Financial Markets

Syllabus:
Section I
Financial System: Overview, Components of Financial System, functions of Financial System Money Market: concept, classification, role of Money Markets, characteristics of Money market, Organized and unorganized Money markets, role of RBI Call Money market: Concept, Evolution, Importance, Present Status of Call Money Market DFHI: Evolution, Role, Functions, Limitations Bills Market: Concept, Characteristics, Importance, Salient features of old and new scheme of bills discounted Capital Market: Characteristics, Types (Primary and Secondary, structure, Role, Constituents of capital Market New Issue Markets

Section II
Foreign Exchange Markets: Concepts, Instruments, Components, Functions, Role of RBI, Introduction to Asian Clearing Unit and Asian Currency Unit, Operations in Foreign Exchange markets, Euro bonds Foreign Currency Financing for projects Exchange Rate determination Stock Exchange: Introduction, Classification, Recognition, Functions, Advantages, Dealings in Stock Exchanges Introduction to NSE, OTCE, national Depository, Stock Invest Scheme Securities and Exchange Board of India: Evolution, Functions, Objectives, Evolution of performance of SEBI

FINANCIAL MARKET
Que. 1: Introduction to the Financial System/ Markets OR Concepts of Financial System Answer:
The word financial system means of set of Institutions, banks and organizations, both public sector and private sector, by which financial transactions are made in the country. Van Horne has defined the Financial System as the purpose of financial markets to allocate savings efficiently in an economy to ultimate users either for investment in real assets or for consumption. According to Robinson: The primary function of the system is to provide a link between savings and investment for the creation of new wealth and to permit portfolio adjustment in the composition of the existing wealth. The following illustration can explain the concept of financial market which appears from the above definition. Financial system Savings Finance Investment Capital Formulation Economic Growth

The Financial System channels, savings of individuals to output and streamline (make more efficient) it into investments. Channel by providing seed capital and long term credit to corporate, industries, government and other sectors of the economy. It therefore promotes capital Formation. The process of savings, financing and investments involve financial institutions, market instruments and services. The financial market also provides supervision and control over the financial dealings in the country. Financial system includes the mechanism through which all financial dealings are done in the economy. The financial system comprises two parts: A) Organized Financial System B) Unorganized Financial System The financial system determines the economic process of the country. It interprets the Fiscal and Monetary policies of the government. The financial system establishes a strong link between saving and investment by creating the infrastructure by which economic activities are created, sustained and developed. The market comprises the providers of finance and financial services and the users of financial services. The financial system provides services that are vital for the modern economy. It facilitates commerce and business. It facilitates the integration of the domestic financial market with the international financial market. It enables the efficient use of resources, which are scarce. It is one of the key ingredient and for the growth of the modern economy. It provides employment opportunities to a number of institutions, individuals, government sector etc. It controls the movement of funds in the economy. It also provides for earnings to individuals, banks, government and other sectors.

Que. 2 Overview/ Phases/ Evolution of Financial Systems: Answer:

The Indian Financial System went through the following stages to evolve as a mature system today. 2

A) Phase I (Pre-1951 organization) The Indian Financial System before 1951 was similar to the theoretical model of financial organization in traditional economy as given by R.L. Bennett, according to him, traditional economy is an economy in which the per capita output is low and constant. L.C. Gupta aptly (rightly) described the pre 1951 financial system as follows: The principal features of the pre independence industrial and financial organizations are the closed circle characters of industrial entrepreneurship, is semi organized and has a narrow industrial securities market, devoid of issuing institutions and the virtual (actual) absence of participation by intermediary financial institution in the long term financing of the industry. During this phase the industry did not have a full access to outside savings. In this system, there was no chance of high rate of industrial growth. Agriculture was the mainstay of the economy. B) Phase II (1951 to mid 80s) In the second phase, the organization of financial system underwent (undergo) a sea change due to planned economic development in pursuance of broad economic and social aims of the state to secure economic growth with social justice, under the directive principles of state policy. The scheme of planned economic development was stared in 1951. The introduction of planning has held (In custody) important implications for financial system with the adoption of mixed economy as the pattern of development in which complimentary role was conceived (imagine) for public and private sector. This was a need for an alignment of financial mechanism with priorities laid down by government economic policy. In other words, planning signified (suggested) the distribution of resources by the financial system to be in conformity (consistency) with 5 years plans. The requirement to allocate funds in keeping with corresponding (parallel) pattern implied government control over distribution of credit and finance. The main elements of financial organization can be categorized as follows: i) ii) iii) iv) Public/ government ownership of financial institution Fortification (strengthening, reinforcement) of institutional structure Protection of investors Participation of financial institutions in corporate management

