A PROJECT ON

"AWARENESS ABOUT VARIOUS FINANCIAL INSTRUMENTS

USED IN INDIA."

Submitted to

University Of Mumbai for Partial Completion of Degree Of

Bachelor of Commerce (Accounting and Finance)

Semester VI 2018-19

Submitted By:

MAMTA VIJAY YADAV

Roll No. 552

Under the Guidance of

Professor: Neha Mishra

Uttari Bharat Sabha’s

RAMANAND ARYA D.A.V. COLLEGE

DATAR COLONY BHANDUP (E), MUMBAI- 400042.

March, 2018-19

1
 Uttari Bharat Sabha’s

RAMANAND ARYA D.A.V. COLLEGE

DATAR COLONY BHANDUP (E), MUMBAI- 400042.

2018-19

CERTIFICATE

This is to certify that Miss. MAMTA VIJAY YADAV, Roll No. 552 have worked
and duly completed his project work for the degree of Bachelor of Commerce
(Accounting & Finance) under the faculty of commerce in the subject of management
and his project is entitled, AWARENESS ABOUT VARIOUS FINANCIAL
INSTRUMENTS USED IN INDIA under the supervision. I further certify that the
entire work has been done by the learner under my guidance and that no part of it has
been submitted previously for any degree of diploma of any University.

It is his own work and facts reported by his personal findings and investigation.

Date -____________

Course Co-coordinator Principal

Mrs. Chandrakala Srivastava Dr. Ajay Bhamre

Project Guide / Internal Examiner External Examiner

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 Declaration by Learner

I the undersigned Miss. MAMTA VIJAY YADAV here by, declare that the work
embodied in this project work titled “AWARENESS ABOUT VARIOUS
FINANCIAL INSTRUMENTS USED IN INDIA.”, forms my own contribution to
the research work carried out under the guidance of Miss. Neha Mishra is a result of
my own research work and as not been previously submitted to any other University
for any other Degree / Diploma to this or any other Universsity.

Wherever reference has been made to previous work of others, it has been clearly
indicated as such and included in the bibliography.

I, here by further declare that all information of this document has been obtained and
presented in accordance with academic rules and ethical conduct.

Name & Signature of the learner

MAMTA VIJAY YADAV.

Certified By:

Name & Signature of the Guiding Professor

NEHA MISHRA.

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 Acknowledgement

To list who all have helped me is difficult because they are so numerous and the depth
is so enormous.

I would like to acknowledge the following as being idealistic channels and fresh

dimensions in the completion of this project.

I take this opportunity to thank the University of Mumbai for giving me chance to do
this project.

I would like to thank my PRINCIPAL, MR. AJAY M BHAMRE for providing the
necessary facilities required for completion of this project.

I take this opportunity to thank our Coordinator MRS. CHANDRAKALA

SHRIVASTAVA for her moral support and guidance.

I would also like to express my sincere gratitude towards my project guide MISS.
NEHA MISHRA whose guidance and care made the project successful.

I would like to thank College Library, for having provided various reference books
and magazines related to my project.

Lastly, I would like to thank each and every person who directly and indirectly helped
me in the completion of the project especially my parents and peers who supported
me throughout my project.

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 TABLE OF CONTENT

Chapter no. Title Page no.

1. Introduction
1.1 Introduction of the topic. 6
1.2 History and general information. 7
1.3 Definitions. 8
1.4 Characteristics of the study. 9

2. Research Methodology
2.1 Objectives of the study. 10
2.2 Scope of the study. 11
2.3 Significance of the study. 12
2.4 Limitations of financial instruments. 13

3. Literature Review 14

4. Data Analysis, Interpretation

4.1 Capital Market 16
4.2 Equity Shares 17-21
4.3 Preference Shares 22-28
4.4 Debentures 29-39
4.5 Derivatives 40-50
4.6 Money Market 51-54
4.7 Types of Money Market 55-64
4.8 Growth of Money market in India 65-66
4.9 Participants in Money Market 67-71
4.10 Money Market scenario in India 72

5. Classification, financial Instruments

functional categories & Interest rate
5.1 General Issue 73
5.2 Overview of classification of financial 74-78
Instruments
6. Recommendation 79
7. Suggestion 80
8. Conclusion 81
9. Bibliography 82

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 CHAPTER 1
1.1 INTRODUCTION
Financial instruments are monetary contracts between parties. They can be created,
traded, modified and settled. They can be cash (currency), evidence of an ownership
interest in an entity (share), or a contractual right to receive or deliver cash (bond).

The use of financial instruments – including public loans, public equity or venture
capital, or credit guarantees – is becoming increasingly widespread in regional and
local economic development (European Commission, 2015). Since the global
financial crisis, there has been a resurgence of interest in these tools for several
principal reasons. First, the crisis – and the “credit crunch” which formed part of it –
led to a protracted problem with access to finance in many countries. According to the
European Central Bank, in 2009 around 17% of firms in the euro area argued that
access to finance were their most pressing concern. This figure has abated
significantly; in 2016 it was closer to 9% (ECB, 2017). Second, while the cyclical
issues in the availability of finance have waned, there is now increasing recognition
that endemic problems remain for certain types of firms or types of investment. Third,
some observers have also argued that the decline in relationship lending1 coupled
with the upsurge of automated lending technologies and increasingly centralized
organizational structures has further exacerbated this situation. Finally, stretched
budgets have encouraged policy makers to seek new ways to leverage finance for
public projects. At the same time, the crisis also led to an upsurge of interest in
activist approaches to economic development, in particular industrial policy, within
advanced economies. 2 Scholars claim that there has been a “rejuvenation” of
industrial policy in the wake of the global financial crisis to the extent that the
question is not “whether any government should engage in industrial policy but how
to do it right” There has been a significant shift in the manner in which governments
attempt to shape their national economies. Policy makers are adopting new
mechanisms, targeting approaches and conditionality agreements substantively
different from those found in previous policy frameworks.

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1.2 HISTORY OF FINANCIAL INSTRUMENTS
The history of Indian Financial sector, and highlight what were the major changes that
took place in liberalization policies of 1991-92 in India’s Financial Sector.

The role of financial system in economic development has been a much discussed
topic among economists. Is it possible to influence the level of national income,
employment, standard of living, and social welfare through variations in the supply of
fiancé? In what way financial development itself is affected by economic
development? There is no unanimity of views on such questions. A recent literature
survey concluded that the existing theory on this subject has not given any generally
accepted model to describe the relationship between finance and economic
development. In the environment-friendly, appropriate-technology-based,
decentralized Alternative Development Model, finance is not a factor of crucial or
critical importance. But even in a conventional model of modern industrialism, the
perceptions in the regard vary a great deal. One view holds the finance is not
important at all. The opposite view regards it to be very important.

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 1.3 DEFINITIONS OF FINANCIAL INSTRUMENTS

The Association of Chartered Certified Accountants (ACCA) has the following

definition or a financial instrument:

“A financial instrument is any contract that gives rise to a financial asset of one entity
and a financial liability or equity instrument of another entity.”

“The definition is wide and includes cash, deposits in other entities, trade receivables,
loans to other entities. Investments in debt instruments, investments in shares and
other equity instruments.”

A financial instrument is a document or contract that can be traded in a market,

which represents an asset to one party and a liability or equity to the other.

In finance, a margin is collateral that the holder of a financial instrument has to

deposit to cover some or all of the credit risk of their counterparty.

A promissory note is a financial instrument made by the debtor stating that the
debtor intends to pay the money he owes to the creditor in the specified period.

A financial instrument is a document or contract that can be traded in a market that

represents an asset to one party and a liability or equity to the other.

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 1.4 CHARACTERISTICS

 Easy transferability.
 Ready market.
 Possess liquidity.
 Possess security value.
 Enjoy tax status.
 Carry risk.
 Facilitate futures trading.
 Less handling costs.
 Risk and return proportionate.
 Maturity period variations.

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 CHAPTER 2
RESEARCH METHODOLOGY

2.1 OBJECTIVES OF THE STUDY

1. The specific objectives are: to increase the number of new companies with high
growth potential; to involve financial market actors in the development of high quality
financial instruments to boost growth and competitiveness; and to increase investment
in R&D and encourage private investment.

2. After studying this chapter the learner should / should be able to:

• Define financial instruments.

• Distinguish primary and indirect securities.

• Discuss the broad categories of financial instruments.

• Differentiate marketable and non-marketable instruments.

• Categorize all forms of securities.

• Describe all types of securities.

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 2.2 SCOPE OF THE STUDY

Financial instruments act as a means of payment (like money).

Employees take stock options as payment for working.

Financial instruments act as stores of value (like money).

Financial instruments generate increases in wealth that are larger than from holding
money.

Financial instruments can be used to transfer purchasing power into the future.

Financial instruments allow for the transfer of risk (unlike money).

Futures and insurance contracts allow one person to transfer risk to another.

