securities. |
| Organisational difference | It is not rooted in any particular spot and has no geographical existence. it has neither any tangible form nor any administrative organisational set up. | Secondary markets have physical existence in the form of stock exchange and are located in a particular geographical area having an administrative organisation. |
| Requirement | Helps in creating new capital. | Helps in maintenance of existing capital. |
| Volume | Volume of transaction is low as com- pared to secondary market. | Volume of transaction is high as compared to primary market. |
Similarities between Primary and Secondary Market:
Basic Capital Market Insruments
| A. Equity Securities | B. Debt Securities |
| Equity Shares | Debentures |
| Preference Shares | Bonds |
These two types of securities are traded in separate markets in stock exchanges. They are briefly outlined as under:
Where the public or rights issue of debt security of issue greater than ₹ 100 crore or its equivalent are issued, two ratings from two different agencies shall be obtained. in case of issue of debentures with maturity of more than 18 months, the issuer shall also appoint a debenture trustee. The names of the debenture trustees must be stated in the offer document. a company issuing debentures with a maturity of more than 18 months should create a debenture redemption reserve.
Some of the prominent types of debentures are: a) Based on Security- Secured and Unsecured Debentures, b) Based on Registration of the instrument- Registered and Bearer Debentures, c) Based on Convertibility- Fully Convertible Debentures, Zero Interest Fully Convertible Debentures, Partly Convertible Debentures, Non-convertible Debentures, Non- convertible Debentures with Detachable Warrants, Optionally Convertible Debentures , d) Based on Redemption- Redeemable Debentures and Irredeemable Debentures, e) Other Types- Participating Debentures and Debentures with a Floating rate of interestA Debenture is a document issued by a company under its common seal acknowledging a debt to the holders. It is a debt security issued by a company which offers to pay interest for the money it borrows for a certain period. Debenture holders are treated as creditors of the company. As per SEBI guidelines, no public or rights issue of convertible or non-convertible debentures shall be made unless a credit rating from a credit rating agency has been obtained and disclosed in the offer document.Other Financial Instruments that are traded in Market
2.2 Compulsary / Optionally Convertible Financial Insruments, Deep Disscount Bonds
Compulsory / Optionally Convertible Financial Instruments
i. Compulsory Convertible Debenture (CCD)
A compulsory convertible debenture (CCD) is a type of bond which must be converted into stock by a specified date. It is classified as a hybrid security, as it is neither purely a bond nor purely a stock.
ii. Optionally Convertible Debentures (OCD)
These are the debentures that include the option to get converted into equity. the investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.
Advantages of OCD:
a. Issuer
High Equity Line: It is possible to maintain equity price at a high level, by issuing odd-lot shares consequent to conversion of the debentures, and hence lower floating stocks.
Dispensing Ownership: Optionally Convertible Debentures enable to achieve wide dispersal of equity ownership in small lots pursuant to conversion.
Marketability: The marketability of the issue will become significantly easier, and issue expenses can be
expected to come down with the amounts raised becoming more
b. Investor
c. Goverment
Disadvantage of OCD:
Issuer
Investor: There are many regulatory requirements to be complied with for conversion.
iii. Deep Discount Bonds (DDBs)
Deep Discount Bond is a form of zero-interest bonds, which are sold at a discounted value (i.e. below par) and on maturity, the face value is paid to investors. A bond that sells at a significant discount from par value and has no coupon rate or lower coupon rate than the prevailing rates of fixed-income securities with a similar risk profile. They are designed to meet the long term funds requirements of the issuer and investors who are not looking for immediate return and can be sold with a long maturity of 25-30 years at a deep discount on the face value of debentures. Example: Bond of a face value of ₹ 1lakh may be issued for ₹ 5,000 for a maturity value of ₹ 1,00,000 after 20 years.
Periodic Redemption: Issuing company may also give options for redemption at periodical intervals such as 5 Years or 10 Years etc.
No Interest: There is no interest payment during the lock-in / holding period.
Market Trade: These bonds can be traded in the market. Hence, the investor can also sell the bonds in stock market and realize the difference between initial investment and market price.
2.3 Euro Bond and Masala Bond
A Eurobond is a debt instrument that is denominated in a currency other than the home currency of the country or market in which it is issued. Eurobonds are frequently grouped together by the currency in which they are denominated, such as eurodollar or Euro-yen bonds.
Masala Bonds were introduced in India in 2014 by International Finance Corporation (IFC). The IFC issued the first masala bonds in India to fund infrastructure projects.
Masala Bonds are rupee-denominated bonds issued outside India by Indian entities. They are debt instruments which help to raise money in local currency from foreign investors. Both the government and private entities can issue these bonds. Investors outside India who would like to invest in assets in India can subscribe to these bonds. Any resident of that country can subscribe to these bonds which are members of the Financial Action Task Force. The investors who subscribe should be whose securities market regulator is a member of the International Organi- sation of Securities Commission. Multilateral and Regional Financial Institutions which India is a member country can also subscribe to these bonds.
2.4 Rolling Settlement, Clearing House Operations
Rolling Settlement
Settlement refers to the process in which traders who have made purchases make payments while those who have sold shares, deliver them. The exchange ensures that buyers receive their shares and the sellers receive payment for the same. The process of settlement is managed by stock exchanges through clearing Houses. SEBI introduced a new settlement cycle known as the ‘rolling settlement cycle’.
A rolling settlement is the settlement cycle of the stock exchange, where all trades outstanding at the end of the day have to be settled, i.e., the buyer has to make payments for securities purchased and seller has to deliver the securities sold.
Example: In case of t + 1 settlement, transactions entered on a day should be settled within the next working day. in case of t + 2 settlement, settlement should be made within two working days from the date of transaction. In India the rolling settlement process was Trading Day (T) +5 but now it is T+3, made effective from April 2002 i.e all transactions to be settled within 3 working days.
Process of Rolling Settlement
| 1. | Trading | Day of Trading | t |
| 2. | Clearing |
Confirmation of Custodial Delivery Generation |
t+1 t+1 |
| 3. | Settlement |
Securities & Funds Pay in Securities & Funds Pay-out |
t+2 t+2 |
Benefits of Rolling Settlement:
Clearing House Operations (CHO)
Clearing House is a body either owned by or independently associated with an exchange and charged with the function of ensuring the financial integrity of each trade. Orders entered into by members are cleared by means of the clearing house. Clearing Houses provide a range of services related to the guarantee of contracts, clearance and settlement of trades, and management of risk for their members and associated exchanges.
Role of CLearing House
Working of CHO
Example: In a transaction where P sells futures to R, R is replaced by the clearing house and the risk taken by P becomes insignificant. Similarly, the credit risk of R is taken over by the clearing house; thus, the credit risk is now assumed by the clearing house rather than by individuals.