In this phase, many financial institutions were created. The 1969 was a major year of change when major commercial banks ware nationalized. In 1972, a general insurance corporation was setup as a consequence (out come, result) to nationalization of general insurance companies. A number of financial institutions were created. The biggest mutual fund of that time. Unit Trust of India (UTI) was also created during this period. A well developed financial system evolved due to the creation of newer institutions and modification in structure and policy of existing Financial System. The most outstanding development in this phase was setting up of different structural developmental banking and financing institutions. Industrial credit got a heavy boost (increase). A new generation of investors and entrepreneurs came on the scene (picture). A number of states created their own financial corporations. ICICI Ltd. which was created in 1955 represented a land mark in diversification of development banking in India. During this period IDBI, SIDBI and other institutions along with LIC played major role in granting credit to industrial users. The companys Act, 1956 regulated the setting up of corporate, industrial enterprises. A number of laws like FERA, MRTP were created. Investors protection was giving a boost. A vast infrastructure was created which laid the foundation of modern growth of Indian Industry. Dependence on agriculture was also reduced. 3

C) Phase III (Post 1990s) This phase was marked by launching a new economic policy in 1991. Major economic changes took place in fiscal and economic sides. The government control over many sectors was liberalized. Rupee was made partly convertible and the service sector industry, specially the Information technology sector, created a vibrant (energetic) economy. The contribution of agriculture to GDP was reduced to 45%, creating new avenues (opportunities) of opportunities. Many new laws were drafted to reflect these changes. The capital markets, Bills market, Call Money markets and Foreign Exchange Markets also developed and flourished (grow, increase). A formation was laid for a modern India which has got a GDP growth rate of 9% and more at present. The stock market is booming and has crossed the 15,000 mark. It reflects the buoyancy (optimism) in the industry sectors. The GDP growth rate is 9% plus and the confidence of foreign investor in the Indian market is very high.

Que. 3 Components of Indian Financial System OR Structure of Financial System OR Types of Financial System Answer:
The Indian Financial System is broadly classified into two parts: A) Organized Financial System B) Unorganized Financial System The financial system can also be classified into users of financial services and providers of finance, but the first classification is construe (interpret) as the structure of financial system. A) Organized Financial System: The organized system includes a number of financial institutions, Non Banking Financial Companies (NBFC), mutual funds, scheduled and non scheduled banks, capital and money markets, Foreign Institutional Investors (FIIs), government institutions and Other Corporate Bodies (OCBs). The organized Financial System has grown by leaps and bounds in just 15 years. The structure of the financial system is as follows: The organized money markets in India are broadest. They are mostly found in urban centers but they have an impressive network in the rural sector also. The organized financial system in India does not operate at its fully efficiency due to a number of government rules and regulations. Urgent regulatory harmonization (coordination) is needed between the various regulations to bolster (boost, encourage) the growth of organized financial system. Most of the transactions in this system are done through the banks. Most of the transactions are transparent. Organized financial system comprises approximately 82% to 85% of the total transactions of the financial system. When India got independence in 1947, the organized sector was under developed and comprised nearly 40% of the total financial system but with the rapid industrialization and rapid strides (steps) made in development, made the organized system stronger than the late 1980s. The Indian economy has liberalized and has been decontrolled to a great extent. From 1999 onwards, the Indian economy has globalized. All these developments had a positive and sobering (serious) effect on the organized system. The organized sector grew at a fast pace (speed) keeping pace with globalization of the Indian Financial System. It was but natural that the Indian Financial System could get partly integrated with the International Financial System. This boosted the organized system tremendously over the years. The structure of financial institutions in India has 4

developed in three areas, (i) State, (ii) Co-operative and (iii) private. Rural and urban areas are well served by the cooperative sectors as well as by corporate bodies with national status. There are more than 4, 58,782 institutions channelizing credit in to the various areas of the economy. B) Unorganized Financial System: India has an indigenous (original, home town) banking system with centuries of traditions. This system was very well developed and comprised (include, consist) an impressive (remarkable) networks across the country and having tentacles in almost all the parts of the country. This system had developed the HOOUDI i.e. a financial instrument still in use that is similar to a commercial bill of the western, Europe; Indigenous bankers combined banking with other activities such as merchant banking, shroffs, etc. It was based upon an well oiled, elaborate (complicated) and extensive (wide, broad) networks of personal relations that overcome the problems of dealings with a large numbers. The unorganized financial system is not under direct control of RBI, like the organized financial system. It comprises mainly money lenders, shroffs, lending pawnbrokers, traders, landlords, indigenous bankers and certain co-operative banks, etc. The unorganized financial system is usually prevalent (common) in small towns and rural sectors. They occupied a very important place at the time of independence, as nearly 70% of financial transactions were done by this system. However, with the modern industrialization and economic growth, their importance was gradually reduced and so also their sphere (area) of influence. With the growth in internet and e banking, it is assumed that by 2050 the unorganized sector would just be 5% of the total financial system. Most of the funds obtained by unorganized financial sector are from the organized sector. During the peak seasons the in organized sector borrows from the organized sectors and during the slack (loose, relaxed) seasons, returns the money back to the organized sectors. There is thus a circular movement of funds between the organized and unorganized sectors. Since the unorganized sector is also governed by the relevant rules and structure of the organized sector, it comes within the indirect control of RBI. The organized and unorganized sectors have own rules to play in developing the economy and therefore both the systems need to be integrated and co-ordained for the betterment of the economy.