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 2.3 SIGNIFICANCE OF THE STUDY

An entity shall disclose information that enables users of its financial statements to
evaluate the significance of financial instruments for its financial position and
performance.

The Indian banking industry is passing through a phase of customers market. The
customers have more choices in choosing their bank .The competition has been
established within the bank operating in India. With stiff competition and advance
technology, the service provided by the bank have become more easy and convenient
This Study will gave a base to the further research in this field.

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 2.4LIMITATIONS OF FINANCIAL INSTRUMENTS

 Important source for the productive use of the economy’s savings.

 Provides incentives to saving and facilitates capital formation.
 Provides an avenue for investors.
 Facilitates increase in production and productivity in the economy.
 Induce economic growth.
 Expert intermediaries.
 Important source of technological up gradation.

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 CHAPTER 3
LITERATURE REVIEW OF THE STUDY

There are four parts to this literature review. First of all, the objectives of financial
reporting and the characteristics of useful reports are discussed in order to indicate
which aspects of financial reports should be looked at in more detail.

The second part establishes a link between the usefulness of financial reporting and
the financial crisis. Key concepts of complexity and understandability as well as
reliability and relevance are discussed here. The debate on fair value accounting plays
a strong part also as its effect on reliability and relevance has been a fairly
controversial subject.

Thirdly, there is a discussion on the implications of financial reporting on regulation

reform. In order to access this discussion, the reactions of several institutions and
regulatory bodies on the financial crisis are studied. Since the actions of regulatory
bodies aim to heal the financial environment and promote trust in financial markets, it
is important to study the areas where they have found problems and are working to
improve standards.

In the final part, issues of transparency and disclosure are discussed. This is because
in the literature reviewed these issues were widely considered as providing possible
solutions to the problems that have surfaced.

This review also exposes gaps in the literature. The unstable environment during the
crisis caused changes in financial reporting of banks. This raises several questions as
to how this has affected client confidence. The literature does not address these
questions adequately. The review therefore gives a base for the upcoming survey
presented to corporate clients of banks.

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 CHAPTER 4
DATA ANALYSIS AND INTERPRETATION

Financial
Instruments

Primary Secondary
Market Market

Capital Money
Market Market

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 4.1 CAPITAL MARKET
A capital market can be either a primary market or a secondary market. In primary
market, new stock or bond issues are sold to investors, often via a mechanism known
as underwriting. The main entities seeking to raise long-term funds on the primary
capital markets are governments (which may be municipal, local or national) and

business enterprises (companies). Governments issue only bonds, whereas companies

often issue both equity and bonds. The main entities purchasing the bonds or stock
include pension funds, hedge funds, sovereign wealth funds, and less commonly
wealthy individuals and investment banks trading on their own behalf. In the
secondary market, existing securities are sold and bought among investors or traders,
usually on an exchange, over-the-counter, or elsewhere. The existence of secondary

markets increases the willingness of investors in primary markets, as they know they
are likely to be able to swiftly cash out their investments if the need arises.

A second important division falls between the stock markets (for equity securities,

also known as shares, where investors acquire ownership of companies) and the bond
markets where investors become creditors.

The instruments used in a capital market are listed below:

1. Shares: Share is the share in the share capital of the company. Share is one of the
units into which the capital of company is divided. A person having the shares of
the company is called as shareholder of that company; He is regarded as the part
of owner of the company. Shares are capital share securities. Owner of shares or
the shareholder is the company co-owner. If the company makes a profit, in
certain cases, a portion of it shall be paid out to shareholders in the form of
dividends. The more shares are owned by the shareholder, the greater the stake it
owns, and the higher the portion of the distributable profits is due. It should be
remembered that when the company's operation brings a loss, its equity should be
reduced, resulting in a decrease in the value of shareholders' investment. If the
company goes bankrupt, there is a possibility for a partial or complete loss of
investments in its shares. There are common and preferred shares. Holder of
common shares is entitled to participate in the company's administration, by
exercising the right to vote at shareholders' meetings. In turn, preferred shares
give to its owner the prior right to receive dividends, but usually do not give the
voting rights. Shares are most often traded in regulated market i.e. at a stock
exchange

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  There are 2 types of shares:

4.2 Equity shares

Meaning: Equity shares are the main source of finance of a firm. It is issued to the
general public. Equity shareholders do not enjoy any preferential rights with regard to
repayment of capital and dividend. They are entitled to residual income of the
company, but they enjoy the right to control the affairs of the business and all the
shareholders collectively are the owners of the company.

Features of equity shares:

1. They are permanent in nature.

2. Equity shareholders are the actual owners of the company and they bear the highest
risk.

3. Equity shares are transferable, i.e. ownership of equity shares can be transferred
with or without consideration to other person.

4. Dividend payable to equity shareholders is an appropriation of profit.

5. Equity shareholders do not get fixed rate of dividend.

6. Equity shareholders have the right to control the affairs of the company.

7. The liability of equity shareholders is limited to the extent of their investment.

Advantages of equity shares:

Equity shares are amongst the most important sources of capital and have certain
advantages which are mentioned below:

i. Advantages from the Shareholders’ Point of View

(a) Equity shares are very liquid and can be easily sold in the capital market.

(b) In case of high profit, they get dividend at higher rate.

(c) Equity shareholders have the right to control the management of the company.

17
(d) The equity shareholders get benefit in two ways, yearly dividend and appreciation
in the value of their investment.

ii. Advantages from the Company’s Point of View:

(a) They are a permanent source of capital and as such; do not involve any repayment
liability.

(b) They do not have any obligation regarding payment of dividend.

(c) Larger equity capital base increases the creditworthiness of the company among
the creditors and investors.

Disadvantages of Equity Shares:

Despite their many advantages, equity shares suffer from certain limitations. These
are:

i. Disadvantages from the Shareholders’ Point of View:

(a) Equity shareholders get dividend only if there remains any profit after paying
debenture interest, tax and preference dividend. Thus, getting dividend on equity
shares is uncertain every year.

(b) Equity shareholders are scattered and unorganized, and hence they are unable to
exercise any effective control over the affairs of the company.

(c) Equity shareholders bear the highest degree of risk of the company.

(d) Market price of equity shares fluctuate very widely which, in most occasions,
erode the value of investment.

(e) Issue of fresh shares reduces the earnings of existing shareholders.

ii. Disadvantage from the Company’s Point of View:

(a) Cost of equity is the highest among all the sources of finance.

(b) Payment of dividend on equity shares is not tax deductible expenditure.

(c) As compared to other sources of finance, issue of equity shares involves higher
floatation expenses of brokerage, underwriting commission, etc.

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Growth Rate of Equity Shares in India for the years July 2015 to July 2017

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The different types of equity issues have been discussed below:

New Issue Right Issue

Bonus Issue Sweat Issue

1. New Issue:

A company issues a prospectus inviting the general public to subscribe its shares.
Generally, in case of new issues, money is collected by the company in more than one
installment— known as allotment and calls. The prospectus contains details regarding
the date of payment and amount of money payable on such allotment and calls. A
company can offer to the public up to its authorized capital. Right issue requires the
filing of prospectus with the Registrar of Companies and with the Securities and
Exchange Board of India (SEBI) through eligible registered merchant bankers.

2. Bonus Issue:

Bonus in the general sense means getting something extra in addition to normal. In
business, bonus shares are the shares issued free of cost, by a company to its existing
shareholders. As per SEBI guidelines, if a company has sufficient profits/reserves it
can issue bonus shares to its existing shareholders in proportion to the number of
equity shares held out of accumulated profits/ reserves in order to capitalize the

20
profit/reserves. Bonus shares can be issued only if the Articles of Association of the
company permits it to do so.

3. Rights Issue:

According to Section 81 of The Company’s Act, 1956, rights issue is the subsequent
issue of shares by an existing company to its existing shareholders in proportion to
their holding. Right shares can be issued by a company only if the Articles of
Association of the company permits. Rights shares are generally offered to the
existing shareholders at a price below the current market price, i.e. at a concessional
rate, and they have the options either to exercise the right or to sell the right to another
person. Issue of rights shares is governed by the guidelines of SEBI and the central
government.

Rights shares provide some monetary benefits to the existing shareholders as

they get shares at a concessional rate—this is known as value of right which can
be computed as:

Value of right = cum right market price of a share – Issue price of a new share /
Number of old shares + 1

4. Sweat Issue:

According to Section 79A of The Company’s Act, 1956, shares issued by a company
to its employees or directors at a discount or for consideration other than cash are
known as sweat issue. The purpose of sweat issue is to retain the intellectual property
and knowhow of the company. Sweat issue can be made if it is authorized in a general
meeting by special resolution. It is also governed by Issue of Sweet Equity
Regulations, 2002, of the SEBI.

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4.3 Preference shares

Preference shares are those shares which carry certain special or priority rights.
Firstly, dividend at a fixed rate is payable on these shares before any dividend is paid
on equity shares.