2.5 Dematerialization, Re-materialization and Depository System
Dematerialization
Dematerialization is the process of converting physical certificates to an equivalent number of securities in elec- tronic form and credited into the investor’s account with his / her Depository Participant. In simple terms, it refers to paperless trading. Dematerialized shares do not have any distinctive numbers. These shares are fungible, which means that all the holdings of a particular security will be identical and interchangeable.
Process of Dematerialization
In order to dematerialize physical securities, one has to fill in a DRF (Demat Request Form) which is available with the DP and submit the same along with physical certificates that are to be dematerialized. Separate DRF has to be filled for each ISIN. The complete process of dematerialization is outlined below:
Scheme
Depository and Depository Participant
Advantages: The advantages of holding securities in demat form are -
| Investor's view Point | Issuer-Company's view Point |
| a. It is speedier and avoids delay in transfers. | a. Savings in printing certificates, postage expenses. |
| b. Avoids lot of paper work. | b. Stamp duty wavier |
| c. Saves on stamp duty. | c. Easy monitoring of buying/selling patterns in securities, increasing ability to spot takeover attempts and attempts at price rigging. |
Rematerialisation
Rematerialiation is the process by which a client/ shareholder can get his electronic holdings converted into physical certificates.
Features of Rematerialisation
Process of Rematerialisation
The process is called rematerialisation. If one wishes to get back his securities in the physical form he has to fill in the RRF (Remat Request Form) and request his DP for rematerialisation of the balances in his securities account. The process of rematerialisation is outlined below:
Depository System
A depository is an organisation which holds securities (like shares, debentures, bonds, government securities, mutual fund units etc.) of investors in electronic form at the request of the investors through a registered Depository Participant. It also provides services related to transactions in securities. At present two Depositories viz. National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL) are registered with SEBI.
The increase in the volume of activity on stock exchanges with the advent of on-screen trading coupled with operational inefficiencies of the former settlement and clearing system led to the emergence of a new system called the depository system. The SEBI mandated compulsory trading and settlement of select securities in dematerialized form.
Need for Setting-up a Depository in India
The need was realized in the 1990s due to various reasons as under:
To overcome these problems, the Government of India, in 1996, enacted the Depositories Act, 1996 to start depository services in India.
Depository Process
There are four parties in a demat transaction: the customer, the depository participant (DP), the depository, and the share registrar and transfer agent (R&T). A Depository Participant (DP) is an agent of the depository through which it interfaces with the investor and provides depository services. Public financial institutions, scheduled commercial banks, foreign banks operating in India with the approval of the Reserve Bank of India, state financial corporations, custodians, stock-brokers, clearing corporations /clearing houses, NBFCs and registrar to an issue or Share Transfer Agent complying with the requirements prescribed by SEBI can be registered as DP. Banking services can be availed through a branch whereas depository services can be availed through a DP. The investor has to enter into an agreement with the DP after which he is issued a client account number or client ID number. PAN Card is now mandatory to operate a demat account.
2.6 Initial Public Offering (IPO), Follow on Public Offer (FPO), Book Building, Green-shoe Option
Initial Public Offering (IPO)
An initial public offering (IPO) or stock market launch is a type of public offering where shares of stock in a company are sold to the general public, on a securities exchange, for the first time. Through this process, a private company transforms into a public company. It is an offering of either a fresh issue of securities or an offer for sale of existing securities, or both by an unlisted company for the first time to the public. Initial public offerings are used by companies to raise expansion capital, to possibly monetize the investments of early private inves- tors, and to become publicly traded enterprises. a company selling shares is never required to repay the capital to its public investors. After the IPO, when shares trade freely in the open market, money passes between public investors. Although an IPO offers many advantages, there are also significant disadvantages. Important among these are the costs associated with the process, and the requirement to disclose certain information that could prove helpful to competitors, or create difficulties with vendors. Details of the proposed offering are disclosed to potential purchasers in the form of a lengthy document known as a prospectus. Most companies undertaking an IPO do so with the assistance of an investment banking firm acting in the capacity of an underwriter. Under- writers provide a valuable service, which includes help with correctly assessing the value of shares (share price), and establishing a public market for shares (initial sale). Alternative methods such as the Dutch auction have also been explored. In terms of size and public participation, the most notable example of this method is the LICI IPO.
The SEBI has laid down eligibility norms for entities raising funds through an IPO and an FPO. The entry norms for making an IPO of equity shares or any other security which may be converted into or exchanged with equity shares at a later date are as follows:
A company cannot make a public or rights issue of debt instruments unless it fulfills the following two conditions: credit rating of not less than investment grade is obtained from not less than two SEBI registered credit rating agencies and it should not be in the list of willful defaulters of the reserve Bank. Moreover, it should not have defaulted payment of interest or repayment of principal, if any, for a period of more than six months.
The IPO process in India consists of the following steps:
Follow on Public Offer (FPO)
A follow-on offering (often but incorrectly called secondary offering) is an offer of sale of securities by a listed company. A follow-on offering can be either of two types (or a mixture of both): dilutive and non-dilutive. A secondary offering is an offering of securities by a shareholder of the company (as opposed to the company itself, which is a primary offering). A follow on offering is preceded by release of prospectus similar to IPO: a Follow-on Public Offer (FPO).
For example, Google’s initial public offering (IPO) included both a primary offering (issuance of Google stock by Google) and a secondary offering (sale of google stock held by shareholders, including the founders).In the case of the dilutive offering, the company’s board of directors agrees to increase the share float for the purpose of selling more equity in the company. This new inflow of cash might be used to pay off some debt or used for needed company expansion. When new shares are created and then sold by the company, the number of shares outstanding increases and this causes dilution of earnings on a per share basis. Usually the gain of cash inflow from the sale is strategic and is considered positive for the longer term goals of the company and its shareholders. Some owners of the stock however may not view the event as favorably over a more short-term valuation horizon.
One example of a type of follow-on offering is an at-the-market offering (ATM offering), which is sometimes called a controlled equity distribution. In an ATM offering, exchange-listed companies incrementally sell newly issued shares into the secondary trading market through a designated broker- dealer at prevailing market prices. The issuing company is able to raise capital on an as-needed basis with the option to refrain from offering shares if unsatisfied with the available price on a particular day.
The non-dilutive type of follow-on offering is when privately held shares are offered for sale by company directors or other insiders (such as venture capitalists) who may be looking to diversify their holdings. Because no new shares are created, the offering is not dilutive to existing shareholders, but the proceeds from the sale do not benefit the company in any way. Usually however, the increase in available shares allows more institutions to take non-trivial positions in the company.
As with an IPO, the investment banks who are serving as underwriters of the follow-on offering will often be offered the use of a green shoe or over-allotment option by the selling company.
A non-dilutive offering is also called a secondary market offering. Follow on Public offering is different from initial public offering.
SEBI has introduced fast track issues (FTI) in order to enable well-established and compliant listed companies satisfying certain specific entry norms/conditions to raise equity through follow-on and rights issues. These norms reduce the process of issue and thereby the time period thus enabling issuers a quick access to primary capital mar- ket. Such companies can proceed with follow-on public offers (FPOs)/right issues by filing a copy of Red Herring Prospectus (RHP)/prospectus with the Registrar of Companies (RoC) or the letter of offer with designated stock exchange (SE), SEBI and stock exchanges. Moreover, such companies are not required to file draft offer document for SEBI comments and to stock exchanges as the relevant information is already in the public domain.
Book Building
Book building means a process by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for such securities is assessed for the determination of the quantum of such securities to be issued by means of notice/ circular / advertisement/ document or information memoranda or offer document. It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at various prices, which are within the price band specified by the issuer. The process is directed towards both the institutional as well as the retail investors. The issue price is determined after the bid closure based on the demand generated in the process.
The book-building system is part of Initial Public Offer (IPO) of Indian Capital Market. It was introduced by SEBI on recommendations of Mr. Y.H. Malegam in October 1995. It is most practical, fast and efficient management of mega issues. Book building involves sale of securities to the public and the institutional bidders on the basis of predetermined price range.
Book Building Process
requisite system of online offer of securities.
Advantages of Book Building
Disadvantages of Book Building
Green-shoe Option
Green shoe option is the option for stabilisation of the post-listing price of securities in a public issue by allotting excess shares. An issuer may provide green shoe option for stabilisation of the post-listing price of its securities by allotting excess shares. Up to 15 per cent of the issue size may be borrowed by the stabilising agent from the promoters/pre-issue shareholders holding more than 5 per cent of the securities.
As per the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000: an issuer company making a public offer of equity shares can avail of the Green Shoe Option (GSO) for stabilizing the post listing price of its shares, subject to the provisions.
2.7 Offer for Sale, Private Placement and Preferential Allotment
Offer for Sale
Offer for sale (OFS), introduced by SEBI, in February 2012, helps promoters of listed companies to dilute their stake through an exchange platform. The promoters are the sellers. The bidders may include market participantsuch as individuals, companies, qualified institutional buyers (QIBs) and foreign institutional investors (FII). The facil- ity is available on the BSE Limited (BSE) and National Stock Exchange of India Limited (NSE).
Size of the offer for Sale of Shares
Eligible Buyer(s)
Private Placement and Preferential Allotment
When an issuer makes an issue of shares or convertible securities to a select group of persons not exceeding 49 persons, and which is neither a rights issue nor a public issue, it is called a private placement. Private placement of shares or convertible securities by listed issuer can be of three types:
2.8 Insider Trading
It is buying or selling or dealing in securities of a listed company by director, member of management, an employee or any other person such as internal or statutory auditor, agent, advisor, analyst consultant etc. who have knowledge of material, ‘inside’ information not available to general public.
Illegal: Dealing in securities by an insider is illegal when it is predicated upon utilization of inside information to profit at the expense of other investors who do not have access to such investment information. It is prohibited and is considered as an offence as per SEBI (Insider Trading) regulations,1992.
Punishable: Insider trading is an unethical practice resorted by those in power, causing huge losses to common investors thus driving them away from capital market, and hence punishable.
Three decades have passed since the SEBI (Prohibition of Insider Trading) Regulations, 1992 were notified which was framed to deter the practice of insider trading in the securities of listed companies. Since then there have been several amendments to the regulations and judicial paradigm through case laws have also evolved in India. in fact, world over, the regulatory focus is shifting towards containing the rising menace of insider trading effectively. To ensure that the regulatory framework dealing with insider trading in India is further strengthened, SEBI seeks review of the extant insider trading regulatory regime in India.
The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations 1992 requires that a person who is connected with a listed company and is in possession of any unpublished price sensitive information likely to materially affect the price of securities of company, shall not:
Accordingly, SEBI has constituted a High-Level Committee under the Chairmanship of Hon’ble Justice Mr. N. K. Sodhi, retired Chief Justice of Karnataka High Court and Former Presiding officer of the Securities Appellate Tribunal, for reviewing the SEBI (Prohibition of Insider Trading) Regulations, 1992.
With a moto to strengthen the insider trading regulations further in India SEBI decided to review the existing regulations of Insider Trading hence and formed a committee under Chairmanship of Hon’ble Justice N. K. Sodhi. The committee formed by SEBI after several discussions has proposed a new regulation in place of the existing regulations. Based on their recommendation and proposal the new regulations have been approved by SEBI in its Board meeting held on November 19, 2014. Finally SEBI (Prohibition of Insider Trading) Regulations 2015 has been notified in January 2015 and has been made effective from May 2015. The objective of this amendment is to strengthen the legal framework of insider trading. Those recent changes relating to insider trading are strengthened the legal and enforcement framework, aligning insider trading norms with international practices, clarity in some definitions and concepts and lastly facilitating legitimate business transactions.
The SEBI further amended the regulations in August, 2021 which states that the reward has been increased from ₹ 1 crore to ₹ 10 crores.
2.9 Credit Rating - Credit Rating Methods and Rating Agencies in India
Credit rating is the assessment of a borrower’s credit quality. it is the assessment carried out from the viewpoint of credit-risk evaluation on a specific date, on the quality of a-
Areas of Assessment: Assessment is done on the: -
Need for Credit Rating:
A firm has to ascertain the credit rating of prospective customers, to ascertain how much and how long can credit be extended. credit can be granted only to a customer who is reliably sound. this decision would involve analysis of the financial status of the party, his reputation and previous record of meeting commitments.
Features:
Ratings are expressed in alphabetical or alphanumeric symbols, enabling the investor to differentiate between debt instruments based on their underlying credit quality.