Secondly, at the time of winding up of the company, capital is repaid to preference

shareholders prior to the return of equity capital. Preference shares do not carry voting
rights. However, holders of preference shares may claim voting rights if the dividends
are not paid for two years or more on cumulative preference shares and three years or
more on non-cumulative preference shares.

Preference shares have the characteristics of both equity shares and debentures. Like
equity shares, dividend on preference shares is payable only when there are profits
and at the discretion of the Board of Directors.

Preference shares are similar to debentures in the sense that the rate of dividend is
fixed and preference shareholders do not generally enjoy voting rights. Therefore,
preference shares are a hybrid form of financing.

Features of preference shares:

FIXED DIVIDENDS

Like debt carries a fixed interest rate, preference shares have fixed dividends attached
to them. But the obligation of paying a dividend is not as rigid as debt. Non-payment
of a dividend would not amount to bankruptcy in case of preference share.

PREFERENCE OVER EQUITY

As the word preference suggests, these type of shares get preference over equity
shares in sharing the income as well as claims on assets. Alternatively, preference

share dividend has to be paid before any dividend payment to ordinary equity shares.
Similarly, at the time of liquidation also, these shares would be paid before equity
shares.

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NO VOTING RIGHTS

Preference share capital is not allotted any voting rights normally. They are similar
to debenture holders and do not have any say in the management of the company.

NO SHARE IN EARNINGS

Preference shareholders can only claim two things. One agreed on percentage of

dividend and second the amount of capital invested. Equity shares are entitled to share
the residual earnings and residual assets in case of liquidation which preference shares
are not entitled to.

FIXED MATURITY

Just like debt, preference shares also have fixed maturity date. On the date of
maturity, the preference capital will have to be repaid to the preference shareholders.
A special type of shares i.e. irredeemable preference shares is an exception to this.
They do not have any fixed maturity.

Advantages of preference shares:

1. Appeal to Cautious Investors:

Preference shares can be easily sold to investors who prefer reasonable safety of their
capital and want a regular and fixed return on it.

2. No Obligation for Dividends:

A company is not bound to pay dividend on preference shares if its profits in a

particular year are insufficient. It can postpone the dividend in case of cumulative
preference shares also. No fixed burden is created on its finances.

3. No Interference:

Generally, preference shares do not carry voting rights. Therefore, a company can
raise capital without dilution of control. Equity shareholders retain exclusive control
over the company.

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4. Trading on Equity:

The rate of dividend on preference shares is fixed. Therefore, with the rise in its
earnings, the company can provide the benefits of trading on equity to the equity
shareholders.

5. No Charge on Assets:

Preference shares do not create any mortgage or charge on the assets of the company.
The company can keep its fixed assets free for raising loans in future.

6. Flexibility:

A company can issue redeemable preference shares for a fixed period. The capital can
be repaid when it is no longer required in business. There is no danger of over-
capitalization and the capital structure remains elastic.

7. Variety:

Different types of preference shares can be issued depending on the needs of

investors. Participating preference shares or convertible preference shares may be
issued to attract bold and enterprising investors.

Preference shares can be made more popular by giving special rights and privileges
such as voting rights, right of conversion into equity shares, right of shares in profits
and redemption at a premium.

Disadvantages of preference shares

1. Fixed Obligation:

Dividend on preference shares has to be paid at a fixed rate and before any dividend is
paid on equity shares. The burden is greater in case of cumulative preference shares
on which accumulated arrears of dividend have to be paid.

2. Limited Appeal:

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Bold investors do not like preference shares. Cautious and conservative investors
prefer debentures and government securities. In order to attract sufficient investors, a
company may have to offer a higher rate of dividend on preference shares.

3. Low Return:

When the earnings of the company are high, fixed dividend on preference shares
becomes unattractive. Preference shareholders generally do not have the right to
participate in the prosperity of the company.

4. No Voting Rights:

Preference shares generally do not carry voting rights. As a result, preference

shareholders are helpless and have no say in the management and control of the
company.

5. Fear of Redemption:

The holders of redeemable preference shares might have contributed finance when the
company was badly in need of funds. But the company may refund their money
whenever the money market is favorable. Despite the fact that they stood by the
company in its hour of need, they are shown the door unceremoniously.

Growth Rate of Preference Shares in India for the year 2012 to 2017

25
Formula for calculating cost of Preference Capital

26
 TYPES OF PREFERENCE SHARES

Cumulative Preference Non Cumulative

Shares Preference Shares

Non
Convertible
convertible
Preference
Preference
Shares
Shares

Redeemable Guaranteed
Preference Preference
Participating Prefernce Shares Shares
Non participating
Shares Preference Shares

27
Some of the most important types of preference shares of a company are as follows:

1. Cumulative preference shares:

A preference share is said to be cumulative when the arrears of dividend are

cumulative and such arrears are paid before paying any dividend to equity
shareholders. Suppose a company has 10,000 8% preference shares of Rs. 100 each.
The dividends for 1987 and 1988 have not been paid so far. The directors before they
can pay the dividend to equity shareholders for the year 1989 must pay the pref.
dividends of Rs. 2, 40,000 i.e. for the year 1987, 1988 and 1989 before making any
payment of dividend to equity shareholders for the year 1989.

2. Non-cumulative preference shares:

In the case of non-cumulative preference shares, the dividend is only payable out of
the net profits of each year. If there are no profits in any year, the arrears of dividend
cannot be claimed in the subsequent years. If the dividend on the preference shares is
not paid by the company during a particular year, it lapses. Preference shares are
presumed to be cumulative unless expressly described as non-cumulative.

3. Participating preference shares:

Participating preference shares are those shares which are entitled in addition to
preference dividend at a fixed rate, to participate in the balance of profits with equity
shareholders after they get a fixed rate of dividend on their shares. The participating
preference shares may also have the right to share in the surplus assets of the
company on its winding up. Such a right may be expressly provided in the
memorandum or articles of association of the company.

4. Non-participating preference shares:

Non- participating preference shares are entitled only to a fixed rate of dividend and
do not share in the surplus profits. The preference shares are presumed to be non-
participating, unless expressly provided in the memorandum or the articles or the
terms of issue.

5. Convertible preference shares:

28
Convertible preference shares are those shares which can be converted into equity
shares within a certain period.

6. Non-Convertible preference shares:

These are those shares which do not carry the right of conversion into equity shares.

7. Redeemable preference shares:

A company limited by shares, may if so authorized by its articles issue preference

shares which are redeemable as per the provisions laid down in Section 80. Shares
may be redeemed either after a fixed period or earlier at the option of the company.

8. Guaranteed preference shares:

These shares carry the right of a fixed dividend even if the company makes no or
insufficient profits.

4.4 Debentures:

Debentures are long term borrowed funds of the company. They have fixed maturity
period as well as fixed interest rate. These are the certificates issued under common
seal of the company. Debentures are a debt instrument used by companies and
government to issue the loan. The loan is issued to corporate based on their reputation
at a fixed rate of interest. Debentures are also known as a bond which serves as an
IOU between issuers and purchaser. Companies use debentures when they need to
borrow the money at a fixed rate of interest for its expansion. Secured and Unsecured,
Registered and Bearer, Convertible and Non-Convertible, First and second are four
types of Debentures. Let us learn more about Debentures in detail.

In layman’s term, a Debenture is the acknowledgment of the debt the organization

has taken from the public at large. They are very crucial for raising long-term debt
capital. A company can raise funds through the issue of debentures, which has a fixed
rate of interest on it. The debenture issued by a company is an acknowledgment that
the company has borrowed an amount of money from the public, which it promises to
repay at a future date. Debenture holders are, therefore, creditors of the company.

29
FEATURES OF DEBENTURES
The most salient features of Debentures are as follows:

1. A debenture acknowledges a debt It is in the form of certificate issued under the

seal of the company (called Debenture Deed). It usually shows the amount & date of
repayment of the loan.

2. It has a rate of interest & date of interest payment.

3. Debentures can be secured against the assets of the company or may be unsecured.

4. Debentures are generally freely transferable by the debenture holder. Debenture

holders have no rights to vote in the company’s general meetings of shareholders, but
they may have separate meetings or votes e.g. on changes to the rights attached to the
debentures.

5. The interest paid to them is a charge against profit in the company’s financial
statements.

Advantages of Debentures:

 Investors who want fixed income at lesser risk prefer them.

 As a debenture does not carry voting rights, financing through them does not
dilute control of equity shareholders on management.

 Financing through them is less costly as compared to the cost of preference or

equity capital as the interest payment on debentures is tax deductible.

 The company does not involve its profits in a debenture.

 The issue of debentures is appropriate in the situation when the sales and
earnings are relatively stable.

Disadvantages of Debentures:

30
 Each company has certain borrowing capacity. With the issue of debentures,
the capacity of a company to further borrow funds reduces.

 With redeemable debenture, the company has to make provisions for

repayment on the specified date, even during periods of financial strain on the
company.