Credit Rating do not measure the following:
Objectives:
Limitations:
Methods /Process of Credit Rating:
The steps involved in the Credit Rating are:
Various Credit Rating Agencies in India
There are seven credit rating agencies registered with the SEBI at present. They are outlined as follows:
1. CRISIL Ratings Limited (Formerly the Credit Rating Information Services of India Limited):
Rating Symbols used by CRISIL
| Long Term Debt instruments | Short - Term Debt instruments | ||
| Earlier Rating Symbol | Revised Rating Symbol | Earlier Rating Symbol | Revised Rating Symbol |
| AAA | CRISIL AAA | P1 | CRISIL A1 |
| AA | CRISIL AA | P2 | CRISIL A2 |
| A | CRISIL A | P3 | CRISIL A3 |
| BBB | CRISIL BBB | P4 | CRISIL A4 |
| BB | CRISIL BB | P5 | CRISIL D |
| B | CRISIL B | ||
| C | CRISIL C | ||
| D | CRISIL D | ||
2. ICRA limited (Formerly Investment Information and Credit Rating Agency of India):
Rating Symbols used by ICRA
| Long-Term Debt instruments | Short-Term Debt instruments | ||
| Earlier Rating Symbol | Revised Rating Symbol | Earlier Rating Symbol | Revised Rating Symbol |
| LAAA | ICRA AAA | A1 | ICRA A1 |
|
LAA LA |
ICRA AA ICRA A |
A2 A3 |
ICRA A2 ICRA A3 |
| LBBB | ICRA BBB | A4 | ICRA A4 |
| LBB | ICRA BB | A5 | ICRA D |
|
LB LC |
ICRA B ICRA C |
||
| LD | ICRA D | ||
3. Care Ratings Limited (Credit Analysis and Research Limited)
Rating Symbols used by CARE
| Long-Term Debt instruments | Short-term Debt instruments | ||
| Earlier Rating Symbol | Revised Rating Symbol | Earlier Rating Symbol | Revised Rating Symbol |
| AAA | CARE AAA | PR-1 | CARE A1 |
| AA | CARE AA | PR-2 | CARE A2 |
|
A BBB |
CARE A CARE BBB |
PR-3 PR-4 |
CARE A3 CARE A4 |
|
BB B |
CARE BB CARE B |
PR-5 | CARE D |
| C | CARE C | ||
| D | CARE D | ||
4. India Ratings and Research Ltd. (Formerly Fitch Ratings India Pvt. Ltd.):
Fitch Rating India was formerly known as DCR India- Duff and Phelps Credit Rating Co. Fitch Ratings, USA and DCR India merged to form a new entity called Fitch India. Fitch India is a 100% subsidiary of fitch ratings, USA and is the wholly owned foreign operator in India. fitch is the only international rating agency with a presence on the ground in India. fitch rating India rates corporates, banks, financial institutions, structured deals, securitized paper, global infrastructure and project finance, public finance, SMEs, asset management companies, and insurance companies.
Rating Symbols used by India Ratings and Research Pvt. Ltd.
| Long-Term Debt instruments | Short-Term Debt instruments | ||
| Earlier rating Symbol | Revised Rating Symbol | Earlier Rating Symbol | Revised Rating Symbol |
| AAA (ind) | Fitch AAA | F1 (ind) | Fitch A1 |
|
AA (ind) A(ind) |
Fitch AA Fitch A |
F2 (ind) F3 (ind) |
Fitch A2 Fitch A3 |
|
BBB (ind) BB (ind) |
Fitch BBB Fitch BB |
F4 (ind) F5 (ind) |
Fitch A4 Fitch D |
| B (ind) | Fitch B | ||
| C (ind) | Fitch C | ||
| D | Fitch D | ||
5. Brickwork Ratings India Private Limited
It is the fifth agency in the ratings business which commenced its activities from September 24, 2008. It rates IPOs, perpetual bonds of banks, non-convertible debenture issues, and certificate of deposits.
Brickwork Ratings India Private Limited
| Long-term Instruments | Short-Term Instruments |
| BWR AAA (BWR Triple A) | BWR A1 |
| BWR AA (BWR Double A) | BWR A2 |
|
BWR A BWR BBB (BWR Triple B) |
BWR A3 BWR A4 |
|
BWR BB (BWR Double B) BWR B |
BWR D |
| BWR C | |
| BWR D |
6. Acuite Ratings & Research Limited (Formerly SMERA):
Acuite Ratings & Research Limited (www.acuite.in) is a full-service credit rating agency accredited by Reserve Bank of India (RBI) as an External Credit Assessment Institution (ECAI) and registered with the Securities and Exchange Board of India (SEBI). This CRA started its first bond rating in 2012 and has a track record of over 5 years in rating the entire range of debt instruments including NCDs, Commercial Paper and Bank Loan Ratings (BLR).
Ratings Symbols used by Acuite Ratings & Research Limited
For Long Term Instruments
| Ratings | Interpretation |
|
ACUITE AAA ACUITE AA |
Heighest Safety, Lowest Credit Risk High Safety, Very Low Credit Risk |
| ACUITE A | Adequate safety, Low Credit Risk |
|
ACUITE BBB ACUITE BB ACUITE B ACUITE C ACUITE D |
Moderate Safety, Moderate Credit Risk Moderate Risk, Moderate Risk of Default High Risk, High Risk of Default Very High Risk, Very High Risk of Default Default / Expected to be in Default soon |
For Short Term Instrument
| Ratings | Interpretation |
|
ACUITE A1 ACUITE A2 ACUITE A3 |
Very Strong degree of Safety, Lowest Credit Risk Strong degree of safety, Low credit risk Moderate degree of safety, Higher credit risk as compared to instruments rated in the two higher categories |
|
ACUITE A4 ACUITE D |
Minimal degree of safety, Very High Credit Risk Default / Expected to be in Default in Maturity |
7. Infomerics Valuation and Rating Ltd.
Infomerics Valuation and Rating Private Limited is a SEBI registered and RBI accredited Credit Rating Agency in the year 2015.
Rating symbols used by Informerics Valuation and Rating Pvt. Ltd.
| Long Term structured Finance Instruments | Long Term Debt Instruments |
|
IVR AAA(SO) IVR AA(SO) IVR A(SO) IVR BBB(SO) IVR BB(SO) |
IVR AAA IVR AA IVR A IVR BBB IVR BB |
|
IVR B(SO) IVR C(SO) IVR D(SO) |
IVR B IVR C IVR D |
Money market is the market for dealing in monetary assets of short-term in nature. Short-term funds up to one year and for financial assets that are close substitutes for money are dealt in the money market. It is not a physical location (like the stock market), but an activity that is conducted over the telephone. Money market instruments have the characteristics of liquidity (quick conversion into money), minimum transaction cost and no loss in value. Excess funds are deployed in the money market, which in turn is availed to meet temporary shortages of cash and other obligations.
Money market provides access to providers (financial and other institutions and individuals) and users (comprising institutions and government and individuals) of short-term funds to fulfill their borrowings and investment requirements at an efficient market-clearing price. The rates struck between borrowers and lenders represent an array of money market rates. The interbank overnight money rate is referred to as the call rate. There are also a number of other rates such as yields on treasury bills of varied maturities. The instruments were limited to call (overnight) and short notice (up to 14 days) money, inter-bank deposits and loans and commercial bills. Interest rates on market instruments were regulated. Sustained efforts for developing and deepening the money market were made only after the initiation of financial sector reforms in early nineties.
Features of Money Market:
a. Instruments Traded: Money market is a collection of instruments like Call Money, Notice Money, Repos, Term Money, Treasury Bills, Commercial Bills, Certificate of Deposits, Commercial Papers, Inter-Bank Participation Certificates, Inter Corporate Deposits, Swaps,
b. Large Participants : The participants of money market are — (i) lenders, (ii) mutual funds, (iii) financial institutions including the RBI, Scheduled Commercial Banks, Discount and Finance House of India and (iv) Network of a large number of Participants exists which add greater depth to the market. This network can be broadly classified as follows:
Organized Sector
Unorganised Sector
c. Zone Centric Activities: Activities in the money market tend to concentrate in some centre, which serves a region or an area. The width of such area may vary depending upon the size and needs of the market itself.
d. Pure Competition: Relationship between participants in a money market is impersonal in character, and the competition is relatively pure.
e. Lower Price Differentials: Price differentials for assets of similar type tend to be eliminated by the interplay of demand and supply.
f. Flexible Regulations: Certain degree of flexibility in the regulatory framework exists and there are constant endeavours for introducing a new instruments / innovative dealing technique.
g. Market Size: It is a wholesale market and the volume of funds or financial assets traded are very large, i.e., in crores of rupees
Major characteristics of money market instruments are:
3.1 Call Money
Call/Notice money is an amount borrowed or lent on demand for a very short period. If the period is more than one day and upto 14 days, it is called notice money and if the period is more than 14 days, it is called call money.
Exclusions: Intervening holidays and / or Sundays are excluded for this purpose. No collateral security is re- quired to cover these transactions.
| Nature of Persons | Persons |
| Borrow and Lend Lenders |
Reserve Bank of India (RBI) through lAFS, Banks, Primary Dealers (PD) Financial Institutions such as: - a. Life insurance corporation of India (LIC) |
| b. Unit Trust of India (UTI) and other mutual funds | |
| c. General Insurance Corporation (GIC) | |
|
d. Industrial Development Bank of India (IDBI) e. National Bank for Agricultural and Rural Development (NABARD) f. Industrial Credit Investment Corporation of India (ICICI) |
Benefits:
Nature of Call Money Market
Call money represents the amount borrowed by the commercial banks from each other to meet their temporary funds requirements. The market for such extremely short period loans is referred to as the “call money market”. Call loans in India are given:
Among these uses, inter-bank use has been the most significant. These loans are given for a very short duration, between 1 day to 15 days. There are no collateral securities demanded against these loans i.e., unsecured. The bor- rower has to repay the loans immediately they are called for i.e., highly liquid. As such, these loans are described as “call loans” or “call money”.
3.2 Treasury Bills
Treasury bills are short-term instruments issued by the Reserve Bank on behalf of the government to tide over short-term liquidity shortfalls. This instrument is used by the government to raise short-term funds to bridge sea- sonal or temporary gaps between its receipts (revenue and capital) and expenditure. They form the most important segment of the money market not only in India but all over the world as well.
T-bills are repaid at par on maturity. The difference between the amount paid by the tenderer at the time of pur- chase (which is less than the face value) and the amount received on maturity represents the interest amount on T-bills and is known as the discount. Tax deducted at source (TDS) is not applicable on T-bills.
Features of T-bills
Issue Price: Treasury Bills are issued at a discount and redeemed at face value.
Investors: Banks, Primary Dealers, State governments, Provident funds, financial institutions, Insurance compa- nies, NBFCs, FIIs (as per prescribed norms), NRIs can invest in T-Bills.
Participants in the T-Bills Market: The Reserve Bank of India, commercial banks, mutual funds, financial institutions, primary dealers, provident funds, corporates, foreign banks, and foreign institutional investors are all participants in the T-bills market. The state governments can invest their surplus funds as non-competitive bidders in T-bills of all maturities.
Yield in Treasury Bills: It is calculated as per the following formula:
Yield = (100-P / P) x (365 / D) x 100
Where,
P = Purchase price D= Days to maturity
Day Count for Treasury Bill: Actual number of days to maturity/ 365
Example
Assuming that the price of a 91 -Day Treasury Bill issues at ₹98.20, the yield on the same would be-
If the same T-Bill traded after 41 days ₹99, the yield then would be
Types of Treasury Bills
At present, the Reserve Bank issues T-bills of three maturities: 91-day, 182-day, and 364-day.
1. 91 Day T-Bills
These are again two types- ordinary and ad-hoc. Ordinary treasury bills are issued to public and RBI for enabling central government to meet temporary requirements of funds. Treasury bills were used to be sold to public at a fixed rate throughout the week to commercial banks and the public. They are repaid at par on maturity. The difference between the amount paid by the tenderer at the time of purchase and the amount received on maturity represents the interest earned and also known by discount.
2. 182 Day T-Bills
These bills were reintroduced in 1999 to enable the development a market for government securities. The Reserve Bank of India introduced 182 days Treasury Bills, as an active money market instrument with flexible interest rates. Features of these T-Bills are:
3. 364 Day T-Bills
In April 1992, the 364-day T-bills were introduced to replace the 182-day T-bills. These T-bills are issued to generate market loans. The auction of these bills is done fortnightly, as their issue has become a regular activity by the Central Government. These bills offer short-term investment offer for investors and created good response. RBI offers these bills periodically and auctions by giving an opportunity to banks and other financial institutions. The Government of India has now floated Treasury bills of varying maturities upto 364 days on an auction basis which are identical to that for the 182 days treasury bills. They contain varying period of maturities help the short-term investors to decide on the period of investment of their funds.
3.3 Commercial Bills
The working capital requirement of business firms is provided by banks through cash-credits / overdraft and purchase/discounting of commercial bills.
Commercial bill is a short term, negotiable, and self-liquidating instrument with low risk. It enhances the liability to make payment in a fixed date when goods are bought on credit. The bill of exchange is a written unconditional order signed by the drawer requiring the party to whom it is addressed to pay on demand or at a future time, a defi- nite sum of money to the payee. It is negotiable and self-liquidating money market instrument which evidences the liquidity to make a payment on a fixed date when goods are bought on credit. It is an asset with a high degree of liquidity and a low degree of risk. Such bills of exchange are discounted by the commercial banks to lend credit to the bill holder or to borrow from the Central Bank. The bank pays an amount equal to face value of the bill minus collection charges and interest on the amount for the remaining maturity period. The writer of the bill (debtor) is drawer, who accept the bill is drawee and who gets the amount of bill is payee.
Types of Commercial Bills
Commercial bills can be inland bills or foreign bills.
Inland bills must:
Foreign bills, on the other hand, are:
Purpose:
Commercial Bills may be used for financing the movement and storage of goods between countries, before ex- port (pre-export credit), and also within the country. In India, the use of bill of exchange appears to be in vogue for financing agricultural operations, cottage and small-scale industries, and other commercial and trade transactions.
The indigenous variety of bill of exchange for financing the movement of agricultural produce, called a ‘hundi’ has a long tradition of use in India it is vogue among indigenous bankers for raising money or remitting funds or to finance inland trade. A hundi is an important instrument in India; so indigenous bankers dominate the bill market. However, with reforms in the financial system and lack of availability of funds from private sources, the role of indigenous bankers is declining.
3.4 Commercial Paper
Commercial paper (CP) is an unsecured short-term promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is issued only by large, well known, creditworthy companies and is typically unsecured, issued at a discount on face value, and redeemable at its face value. the aim of its issuance is to provide liquidity or finance company’s investments, e.g., in inventory and accounts receivable.
The major issuers of commercial papers are financial institutions, such as finance companies, bank holding companies, insurance companies. Financial companies tend to use CPs as a regular source of finance. Non-financial companies tend to issue CPs on an irregular basis to meet special financing needs.