 Debenture put a permanent burden on the earnings of a company. Therefore,

there is a greater risk when the earnings of the company fluctuate.

TYPES OF DEBENTURES

31
 1. secured and 2. Registered
unsecured and Bearer

3. Convertible
4. First and
and Non-
Second
Convertible
1. Secured and Unsecured:

Secured debenture creates a charge on the assets of the company, thereby mortgaging

the assets of the company. Unsecured debenture does not carry any charge or security
on the assets of the company.

2. Registered and Bearer:

A registered debenture is recorded in the register of debenture holders of the

company. A regular instrument of transfer is required for their transfer. In contrast,
the debenture which is transferable by mere delivery is called bearer debenture.

3. Convertible and Non-Convertible:

Convertible debenture can be converted into equity shares after the expiry of a
specified period. On the other hand, a non-convertible debenture is those which
cannot be converted into equity shares.

4. First and Second:

A debenture which is repaid before the other debenture is known as the first

debenture. The second debenture is that which is paid after the first debenture has

been paid back.

32
Issue of Debentures

Debentures can, be issued in three ways.

At par: Debenture is said to have been issued at par when the amount collected for it
is equal to the nominal value of debentures. E.g. the issue of debentures of Rs. 100/-
for Rs. 100/-

At Discount: Debenture is said to have been issued at discount when the amount
collected is less than the nominal value, for e.g., issue of debentures of Rs. 100/- for
Rs. 95/-. The difference of Rs. 5/- is the discount and is called discount on issue of
Debentures. This discount on issue of debentures is a capital loss.

At Premium: When the price charged is more than its nominal value, a debenture is
said to be issued at a premium. e.g., issue of debentures of Rs. 100 each for Rs. 120,
the excess amount over the nominal value i.e., Rs. 20 is the premium on issue of
debentures. Premium received on issue of debentures is a capital gain. Please note that
this Premium on issue of debentures cannot be utilized for distribution of dividend.
Premium on debentures is shown under the head Reserves & Surplus on the liability
side of the Balance Sheet.

3. Bonds: Bonds are the long term borrowed funds of the government and also
companies. Like debentures have fixed maturity and fixed interest rate even bonds
have. Here interest charged on bonds termed as coupon rate.

TYPES OF BONDS ARE AS FOLLOWS:

33
 Government Bonds

Z- Bonds Municiple
Bonds

Corporate Convertible Callable

Bonds Bonds Bonds

Government Bonds: can be issued by national governments as well as lower levels

of government. At the national or federal level, these government bonds are known as
“sovereign” debt, and are backed by the ability of a nation to tax its citizens and to
print currency. In the U.S. federal debt is classified according to its maturity. “Bills”
are bonds maturing in less than one year, “Notes” between one and ten years, and
“Bonds” maturing in more than ten years.  Marketable securities from the U.S.
government - known collectively as “Treasuries” - follow this guideline and are
issued as Treasury bonds, Treasury notes and Treasury bills (T-bills). All debt issued
by the U.S. government is regarded as extremely safe, often referred to as “risk-free”
securities, as is the debt of many stable countries. The debt of developing countries,
on the other hand, does usually carry substantial risk. Like companies, countries can
therefore default on payments. Credit ratings agencies also rate a country’s risk to
repay debt in a similar way that they issue ratings on corporate bond issuers.
Countries with greater default risk must issue bonds at higher interest rates – which
essentially increase their cost of borrowing. Governments also issue bonds that are
linked to inflation, known in the U.S. as Treasury Inflation Protected Securities, or
TIPS.

34
Z-Bonds: The government also issues what are known as zero-coupon or z-
bonds, which pay no coupon, but instead are offered at a discount at sale. For
example, let's say a zero-coupon bond with a $1,000 par value and 10 years to
maturity is trading at $600; you'd be paying $600 today for a bond that will be worth
$1,000 in 10 years. These bonds are known as Treasury STRIPS in the U.S.
Government savings bonds are also zero-coupon bonds that gain value as they mature.

35
Municipal Bonds:  also known as "munis" are bonds issued by state or local
governments or by government agencies. These bonds are typically riskier than
national government bonds; cities don't go bankrupt that often, but it can happen (for
example in Detroit and and Stockton, CA). The major advantage to munis for
investors is that the returns are free from federal tax, and furthermore, state and local
governments will often consider their debt non-taxable for residents, thus making
some municipal bonds completely tax free, sometimes called triple-tax free. Because
of these tax savings, the yield on a muni is usually lower than that of an equivalent
taxable bond. Depending on your personal situation, a muni can be a great investment
on an after-tax basis.

36
Corporate Bonds: The other major issues of bonds are corporations, and corporate
bonds make up a large portion of the overall bond market. Large corporations have a
great deal of flexibility as to how much debt they can issue: the limit is generally
whatever the market will bear. A corporate bond is considered short-term corporate
when the maturity is less than five years; intermediate is five to 12 years, and long-
term is over 12 years. Corporate bonds are characterized by higher yields than
government securities because there is a higher risk of a company defaulting than a
government. The upside is that they can also be the most rewarding fixed-income
investments because of the risk the investor must take on, where higher credit
companies that are more likely to pay back their obligations will carry a relatively
lower interest rate than riskier borrowers. Companies can issue bonds with fixed or

37
variable interest rates and of varying maturity.

Public and Private Issues of Corporate Bonds:

Convertible Bonds: are debt issued by corporations that give the bondholder the
option to convert the bonds into shares of common stock at a later date. The rate at
which investors can convert bonds into stocks, that is, the number of shares an
investor gets for each bond, is determined by a metric called the conversion rate. The
conversion rate may be fixed or change over time depending on the terms of the
offering. A conversion rate of 30 means that for every $1,000 of par value the
convertible bondholder converts, she receives 30 shares of stock. It is not always
profitable to convert bonds into equity. Investors can determine the breakeven price
by dividing the selling price of the bond by the conversation rate. Typically, investors
will exercise this option if the share price of the company exceeds the breakeven

38
price. Convertible bonds typically carry lower yields due to this right given to
investors.

Callable Bonds: are bonds that can be redeemed by the issuer at some point prior to
its maturity. If interest rates have declined since the company first issued the bond, the
company is likely to want to refinance this debt at a lower rate of interest. In this case,
the company calls its current bonds and reissues them at a lower rate of interest.
Callable bonds typically have a higher interest rate to account for this added risk to
investors. When homeowners refinance a mortgage, they are calling in their older debt
for a new loan at better rates. Put able bonds allow the bondholder to force the issuer
to repurchase the security at specified dates before maturity. The repurchase price is
set at the time of issue, and is usually par value, and generally works to the favor of
investors. Therefore, yields on these bonds tend to be lower.

39
4.5 Derivatives: 

These are instruments that derive from other securities, which are referred to as
underlying assets. The price, riskiness and function of the derivative depend on the
underlying assets since whatever affects the underlying asset must affect the
derivative. A derivative is a financial contract that derives its value from
an underlying asset. The buyer agrees to purchase the asset on a specific date at a
specific price. 

Derivatives are often used for commodities, such as oil, gasoline, or gold. Another
asset class is currencies, often the U.S. dollar. There are derivatives based on stocks or
bonds. Still others use interest rates, such as the yield on the 10-year Treasury note. 

40
The contract's seller doesn't have to own the underlying asset. He can fulfill the
contract by giving the buyer enough money to buy the asset at the prevailing price. He
can also give the buyer another derivative contract that offsets the value of the
first. This makes derivatives much easier to trade than the asset itself.

Advantages of Derivatives:

Unsurprisingly, derivatives exert a significant impact on modern finance, because

they provide numerous advantages to the financial markets:

1. Hedging risk exposure

Since the value of the derivatives is linked to the value of the underlying asset, the
contracts are primarily used for hedging risks. For example, an investor may purchase
a derivative contract whose value moves in the opposite direction to the value of the
asset. In addition, it can be utilized to reallocate risk from risk-averse players to risk-
seeking players.

2. Underlying asset price determination

Derivates are frequently used to determine the price of the underlying asset. For
example, the spot prices of the futures can serve as an approximation of a commodity
price.

3. Market efficiency

It is considered that derivatives increase the efficiency of financial markets. By using

derivative contracts, one can replicate the payoff of the assets. Therefore, the prices of
the underlying asset and the associated derivative tend to be in equilibrium to
avoid arbitrage opportunities.

4.  Access to unavailable assets or markets

Derivatives can help organizations get access to unavailable assets or markets. By

employing interest rate swaps, a company may obtain a more favorable interest rate
relative to interest rates available from direct borrowing.

41
Disadvantages of Derivatives:

Despite the benefits that derivatives bring to the financial markets, the financial
instruments come with some significant drawbacks. The drawbacks resulted in
disastrous consequences during the financial crisis of 2007-2008. The rapid
devaluation of mortgage-backed securities and credit-default swaps lead to the
collapse of financial institutions and stock markets around the world.