Commercial paper was introduced in 1990 to enable highly rated investors to diversify their sources, of their short-term borrowings and also to produce an additional instrument in the market. Guidelines issued by RBI are applicable to issuers of CP like Non-banking Finance Companies and non-financial companies. Primary dealers are also permitted to issue commercial paper. CP should be issued for a minimum period of 7 days to a maximum period of one year. No grace period is allowed for payment and if the maturity date falls on a holiday it should be paid on the previous working day. Commercial paper can be permitted to be issued by the companies whose tangible net worth is not less than ₹ 4 crore and fund based working capital limits are not less than ₹4 crore. It must be a listed company on a stock exchange and should have given credit rating by CRISIL.
The difference between the initial investment and the maturity value, constitutes the income of the investor. e.g. a company issues a commercial Paper each having maturity value of ₹ 5,00,000. The investor pays (say) ₹ 4,82,850 at the time of his investment. On maturity, the company pays ₹ 5,00,000 (maturity value or redemption value) to the investor. The Commercial Paper is said to be issued at a discount of ₹ 5,00,000 - ₹ 4,82,850 = ₹ 17,150. This constitutes the interest income of the investor.
Advantages
RBI Guidelines in respect of issue of Commercial Paper
1. Eligible issuers of CP: (a) Corporates, (b) Primary Dealers (PDs), and (c) All-India Financial Institutions (FIs) that have been permitted to raise short-term resources under the umbrella limit fixed by RBI are eli- gible to issue CP.
2. Investors for CP: CP may be issued to and held by —
3. Maturity: CP can be issued for maturities between a minimum of 7 days and a maximum up to one year from the date of issue. Maturity date of CP should not go beyond the date up to which the credit rating of the issuer is valid.
4. Denominations: CP can be issued in denominations of ₹ 5 lakh or multiples Amount invested by a single investor should not be less than ₹ 5 lakh (face value).
5. Basic issue conditions for a corporate: A Corporate would be eligible to issue CP provided –
6. Credit Rating: All eligible participants shall obtain the credit rating for issuance of CP from –
Minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies. At the time of issuance of CP, the rating so obtained should be current and not fallen due for review.
7. Amount of CP:
8. Time Period: The total amount of CP proposed to be issued should be raised within two weeks from the date on which the issue is open for subscription. Every CP issue shall be reported to the RBI, through the Issuing and Paying Agent (IPA) within three days from the date of completion of the issue.
9. Mode of Issuance: The following points are relevant –
10. Issuing and Paying Agent (IPA): Only a scheduled bank can act as an IPA for issuance of Every issuer must appoint an IPA for issuance of CP.
11. Procedure for Issuance: Issuer should disclose its financial position to the potential investors. After the exchange of deal confirmation, issuing Company shall issue physical certificates to the investor or arrange for crediting the CP to the investor’s account with a Investors shall be given a copy of IPA cer- tificate to the effect that the issuer has a valid agreement with the IPA and documents are in order.
12. Mode of Investment in CP: The investor in CP shall pay the discounted value (issue price) of the CP by means of a crossed account payee cheque to the account of the issuer through IPA.
13. Repayment of CP on Maturity: On maturity of CP, when the CP is held in physical form, the holder of the CP shall present the instrument for payment to the issuer through the When the CP is held in demat form, the holder of the CP will get it redeemed through the depository and receive payment from the IPA.
14. Defaults in CP Market: In order to monitor defaults in redemption of CP, Scheduled Banks which act as IPAs, shall immediately report, on occurrence, full particulars of defaults in repayment of CPs to the
15. Stand-by Facility: Non-bank entities including corporates may provide unconditional and irrevocable guarantee for credit enhancement for CP issue provided –
3.5 Certificate of Deposits (CD)
CD is a negotiable money market instrument and issued in dematerialized form or as a usance promissory note, for funds deposited at a Bank or other eligible Financial Institution for a specified time period.
Salient Features:
CDs are issued by Banks, when the deposit growth is sluggish and credit demand is high and a tightening trend in call rate is evident. CDs are generally considered high-cost liabilities and banks have recourse to them only under tight liquidity conditions.
Important RBI guidelines are as follows:
3.6 Repo, Reverse Repo
Repo or ready forward contact is an instrument for borrowing funds by selling securities with an agreement to repurchase the said securities on a mutually agreed future date at an agreed price which includes interest for the funds borrowed. Repo rate is the return earned on a repo transaction expressed as an annual interest rate.
The Reverse of the repo transaction is called ‘reverse repo’ which is lending of funds against buying of securities with an agreement to resell the said securities on a mutually agreed future date at an agreed price which includes interest for the funds lent.
It can be seen from the definition above that there are two legs to the same transaction in a repo/ reverse repo. The duration between the two legs is called the ‘repo period’. Predominantly, repos are undertaken on overnight basis, i.e., for one day period. Settlement of repo transactions happens along with the outright trades in government securities.
The consideration amount in the first leg of the repo transactions is the amount borrowed by the seller of the security. On this, interest at the agreed ‘repo rate’ is calculated and paid along with the consideration amount of the second leg of the transaction when the borrower buys back the security. The overall effect of the repo transaction would be borrowing of funds backed by the collateral of Government securities.
Features of Repo:
Participants: Buyer in a Repo is usually a Bank which requires approved securities in its investment portfolio to meet the statutory liquidity ratio (SLR).
Types of Repos:
Interest:
RBI Guidelines:
3.7 Promissory Notes and Government Securities
Promissory Notes
A written, dated and signed two-party instrument containing an unconditional promise by the maker to pay a defi- nite sum of money to a payee on demand or at a specified future date.
Essentials of a Promissory Note:
“Derivative Usance Promissory Notes” (DuPN)
Derivative Usance Promissory Notes is an innovative instrument issued by the RBI to eliminate movement of papers and facilitating easy multiple rediscounting.
Features:
Government Securities
A government security is a tradable instrument issued by the central government or the state governments. It acknowledges the Government’s debt obligation. Such securities are short-term (usually called treasury bills, with original maturities of less than one year) or long-term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State De- velopment Loans (SDLs). Government securities carry practically no risk of default and, hence, are called riskfree gilt-edged instruments. Government of India also issues savings instruments (Savings Bonds, National Saving Certificates (NSCs), etc.) or special securities (oil bonds, Food Corporation of India bonds, fertilizer bonds, power bonds, etc.). They are, usually not fully tradable and are, therefore, not eligible to be SLR securities.
Government securities are mostly interest bearing dated securities issued by RBI on behalf of the government of India GOI uses these funds to meet its expenditure commitments. These securities are generally fixed maturity and fixed coupon securities carrying semi-annual coupon. Since the date of maturity is specified in the securities, these are known as dated Government Securities.
Features of Government Securities
Government Securities- Types
Government Securities- Issuers
Government securities are issued by the following agencies:
Government Securities- Issue Procedure
Government securities are issued through auctions conducted by the RBI. Auctions are conducted on the elec- tronic platform called the NDS – Auction platform. Commercial banks, scheduled urban co-operative banks, Pri- mary Dealers, insurance companies and provident funds, who maintain funds account (current account) and secu- rities accounts (SGL account) with RBI, are members of this electronic platform. All members of PDO-NDS can place their bids in the auction through this electronic platform. All non-NDS members including non-scheduled urban co-operative banks can particIPAte in the primary auction through scheduled commercial banks or Primary Dealers. For this purpose, the urban co-operative banks need to open a securities account with a bank / Primary Dealer – such an account is called a gilt account. a gilt account is a dematerialized account maintained by a sched- uled commercial bank or Primary Dealer for its constituent (e.g., a non-scheduled urban co-operative bank).
The RBI, in consultation with the Government of India, issues an indicative half-yearly auction calendar which contains information about the amount of borrowing, the tenor of security and the likely period during which auc- tions will be held. A Notification and a Press Communique giving exact particulars of the securities, viz., name, amount, type of issue and procedure of auction are issued by the Government of India about a week prior to the actual date of auction. RBI places the notification and a Press Release on its website (www.RBI.org.in) and also issues an advertisement in leading English and Hindi newspapers. Information about auctions is also available with the select branches of public and private sector banks and the Primary Dealers.
Solved Case 1
Delhi Manufacturers intend to raise ₹ 40,00,000 of equity capital through a rights offering. It currently has 10,00,000 shares outstanding which have been most recently selling / trading for ₹ 50 and ₹ 56 per share. In consul- tation with the SEBI Caps, the company has set the subscription price for the rights at ₹ 50 per share.
You are required to:
Solution:
a. Number of new share = ₹ 40,00,000 ( to be raised) / ₹ 50 ( Subscription price) = 80,000 Shares
b. Number of shares per right = 80,000 (new shares) / 10,00,000 (Shares outstanding) = 0.08 Shares
Solved Case 2
The RBI offers 91-Days Treasury Bills to raise ₹1,500 crore. The following bids have been received.
| Bidder | Bid Rate (₹) | Amount (₹ in crore) |
| X | 98.95 | 1,800 |
| Y | 98.93 | 700 |
| Z | 98.92 | 1,000 |
What is the yield for each of the price at which the bid has been made?
Who are the winning bidders if it was a yield-based auction and how much of the security will be allocated to each winning bidder?
Solution:
a. Yield = Y = {( F - P) / 9} x (365 / M) x 100
Where, M = 91 Days for all. F = Face Value = `100
By using the above formula, yields are calculated as below:
X = 4.26% (P = Price = ` 98.95)
Y = 4.34% (P = Price = ` 98.93)
Z = 4.38% (P = Price = ` 98.92)
b. As this is the yield-based auction, so lowest yield rate will be allotted first and so on. Bidder X will be
allotted the entire amount of ` 1,500 crore at the lowest yield and X’s would be accepted.
X = 4.26% (P = Price = ` 98.95)
A. Theoretical Questions:
1. Assets Management company is formed
Answer: b. To manage mutual funds investments
2. Prime duty of a merchant banker is -
Answer: c. Working as a Capital Market Intermediary
3. Basic objective of a money market mutual fund is
Answer: b. Investment in short-term securities
4. Short selling refers to
Answer: b. Selling shares without owning them
5. Which of the following is not regulated by SEBI?
Answer: b. Foreign Direct Investment
6. Which of the following is true for mutual funds in India?
Answer: d. Exit load allowed in some cases
7. Which of the following is not available in India?
Answer: c. Commodity Options
8. Which of the following is the benefit of Depositories?
Answer: d. All of the above
9. Credit Rating of a debt security is
Answer: b. Merely opinion
10. The first computerised online stock exchange in India was
Answer: b. OTCEI
11. Which of the following derivative is not traded on Indian Stock Market?
Answer: d. Forward Rate Argreements
12. How many depositories are there in India?
Answer: a. 2
13. Secondary Market in India is regulated by
Answer: b. Securities and Exchnage Board of India
14. __________funds do not have a fixed date of
Answer: a. Open ended funds
15. In India, NIFTY and SENSEX are calculated on the basis of
Answer: c. Free-float Capitalization
16. The type of collateral (security) used for short-term loan is
Answer: c. Stock of good
17. Which of the following is a liability of a bank?
Answer: c. Certificate of Deposits
18. Commercial paper is a type of
Answer: b. Unsecured short-term debt
19. Which of the following is not a spontaneous source of short-term funds?
Answer: c. Provision for dividend
20. In India, Commercial Papers are issued as per the lines issued by -
Answer: b. Reserve Bank of India
21. Commercial paper are generally issued at a pries
Answer: c. Less than face value
22. Which of the following is not applicable to commercial paper?
Answer: d. All of the above
1. What do you mean by Monetary Policy?
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2. What is Cash Reserve Ratio (CRR)?
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3. What do you mean by Statutory Liquidity Ratio (SLR)?
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4. What do you mean by Liquidity Adjustment Facility (LAF)?
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5. Write short notes on Repo Rate and Reverse Repo Rate.
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6. Discuss the role of RBI as the Governments’ Debt manager.
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7. Narrate down the regulatory objectives of NBFCs.
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8. Discuss on ‘Registration requirement of NBFCs’.
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9. State various prudential regulations applicable to NBFCs.
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10. Discuss on ‘residuary Non-Banking Company (RNBC)’.
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11. State the general nature of Insurance
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12. Write short notes on:
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13. Explain ‘Bank Employees Pension Scheme (BEPS)’
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14. Discuss the hedging strategies adopted in case of Hedge Funds.
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15. What is hedge fund? Mention the benefits of Hedge Funds.
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16. What are the functions of the Secondary Market?
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17. Make differences between Primary and Secondary Market.
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18. Write down the similarities between Primary and Secondary Market.
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19. Write short notes on (a) American Depository Receipts (ADRs) (b) Global Depository Receipts (GDRs)
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20. What is compulsory convertible debenture (CCD)? Discuss its advantages and disadvantages.
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21. What are Euro and Masala Bonds?
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22. What is Rolling Settlement? State its benefits.
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23. Discuss the Clearing House Operations (CHO)
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24. State the merits and demerits of Depository system of recording shares and trading in shares and securities
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25. What is Follow on Public Offer (FPO)?
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26. What is Reverse Book Building? Discuss the process for Reverse Book Building.
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27. Explain briefly the concept of Green-shoe option.
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28. Discuss the Private Placement issue mechanism.
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29. What do you mean by Insider Trading?
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30. Discuss on Credit Rating Symbols in India.
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31. What is Money Market? Discuss the features of Money Market.
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32. Mention the features of Treasury Bills.
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33. Discuss different types of Commercial Bills.
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34. What is Commercial Paper? Discuss its salient features and advantages.
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35. Discuss on RBI Guidelines in respect of issue of commercial Paper.