1. High risk

While the high volatility of the derivatives exposes them to potentially huge losses,
the sophisticated design of the contracts makes the valuation extremely complicated
or even impossible. Thus, they bear the high inherent risk.

2. Speculative features

Derivatives are widely regarded as a tool of speculation. Due to the extremely risky
nature of the financial instrument and their unpredictable behavior, the unreasonable
speculation may lead to huge losses.

3. Counter-party risk

Although derivatives traded on the exchanges generally go through a thorough due

diligence process, some of the contracts traded over-the-counter do not include a
benchmark for due diligence. Thus, there is a high probability of counter-party
default.

Growth of Derivatives in India

42
Some examples of derivatives are:

43
 1. Futures 2. OPtions

4. Exchange
3. Swaps Traded Funds
or Commodities

1. Futures:

They are financial contracts that obligate the contracts’ buyers to purchase an asset at
a pre-agreed price on a specified future date. Both forwards and futures are essentially
the same in their nature. However, forwards are more flexible contracts because the
parties can customize the underlying commodity as well as the quantity of the
commodity and the date of the transaction. On the other hand, futures are standardized
contracts that are traded on the exchanges.

 2. Options:

44
They provide the buyer of the contracts the right but not the obligation to purchase or
sell the underlying asset at a predetermined price. Based on the option type, the buyer
can exercise the option on the maturity date (European options) or on any date before
the maturity (American options).

 3. Swaps:

Derivative contracts that allow the exchange of cash flows between two parties. The
swaps usually involve the exchange of a fixed cash flow for a floating cash flow. The
most popular types of swaps are interest rate swaps, commodity swaps, and currency

45
swaps.

4. Exchange Traded Funds or Securities:

An ETF, or exchange-traded fund, is a marketable security that tracks a stock index, a

commodity, bonds, or a basket of assets. Although similar in many ways, ETFs differ
from mutual funds because shares trade like common stock on an exchange. The price
of an ETF’s shares will change throughout the day as they are bought and sold. The
largest ETFs typically have higher average daily volume and lower fees than mutual
fund shares which makes them an attractive alternative for individual investors.

While most ETFs track stock indexes, there are also ETFs that invest in commodity
markets, currencies, bonds, and other asset classes. Many ETFs also have options
available for investors to use income, speculation, or hedging strategies.

46
Types of Risk in Capital Market:

Every saving and investment product involves different risks and returns. Broadly
speaking, investors are exposed to both systematic and unsystematic risks. Systematic
risk is the risk inherent to the entire market or market segment, and it can affect a
large number of assets. Also known as undiversifiable risk, volatility and market risk,
systematic risk affects the overall market – not just a particular stock or industry. This
type of risk is both unpredictable and impossible to avoid completely. Examples
include interest rate changes, inflation, recessions and wars.

1. Unsystematic Risk

On the other hand, risk affects a very small number of assets. Also called
nonsystematic risk, specific risk, diversifiable risk and residual risk, this type of risk

47
refers to the uncertainty inherent in a company or industry investment. Examples
include a change in management, a product recall, a regulatory change that could
drive down company sales and a new competitor in the marketplace with the potential
to take away market share from a company in which you’re invested.

2. Credit or Default Risk

Credit risk is the risk that a borrower will be unable to pay the contractual interest or
principal on its debt obligations. This type of risk is particularly concerning to
investors who hold bonds in their portfolios. Government bonds, especially those
issued by the federal government, have the least amount of default risk and, as such,
the lowest returns. Corporate bonds, on the other hand, tend to have the highest
amount of default risk, but also higher interest rates. Bonds with a lower chance of
default are considered investment grade, while bonds with higher chances are
considered junk bonds. Investors can use bond rating agencies – such as Standard and
Poor’s, Fitch and Moody's – to determine which bonds are investment-grade and
which are junk.

3. Country Risk

Country risk refers to the risk that a country won't be able to honor its financial
commitments. When a country defaults on its obligations, it can harm the
performance of all other financial instruments in that country – as well as other
countries it has relations with. Country risk applies to stocks, bonds, mutual funds,
options and futures that are issued within a particular country. This type of risk is
most often seen in emerging markets or countries that have a severe deficit. 

4. Foreign-Exchange Risk

When investing in foreign countries, it’s important to consider the fact that currency
exchange rates can change the price of the asset as well. Foreign exchange risk (or
exchange rate risk) applies to all financial instruments that are in a currency other than
your domestic currency. As an example, if you live in the U.S. and invest in a
Canadian stock in Canadian dollars, even if the share value appreciates, you may lose
money if the Canadian dollar depreciates in relation to the U.S. dollar.

5. Interest Rate Risk

48
Interest rate risk is the risk that an investment's value will change due to a change in
the absolute level of interest rates, the spread between two rates, in the shape of the
yield curve or in any other interest rate relationship. This type of risk affects the value
of bonds more directly than stocks and is a significant risk to all bondholders. As
interest rates rise, bond prices fall – and vice versa.

6. Political risk

It is the risk an investment’s returns could suffer because of political instability or
changes in a country. This type of risk can stem from a change in government,
legislative bodies, other foreign policy makers or military control. Also known as
geopolitical risk, the risk becomes more of a factor as an investment’s time horizon
gets longer. 

7. Market Risk

Market risk is the risk that an investment will face fluctuations and decline in value
because of economic developments and other events that influence the entire market.
Also referred to as systematic risk, this type of risk affects all securities in the same
manner. Specific market risks can include interest rate risk, inflation risk, currency
risk, liquidity risk, country risk and sociopolitical risk.

Capital Market (Annual Report)

2016-17 2017-18 P

Item Numbe Amoun Numbe

Amount
r t r

1 2 3 4 5

I. PRIMARY MARKET

A. Prospectus and Rights Issues

1. Private Sector (a+b) 132 599 221 730

a) Financial 26 454 20 361

49
b) Non-Financial 106 145 201 369

2. Public Sector (a+b+c) 2 22 8 372

a) Public Sector Undertakings 1 10 4 69

b) Government Companies … … … …

c) Banks/Financial Institutions 1 11 4 303

3. Total (1+2, i+ii, a+b) 134 621 229 1,102

Instrument Type

(i) Equity 118 325 222 1,052

(ii) Debt 16 296 7 50

Issuer Type

(a) IPOs 105 291 200 838

(b) Listed 29 330 29 264

B. Euro Issues (ADRs and GDRs) … … … …

C. Private Placement

1. Private Sector (a+b) 3,189 4,201 2,366 4,478

a)  Financial 2,588 3,083 1,723 3,412

b) Non-Financial 601 1,117 643 1,065

2. Public Sector (a+b) 247 2,471 208 2,323

a) Financial 155 1,586 167 1,926

b) Non-Financial 92 885 41 396

3. Total (1+2, i+ii) 3,436 6,672 2,574 6,800

50
(i) Equity 24 137 56 694

(ii) Debt 3,412 6,534 2,518 6,107

D. Qualified Institutional Placement 20 85 53 673

E. Mutual Funds Mobilisation (Net)# 3,431 2,718

1. Private Sector 2,794 2,285

2. Public Sector 637 433

II. SECONDARY MARKET

BSE

BSE Sensex: End-Period 29,621 32,969

Period Average 27,338 32,397

Price Earning Ratio 23 24

Market Capitalisation to GDP ratio

80 85
(%)

Turnover Cash Segment 9,983 10,830

Turnover Derivatives Segment 69 33

NSE

S&P CNX Nifty: End-Period 9,174 10,114

Period Average 8,421 10,030

Price Earning Ratio 23 25

Market Capitalisation to GDP ratio

79 84
(%)

Turnover Cash Segment 50,559 72,348

51
 1,649,84
Turnover Derivatives Segment 943,703
9

P: provisional.    …: Nil.    #: Net of redemptions.

Source: SEBI, NSE, BSE, CSO and various merchant bankers.

4.6 MONEY MARKET

The term ‘Money Market’, according to the Reserve Bank of India, is used to define a
market where short-term financial assets are traded. These assets are a near substitute
for money and they aid in the money exchange carried out in the primary and
secondary market. So, essentially, the money market is an apparatus which facilitates
the lending and borrowing of short-term funds, which are usually for a duration of

under a year. Short maturity period and high liquidity are two characteristic features
of the instruments which are traded in the money market. Institutions like commercial

52
banks, non-banking finance corporations (NBFCs) and acceptance houses are the
components which make up the money market.

The money market is a part of the larger financial market and consists of numerous

smaller sub-markets like bill market, acceptance market, call money market, etc .
Money market deals are not carried out in money / cash, but other instruments like
trade bills, government papers, promissory notes, etc. Also, money market
transactions cannot be done via brokers but have to be carried out via mediums like
formal documentation, oral or written communication.

Features of Money Market:

The following are the general features of a money market:

1. It is market purely for short-term funds or financial assets called near money.

2. It deals with financial assets having a maturity period up to one year only.

3. It deals with only those assets which can be converted into cash readily without
loss and with minimum transaction cost.

4. Generally transactions take place through phone i.e., oral communication.

Relevant documents and written communications can be exchanged

subsequently. There is no formal place like stock exchange as in the case of a

capital market.

5. Transactions have to be conducted without the help of brokers.

6. The components of a money market are the Central Bank, Commercial Banks,
Non-banking financial companies, discount houses and acceptance house.
Commercial banks generally play a dominant in this market.

Advantages of Money Market:

1. Financing Trade:

53
Money market plays a very important role in both internal and international trade.
Through the bill of exchange the commercial finance is very much available to the
traders.

2. Provides Funds:

Money market provides short-term funds to the both public and private institutions
which needs financing for their working capital requirements. Money market do these
by discounting trade bills through commercial banks, discount houses, brokers and
acceptance houses. By all these money market helps the development of commerce,
industry and trade within and outside the country.

3. Profitable Investment:

Money market makes it possible for the banks and other financial institutions to use
their surplus funds profitably for a short period. These institutions include not only
commercial banks and other financial institutions but also large non-financial business
corporations, states and local governments.

4. Helps Governments:

The money market helps the government when they borrow short-term funds at a
lower interest rates on the basis of treasury bills. On the other hands, if the
government were to issue paper money or borrow from the central bank, it would lead
to inflationary pressures in the economy.

5. Helps in Monetary Policy:

A well-developed money market helps in the successful implementation of the

monetary policies of the central bank. It is trough the money market that the central
banks are in a position to control the banking system and thereby influence commerce
and industry

6. Helps in Financial Mobility:

54
Money market makes it easier to transfer various funds from different sector to sector
and place to place, this facility of the money market helps in increasing the financial
mobility of the country.

7. Promotes Liquidity and Safety:

One of the important functions of the money market is that to promote liquidity and
safety of financial assets. It thus encourages savings and investments.

8. Equilibrium between Demand and Supply of Funds:

The money market brings equilibrium between the demand and supply of loadable
funds. The money market does all these by allocating different savings into
investment sectors and channels.

9. Providing Sufficiency to the Commercial Banks:

When the commercial banks face any scarcity of money they can recall their old short
term loans from money market rather than going to the central bank and borrowing
money at a higher interest rate.

10. Reducing the Use of Cash:

Money market mostly deals with the asset that has very high liquidity. It helps to
reduce the use of cash money and it is also safer to move one place to another.

Disadvantages of Money Market:

1. Low Transaction Limits 

Money market funds permit very few free transactions per month, so that the funds
can be invested in higher tenure papers and thereby earn higher interest for the
investor. For instance, most money market funds allow only 3 to 5 checks to be issued
per month, beyond which charges could be levied. The way out is to have the money
market fund as a secondary account in which the investor doesn’t need to access his

55
funds for a considerable amount of time. The primary account should be a checking

account which allows many more transactions per month even though no interest is
paid on such an account.

2. Low Interest Rates 

When compared to other market linked investments or even term deposits or

government securities, many money market funds offer much lower interests, since
their main priority is to preserve the capital and maintain the net asset value at $1.

First, one can purchase this fund from a brokerage firm which might be able to
negotiate for better rates on your behalf on account of the higher volume of business
they generate. Second, you should have a reasonable mix of high returns and low risk
in your total investment portfolio. This will help in averaging out the low return

investments and give you a better overall return on investment.

3. High Fees 

Unlike many savings and checking accounts which have the option of negotiation for
getting a charge free product, most money market funds have high annual fees which
eat away a large portion of your investment upfront. The solution to this is to scout
around for the fund which offers the best rate, so that the impact of the annual fees
can be reduced.

56
 4.7 Types of Money Market:

Money Market Instruments provide the tools by which one can operate in the money
market. Money market instrument meets short term requirements of the borrowers and
provides liquidity to the lenders. The most common money market instruments are
Treasury Bills, Certificate of Deposits, Commercial Papers, Repurchase Agreements
and Banker's Acceptance.

57
1. Treasury Bills (T-Bills):
Treasury Bills are one of the safest money market instruments as they are issued by
Central Government. They are zero-risk instruments, and hence returns are not that
attractive. T-Bills are circulated by both primary as well as the secondary markets.
They come with the maturities of 3-month, 6-month and 1-year.

The Central Government issues T-Bills at a price less than their face value and the
difference between the buy price and the maturity value is the interest earned by the
buyer of the instrument. The buy value of the T-Bill is determined by the bidding
process through auctions.

How it works (Example):

T-Bills are issued at a discount to the maturity value. Rather than paying a coupon

rate of interest, the appreciation between issuance price and maturity price provides
the investment return.

For example, a 26-week T-bill is priced at $9,800 on issuance to pay $10,000 in six
months. No interest payments are made. The investment return comes from the
difference between the discounted value originally paid and the amount received back
at maturity, or $200 ($10,000 - $9,800). In this case, the T-bill pays a 2.04% interest
rate ($200 / $9,800 = 2.04%) for the six-month period.

58
2. Certificate of Deposits (CDs):
Certificate of Deposit is like a promissory note issued by a bank in form of a
certificate entitling the bearer to receive interest. It is similar to bank term deposit
account. The certificate bears the maturity date, fixed rate of interest and the value.
These certificates are available in the tenure of 3 months to 5 years. The returns on
certificate of deposits are higher than T-Bills because they carry higher level of risk.

59
3. Commercial Papers (CPs):
Commercial Paper is the short term unsecured promissory note issued by corporate
and financial institutions at a discounted value on face value.

They come with fixed maturity period ranging from 1 day to 270 days. These are
issued for the purpose of financing of accounts receivables, inventories and meeting
short term liabilities.

The return on commercial papers is is higher as compared to T-Bills so as the risk as

they are less secure in comparison to these bills. It is easy to find buyers for the firms
with high credit ratings. These securities are actively traded in secondary market.

Use of commercial papers in past years:

4. Repurchase Agreements (Repo):

Repurchase Agreements which are also called as Repo or Reverse Repo are short term

60
loans that buyers and sellers agree upon for selling and repurchasing. Repo or Reverse
Repo transactions can be done only between the parties approved by RBI and allowed
only between RBI-approved securities such as state and central government securities,
T-Bills, PSU bonds and corporate bonds. They are usually used for overnight
borrowing. Repurchase agreements are sold by sellers with a promise of purchasing
them back at a given price and on a given date in future. On the flip side, the buyer
will also purchase the securities and other instruments with a promise of selling them
back to the seller.

5. Bankers Acceptance:
Banker's Acceptance is like a short term investment plan created by non-financial
61
firm, backed by a guarantee from the bank. It's like a bill of exchange stating a buyer's
promise to pay to the seller a certain specified amount at a certain date.

And, the bank guarantees that the buyer will pay the seller at a future date. Firm with
strong credit rating can draw such bill. These securities come with the maturities
between 30 and 180 days and the most common term for these instruments is 90 days.
Companies use these negotiable time drafts to finance imports, exports and other
trade.

6. Corporate Bonds:

62
A corporate bond is a bond issued by a corporation in order to raise financing for a
variety of reasons such as to ongoing operations, M&A, or to expand business. The
term is usually applied to longer-term debt instruments, with maturity of at least one
year. Corporate debt instruments with maturity shorter than one year are referred to
as commercial paper.

The term "corporate bond" is not strictly defined. Sometimes, the term is used to
include all bonds except those issued by governments in their own currencies. In this
case governments issuing in other currencies (such as the country of Mexico issuing
in US dollars) will be included. The term sometimes also encompasses bonds issued
by supranational organizations (such as European Bank for Reconstruction and
Development). Strictly speaking, however, it only applies to those issued by
corporations. The bonds of local authorities (municipal bonds) are not included.

Types of risk in Money Market

63
1. Market risk

The risk of investments declining in value because of economic developments or

other events that affect the entire market. The main types of market risk are equity
risk, interest rate risk and currency risk.

 Equity risk – applies to an investment in shares. The market price of shares

varies all the time depending on demand and supply. Equity risk is the risk of
loss because of a drop in the market price of shares.

 Interest rate risk – applies to debt investments such as bonds. It is the risk of

losing money because of a change in the interest rate. For example, if the
interest rate goes up, the market value of bonds will drop.

 Currency risk – applies when you own foreign investments. It is the risk of
losing money because of a movement in the exchange rate. For example, if the
U.S. dollar becomes less valuable relative to the Canadian dollar, your U.S.
stocks will be worth less in Canadian dollars.

2. Liquidity Risk

The risk of being unable to sell your investment at a fair price and get your money out
when you want to. To sell the investment, you may need to accept a lower price. In
some cases, such as exempt market investments, it may not be possible to sell the
investment at all.

3. Concentration risk

The risk of loss because your money is concentrated in 1 investment or type of

investment. When you diversify your investments, you spread the risk over different
types of investments, industries and geographic locations.