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36. What is Certificate of Deposits? State its features.
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37. What is Promissory Note? Discuss the essentials of a Promissory Note.
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38. What is Government Securities? Discuss the features of Goverment securities.
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Essay Type Questions
1. Discuss the structure, organisation and governance of RBI.
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2. Explain the regulatory role of RBI.
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3. Discuss the functions of Commercial Banks.
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4. State the objectives and functions of State Cooperative Banks.
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5. Mention different types/categories of NBFCs registered with RBI.
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6. Discuss the statutory functions of IRDA.
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7. What is Pension Fund? Classify different Pension Plans.
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8. Discuss different types of Alternative Investment Funds (AIF).
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9. State different styles of Hedge Funds.
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10. Compare Hedge Funds and Mutual Funds.
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11. Discuss important Securities and Exchange Board of India (SEBI) Regulations.
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12. Highlight the functions of a capital market.
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13. Write short notes on: Initial Public Offering (IPO), Follow on Public Offer (FPO), Book Building, Green-shoe Option Initial Public Offering (IPO).
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14. What is Book Building Process? Discuss advantages and disadvantages of Book Building.
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15. What is Credit Rating? Discuss on Credit Rating Methods and Rating Agencies in India.
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16. Discuss different types of Money Market Instruments.
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17. Discuss different types of Government Securities.
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18. What are the risks involved in holding Government securities?
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19. What is preference share? What are the key merits and demerits of preference shares as a source of long-term finance?
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20. Write short notes on: straight bond value, conversion value, market value and market premium.
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21. Discuss the method for valuation of compulsorily convertible debentures into shares.
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22. How is the value of an optionally convertible debenture affected by the straight debenture value,conversion value and option value?
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23. What is a warrant? How does it differ from convertible securities?
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1. Gupta Dairy Ltd. is one of the leading manufacturers and marketers of dairy-based branded foods in Hyderabad. In the initial years, its operation was restricted only to collection and distribution of milk. But, over the years it has achieved a reasonable market share by offering a diverse range of dairy-based products including fresh milk, flavoured yogurt, ice creams, butter milk, cheese, ghee etc. In order to raise the capital finance its expansion plans, Gupta Dairy Ltd. has decided to approach capital market through a mix of offer for sale of 4 crore shares and a public issue of 2 crores shares.
In context of the above case:
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2. The SEBI has imposed a penalty of ₹ 6200 crore on Asianol Corporation Limited (ACL) and its four directors, namely Mr. T. Ghosh, Mr. S. Singh, Mr. Tanay Bose, and Mr. K. Bhattacharyya who had mobilized funds from the general public through illegal collective investments schemes in the name of purchase and development of agriculture land.
While imposing the penalty, the biggest in its history, SEBI said ACL that to deserve the maximum penalty for duping the common man. Its prevention of Fraudulent and Unfair Trade Practices Regulations provides for severe-to-severe penalties for dealing with such violation. As per SEBI norms, it can impose penalty of ₹ 25 crore or three times of the profit made by indulging in Fraudulent and Unfair Trade Practices of the illicit gains.
In the context of the above case:
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3. S. Ltd. is a large creditworthy company operating in Eastern India. It is an export-oriented unit, dealing in high quality Basmati Rice. The floods in the region have created many problems for S. Ltd. Packaged rice has been destroyed due to this. The S. Ltd. is therefore, unable to get an uninterrupted supply of rice from the wholesale suppliers. To add to the problems of the organisation, the wholesale suppliers of rice who were earlier selling on credit are asking the S. Ltd. for advance payment or cash payment on delivery. The company (S. Ltd.) is facing a liquidity crisis.
The CEO of the S. Ltd. feels that taking a bank loan is the only option with the company to meet its short- term shortage of cash.
As a finance manager of the S. Ltd., name and explain the alternative to bank borrowings that the company (S. Ltd) can use to resolve the crisis.
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Ruchika Saboo
An All India Ranker (AIR 7 - CA Finals, AIR 43 - CA Inter), she is one of those teachers who just loved studying as a student. Aims to bring the same drive in her students.
Ruchika Ma'am has been a meritorious student throughout her student life. She is one of those who did not study from exam point of view or out of fear but because of the fact that she JUST LOVED STUDYING. When she says - love what you study, it has a deeper meaning.
She believes - "When you study, you get wise, you obtain knowledge. A knowledge that helps you in real life, in solving problems, finding opportunities. Implement what you study". She has a huge affinity for the Law Subject in particular and always encourages student to - "STUDY FROM THE BARE ACT, MAKE YOUR OWN INTERPRETATIONS". A rare practice that you will find in her video lectures as well.
She specializes in theory subjects - Law and Auditing.
Yashvardhan Saboo
A Story teller, passionate for simplifying complexities, techie. Perfectionist by heart, he is the founder of - Konceptca.
Yash Sir (As students call him fondly) is not a teacher per se. He is a story teller who specializes in simplifying things, connecting the dots and building a story behind everything he teaches. A firm believer of Real Teaching, according to him - "Real Teaching is not teaching standard methods but giving the power to students to develop his own methods".
He cleared his CA Finals in May 2011 and has been into teaching since. He started teaching CA, CS, 11th, 12th, B.Com, M.Com students in an offline mode until 2016 when Konceptca was launched. One of the pioneers in Online Education, he believes in providing a learning experience which is NEAT, SMOOTH and AFFORDABLE.
He specializes in practical subjects – Accounting, Costing, Taxation, Financial Management. With over 12 years of teaching experience (Online as well as Offline), he SURELY KNOWS IT ALL.
"Koncept perfectly justifies what it sounds, i.e, your concepts are meant to be cleared if you are a Konceptian. My experience with Koncept was amazing. The most striking experience that I went through was the the way Yash sir and Ruchika ma'am taught us in the lectures, making it very interesting and lucid. Another great feature of Koncept is that you get mentor calls which I think drives you to stay motivated and be disciplined. And of course it goes without saying that Yash sir has always been like a friend to me, giving me genuine guidance whenever I was in need. So once again I want to thank Koncept Education for all their efforts."
"Hello everyone, I am Kaushik Prajapati. I recently passed my CA Foundation Dec 23 exam in first attempt, That's possible only of proper guidance given by Yash sir and Ruchika ma'am. Koncept App provide me a video lectures, Notes and best thing about it is question bank. It contains PYP, RTP, MTP with soloution that help me easily score better marks in my exam. I really appericiate to Koncept team and I thankful to Koncept team."
"Hi. My name is Arka Das. I have cleared my CMA Foundation Exam. I cleared my 12th Board Exam from Bengali Medium and I had a very big language problem. Koncept Education has helped me a lot to overcome my language barrier. Their live sessions are really helpful. They have cleared my basic concepts. I think its a phenomenal app."
"I cleared my foundation examination in very first attempt with good marks in practical subject as well as theoretical subject this can be possible only because of koncept Education and the guidance that Yash sir has provide me, Thank you."