4. Credit risk

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The risk that the government entity or company that issued the bond will run into
financial difficulties and won’t be able to pay the interest or repay the principal at
maturity. Credit risk applies to debt investments such as bonds. You can evaluate
credit risk by looking at the credit rating of the bond. For example, long-
term Canadian government bonds have a credit rating of AAA, which indicates the
lowest possible credit risk.

5. Reinvestment risk

The risk of loss from reinvesting principal or income at a lower interest rate. Suppose
you buy a bond paying 5%. Reinvestment risk will affect you if interest rates drop and
you have to reinvest the regular interest payments at 4%. Reinvestment risk will also
apply if the bond matures and you have to reinvest the principal at less than 5%.
Reinvestment risk will not apply if you intend to spend the regular interest payments
or the principal at maturity.

6. Inflation risk

The risk of a loss in your purchasing power because the value of your investments
does not keep up with inflation. Inflation erodes the purchasing power of money over
time – the same amount of money will buy fewer goods and services. Inflation risk is
particularly relevant if you own cash or debt investments like bonds. Shares offer
some protection against inflation because most companies can increase the prices they
charge to their customers. Share prices should therefore rise in line with inflation.
Real estate also offers some protection because landlords can increase rents over time.

7. Horizon risk

The risk that your investment horizon may be shortened because of an unforeseen

event, for example, the loss of your job. This may force you to sell investments that
you were expecting to hold for the long term. If you must sell at a time when the
markets are down, you may lose money.

8. Long equity risk

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The risk of outliving your savings. This risk is particularly relevant for people who
are retired, or are nearing retirement.

9. Foreign investment risk

The risk of loss when investing in foreign countries. When you buy foreign
investments, for example, the shares of companies in emerging markets, you face
risks that do not exist in Canada, for example, the risk of nationalization.

4.8 Growth of Money Market in India.

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While the need for long term financing is met by the capital or financial markets,
money is a mechanism which deals with lending and borrowing of short term
funds. Post reforms age in India has witnessed marvelous increase of the Indian
money markets. Banks and other financial institutions have been able to meet the
high opportunity of short term financial support of important sectors like the
industry, services and agriculture. It performs under the regulation and control of
the Reserve Bank of India (RBI). The Indian money markets have also exhibit the
required maturity and flexibility over the past two decades. Decision of the
government to permit the private sector banks to operate has provided much
needed healthy competition in the money markets resulting in fair amount of
improvement in their performance.

Money markets denote inter-bank market where the banks borrow and lend between
themselves to meet the short term credit and deposit needs of the economy. Short term
normally covers the time period up to one year. The money market operation help the
banks rush over the provisional mismatch of funds with them. In case a particular
bank needs funds for a few days it can lend from another bank by paying the strong-
minded interest rate. The lending bank also gains as it is able to earn interest on the
funds lying idle with it. In other words money market provides avenues to the players
in the market to strike balance between the surplus funds with the lenders and the
obligation of funds for the borrowers. An significant function of the money market is
to provide a central point for interventions of the RBI to pressure the liquidity in the
financial system and implement other monetary policy measures. Quantum of
liquidity in the banking system is of dominant importance as it is an important
determinant of the inflation rate as well as the formation of credit by the banks in the
financial system. Market forces generally indicate the need for borrowing or liquidity
and the money market adjusts itself to such calls. RBI facilitates such adjustments
with monetary policy tools obtainable with it. Heavy call for funds overnight indicates
that the banks are in need of short term funds and in case of liquidity crunch the
interest rates would go up.

Depending on the financial situation and available market trends the RBI intervenes in
the money market through a crowd of interventions. In case of liquidity crunch the
RBI has the option of either dropping the Cash Reserve Ratio (CRR) or pumping in

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more money supply into the system. Recently to conquer the liquidity crunch in the
Indian money market the RBI has released more than Rs 75,000 crores with two back-
to-back reductions in the CRR. In adding to the lending by the banks and the
monetary institutions, various companies in the commercial sector also issue fixed
deposits to the public for shorter period and to that amount become part of the money
market mechanism selectively. The maturities of the instruments issued by the money
market as a whole, range from one day to one year. The money market is also closely
linked with the Foreign Exchange Market throughout the procedure of covered
interest arbitrage in which the forward premium acts as a bridge among the domestic
and foreign interest rates. Determination of appropriate interest for deposits or loans
by the banks or the other financial institutions is a complex device in itself. There are
several issues that need to be determined before the optimum rates are determined.
While the term arrangement of the interest rate is a very important determinant, the
difference between the existing domestic and international interest rates also emerges
as a significant factor. Further, there are several credit instruments which involve
similar maturity but diversely different risk factors. Such distortions are accessible
only in rising and diverse economies like the Indian economy and need extra care
while handling the issues at the policy levels.

4.9 Participants in Money Market:

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The money market consists of financial institutions and dealers in money or credit
who wish to either borrow or lend. Participants borrow and lend for short periods,
typically up to twelve months. Money market trades in short-term financial
instruments commonly called "paper". This contrasts with the capital market for
longer-term funding, which is supplied by bonds and equity.

The core of the money market consists of interbank lending—banks borrowing and
lending to each other using commercial paper, repurchase agreements and similar
instruments. These instruments are often benchmarked to (i.e., priced by reference to)

the London Interbank Offered Rate (LIBOR) for the appropriate term and currency.
Finance companies typically fund themselves by issuing large amounts of asset-
backed commercial paper (ABCP), which is secured by the pledge of eligible assets
into an ABCP conduit. Examples of eligible assets include auto loans, credit card
receivables, residential/commercial mortgage loans, mortgage-backed securities and
similar financial assets. Some large corporations with strong credit rating issue
commercial paper on their own credit. Other large corporations arrange for banks to
issue commercial paper on their behalf.

 Trading companies often purchase bankers' acceptances to tender for payment

to overseas suppliers.

 Retail and institutional money market funds.

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 Banks

 Central banks

 Cash management programs

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  Merchant banks

Functions of the money market:

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Money markets serve five functions—to finance trade, finance industry, invest
profitably, enhance commercial banks' self-sufficiency, and lubricate central bank
policies.

1. Financing trade:

The money market plays crucial role in financing domestic and international trade.
Commercial finance is made available to the traders through bills of exchange, which
are discounted by the bill market. The acceptance houses and discount markets help in
financing foreign trade.

2. Financing industry:

The money market contributes to the growth of industries in two ways:

 They help industries secure short-term loans to meet their working capital
requirements through the system of finance bills, commercial papers, etc.

 Industries generally need long-term loans, which are provided in the capital
market. However, the capital market depends upon the nature of and the
conditions in the money market. The short-term interest rates of the money
market influence the long-term interest rates of the capital market. Thus,
money market indirectly helps the industries through its link with and
influence on long-term capital market.

3. Profitable investment:
The Money Market enables the commercial banks to use their excess reserves in
profitable investment. The main objective of the commercial banks is to earn
income from its reserves as well as maintain liquidity to meet the uncertain cash
demand of the depositors. In the money market, the excess reserves of the
commercial banks are invested in near-money assets (e.g., short-term bills of
exchange), which are easily converted into cash. Thus, commercial banks earn
profits without sacrificing liquidity.

4. Self-sufficiency of commercial bank:

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Developed money markets help the commercial banks to become self-sufficient. In
the situation of emergency, when the commercial banks have scarcity of funds, they
need not approach the central bank and borrow at a higher interest rate. On the other
hand, they can meet their requirements by recalling their old short-run loans from the
money market.

5. Help to central bank:

Though the central bank can function and influence the banking system in the absence
of a money market, the existence of a developed money market smoothes the
functioning and increases the efficiency of the central bank. Money markets help
central banks in two ways:

 Short-run interest rates serve as an indicator of the monetary and banking

conditions in the country and, in this way, guide the central bank to adopt an
appropriate banking policy,
 Sensitive and integrated money markets help the central bank secure quick and
widespread influence on the sub-markets, thus facilitating effective policy
implementation.

4.10 Money Market Scenario in India:

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74
 CHAPTER 5.

Classifications:
Financial Instruments, Functional Categories, Maturity, Currency,
and Type of Interest Rate

A. Financial Instruments

5.1 General issue

This section will briefly define financial instruments. The relationship between
financial assets and other financial instruments will be explained.
Also instruments that are not financial assets will be identified (viz., contingencies,
guarantees, nonfinancial contracts). It will be noted that the financial assets
classification generally applies to both claims (described as assets) and obligations
(described as liabilities). There are exceptions in that monetary gold and SDRs are
international financial assets with no counterpart liabilities and that “accounts
receivable” is an asset, while “accounts payable” is the corresponding liability.
The objectives of classification of financial instruments will be spelled out. The
potential dimensions by which instruments can be classified are numerous, so the
classification involves identifying the most economically crucial features. The
implications of a high degree of financial innovation will be discussed—in particular,
that the classification will need to define the instruments with reference to the
characteristics, not just specific types of instrument, so that it is applicable to new
instruments and helps deal with hybrid and other borderline cases. The importance of
classification of financial assets for understanding financial markets and for
consistency with other datasets, particularly monetary and financial statistics, will be
highlighted. In addition, the financial asset classification will be presented as the
foundation for the functional category classification, which in some cases takes into
account the type of instrument.

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5.2 Overview of classification of financial instruments
It is proposed to adopt an instrument classification that is based largely on that of the
differences is
(i) A rearrangement into broad category headings: equity, debt instruments, and other
instruments, and
(ii) Some clarification

Of terminology. In addition, an explicit concordance is made between the assets and

the corresponding income. The underlying components remain identical.
Possible additional instrument classifications shown in italics.
An imputed instrument for the imputed financial transaction.
Possible sub-item that could be added as a component of any debt instrument on an
“as relevant” basis.

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If included as an asset, financial gold would appear in international transactions, but
not the international investment position, as there is counterpart liability which means
that the positions lack an international dimension.
Definitions of debt and equity will be given, based on definitions in Certain financial
assets that have no counterpart liability do not qualify as debt or equity and so have

been included under “other.” Given that equity in insurance reserves and pension
funds has components of both equity and debt, it has been classified to “other” In
addition; financial derivatives do not meet the definitions of debt or equity, so they
have been classed as other. The instrument classification appears implicitly in
conjunction with the functional and institutional sector classifications.

The following more detailed comments on the proposed instrument classification

should be noted:
(a) Monetary gold and SDRs will continue to be shown separately, as in the
classification, because of their analytical importance in the international accounts.
(b) “Securities” will be defined.

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(c) “Debt securities” is considered to be a clearer term than “securities other than
shares.
(d) The generic term “equity finance” will be used, as opposed to “shares and other
equity, “Equity finance” is considered to be a clearer term and it is also shorter. It will
be used instead of “equity capital,” to avoid confusion with the term “capital” in the
capital account.
(e) “Equity in mutual funds” would be proposed as a supplementary or memorandum
item under equity. It would include equity in mutual funds, unit trusts, and other
collective investment schemes, other than life insurance and pension funds to be
identified separately from “equity finance” in view of their importance. Within such
collective investment schemes, there could be separate components for the type of
investment, namely
(a) Money market
(b) Real estate
(c) Stocks and
(d) Mixed
As supplementary information, where this information is felt to be analytically
important.
(f) Money market mutual funds (MMMFs) and other pooled investments that are
included in broad money may be shown as a supplementary category. In light of the
treatment in the MFSM of such holdings as “deposits” and recognizing their money-
like properties, the manual will recommend that, where significant, they need to be
identified separately for reconciliation with monetary and financial statistics.
(g) As agreed by the Advisory Expert Group on National Accounts in its February
2004 meeting, the manual will recommend an instrument category “financial
derivatives and employee stock options” with the subcategories of
(i) Financial derivatives and
(ii) Employee stock options.
Although employee stock options share some characteristics with financial
derivatives, they do not fully meet the definition of financial derivatives.

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Discussion of the classification of particular instruments:

(a) Repurchase agreements, securities lending, and gold swaps will be defined and
illustrated. The instrument classification will be highlighted by identification of
security and loan aspects. An example will be given.
(b) The borderline between monetary gold and other gold will be discussed, and the
process of monetization and demonetization of gold will be explained. (In addition, if
financial gold were to be recognized as a financial instrument, the borderline with
nonfinancial gold would also be discussed.)
(c) Gold loans, gold swaps, and gold deposits will be defined. Possible treatments are
as the gold staying on the books of the gold provider, in conjunction with a loan or
deposit.
(d) Employee stock options will be classified as a subcategory under a new
instrument category “financial derivatives and employee stock options,” the other
subcategory being financial derivatives.
(e) Inclusion of financial leases as loans will be noted.
(f) Loans that have been traded will be classified as securities under certain
conditions, as stated in the Debt Guide. It will be noted that many loans are traded but
not sufficiently to become securities.
(h) Ownership of mutual funds, unit trusts, and other pooled investments will be
regarded as equity, regardless of what kind of assets the fund holds. In contrast,
because the assets of an asset-backed security remain owned by the issuer, the
security is a debt instrument.
(i) Convertible bonds will be classified as debt securities until the option to convert
them is exercised, at which time they will be classified as the new instrument.
(j) Islamic instruments will be discussed.
(k) Trade credit and advances that are sold to another party (e.g., discounting of an
importer’s bill) will be treated as ceasing to be trade credit and advances and will be
classified as a loan or some other instrument, depending on its nature.
(l) Financial reinsurance will be explained and will be treated as a loan.
(m) Activation of guarantees. Chapter 3 Accounting Principles will state the
recommended treatment in instances when a debt guarantee is invoked. It will state
that, once the guarantee has been invoked, the debt of the primary debtor is assumed
to have been repaid and then assumed by the guarantor, as its own debt.

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B. Functional Categories
The five current functional categories will be highlighted as the major classification
for each of financial transactions, positions, and income. It will be noted that the
classification combines functions and instruments to give a useful breakdown of
investment flows and levels. The proposed category and instrument breakdown is
shown in the following table. Table 5.3 shows a combined classification by functional
category, major instruments, and maturity.

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 CHAPTER 6

Recommendations to the Commission for the 2014-20 periods:

The members of the High Level Group felt there was still a need for greater
understanding and awareness from those looking at compliance and audit of the
differences between grants and financial instruments. Regular, specific seminars for
auditors were recommended to address this issue and improve the awareness in 2014-
20 before first audits would be carried out.
A working group of practitioners, including key types of beneficiaries, should be
established as soon as possible to review and consider concrete issues related to
financial instruments including:
The requirements for final recipients (documents required, periods for retention of the
documents, etc.) to align them as far as possible with market practice. The possibility
to reduce requirements for smaller instruments or pilots to encourage more use among
those managing authorities with limited experience of financial instruments.
Certain privileges that seemed to be offered to the EIB in terms of entrustment of
implementation tasks or application of state aid rules should also be offered to
Member States or national banks or other public institutions when managing ESI
Funds.
The impact of the clause on repaying in case of irregularity.
Public procurement and State Aid rules.
The strict application of the requirements of selection of financial intermediaries via
an open procedure (call for expression of interest), follow-up investments in firms that
have become a firm in difficulty only after the first ESIF-investment should be
permitted if all other private investors are equally willing to invest further. Payouts
to private investors within the funding period irrespective of whether the financial
instrument is classified as State Aid or not.
Public procurement should not be the primary procedure for selection of such bodies.

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 CHAPTER7

Suggestions for further reflection for post 2020:

Based on their review of the legal framework for financial instruments on the key
principles identified and in addition it underlines that:

Capacity building in the area of financial instruments developed throughout the period
of 2014-20 will facilitate and improve the use of financial instruments post 2020.
Rules between ESI Funds and other EU funds should be further harmonized and the
possibility of own contribution by the final recipient should be explored.
A legal framework common to ESIF and state aid regulation covering both
regulations would provide a uniform set of common rules and simplify the creation of
financial instruments.
A differentiated and streamlined legal framework for micro-credit; social economy, as
well as very small businesses and micro-enterprises should be provided.

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 CHAPTER 8

Conclusions:
The members of the Group noted the increased focus on using financial instruments in
the 2014-20 period and the opportunities these instruments could bring to leverage in
additional resources to help support the achievement of the investment goals of the
ESI Funds. They also acknowledged the political significance of facilitating further
the use of financial instruments in the context of complimentarily with the European
Fund for Strategic Investments (EFSI) and other financial sources. However, from
the evidence presented during the meeting, they noted the following challenges
relating to financial instruments:
Setting up the financial instruments involved lengthy processes for the Managing
Authorities including an intensive ex-ante assessment.
The guidance provided from the Commission on the subject is extensive but often
interprets the regulations in a different way than had been understood by Member
States, some of which created more difficulties and questions than they answered. EU
level "gold-plating" for financial instruments should be avoided to not increase the
weight of obligations already incumbent on the private managers of funds, but also to
avoid additional administrative demands on the enterprises supported by the financial
instruments.
There was little sense of proportionality in the requirements for financial instruments
according to their size, and therefore little incentive to use them for smaller scale
instruments.
The rules established for the financial instruments do not take into account the fact,
that each type of financial product has its own specific character and therefore some
rules applicable to one type of a product may not apply to another one (e.g. what is
applicable to loans may not be applicable to guarantees).

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 CHAPTER 9
Bibliography:

Bharti V. Pathak, “The Indian Financial System”, Pearson Education [India] Ltd. 2nd
Edition, Year 2006.

Websites:

1. www.Capitaline.com

2. www.Capitalmarket.com

3. www.Wikipidia.com

5. www.CNBC.com

6. www.Moneycontrol.com

7. www.Indiainfo.com

8. www.googlebook.com

9. www.financial instruments.com

Newspapers:

1. The Economic Times

2. The Times of India

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