Que. 4 Functions of Financial System Answer:

The financial system basically performs the following functions:

A) Regulatory Functions:
(i) Bankers Bank The financial system provides the total funds required by the system a whole and it is the borrower and lender of the last resort (option). (ii) Supervision of Financial Institutions:

It provides the mechanism for overall supervision of all the markets participants to ensure compliance (fulfillment) with the rules and regulation. (iii) Regulations and Control of Financial Institutions:

The Financial System frames the laws for the financial system participants. It adopts various measures to effectively regulate the financial units. Licensing and calling of information is part of regulation and control procedures, including strict implementation of fiscal and monetary controls. (iv) Directive Investments:

The financial system has created a structure for the whole economy. It seeks to direct investments to areas which are more profitable and in some cases to areas which are underdeveloped to remove imbalances in the development.

B) Development Functions:
(i) Training of Intermediaries:

The financial system provides support facilities for a proper training of merchant bankers, venture capitalist and other market intermediaries who perform certain duties on behalf of the other. (ii) Promotion of Fair Practices:

The financial system has evolved a network of inter relationship and has made it possible for the information to be more transparent and online by which manipulations (management) and unfair trade practices can be avoided. (iii) Industrial Building and development:

The financial system strives (try hard) to create new institutions and develop them, so that all round development can take place. (iv) Creating Financial Awareness and Upgrading managerial Skills:

The financial system creates the financial awareness amongst the market participants. It also provides information about the new trends to upgrade the managerial skills in the light of new information, opportunities and threats. It also promotes self employment by giving guarantees or counter guarantees on loans raised. It further provides economic and financial help to green shoe companies.

C) Advisory Functions:
(i) Credit Information and Investor Education: The financial system gives latest information about the credit worthiness of the various market participants and of buyers in distant (remote) countries. It also educates the prospective investors about the most profitable channels of investment and growth. It also identities (characteristics) the risks involved with a particular investment proposal. (ii) Conducting Research and Managerial Update:

The financial system collects and sorts (arrange) data of change processers and current environment and converts it into meaningful information. It also undertakes to furnish the interpretation of research results to the management to keep them aware of any new changes in the government policies or of emerging scenario (situation).

MONEY MARKET
Que. 1 Meaning OR Concept of Money market: Answer:
Any economy can only developed, if its financial market is efficient and vibrant. Such financial markets channel savings into investment and helps in capital formation. It encourages the Institutions and people of the country to save and increase the fund supply in the economy. It also develops a viable financial structure. Well developed financial markets, enlarge the range of financial services under suitable conditions. Financial markets can provide long term finance to government and large business concerns. The development of securities market usually starts with trading in a short term money market instrument, often a government security. So before capital or long term markets develop and become full fledged, money markets have to develop and grow. Money market has been broadly defined as an organization for dealing in loan money or borrowed funds. This definition is very broad but not exacting. A near perfect and inclusive (complete) definition is as follows: A money market is a mechanism through which short term funds are loaned and borrowed and through which a large part of the financial transactions of a particular country or world are cleared. In a broader perspective, it includes the entire structure of financial system in which funds are lent and financial dealings are done. In a narrower sense, it however means dealing in call loans and in credit instruments such as bills of exchange and treasury bills. The main instruments of money market are as follows. 1) 2) 3) 4) 5) 6) 7) Certificate of Deposit Bankers Acceptance Commercial Papers Treasury Bills Interbank Deposits Government Securities Other credit Instruments

The money market in a broad sense includes the following sub-markets: a) b) c) d) e) f) Discount Market Bills Market or Treasury Bills Market Bond Market or Stock Market Capital Market Short Term Money Market Call Money Market

Money markets are short term in nature. In a broad sense they include both long term and short term markets. If this definition is accepted then even the capital markets would be part of money markets. But however, money markets in the actual sense only include short term markets. The time period of borrowings, in the money markets can be one day to one year. Traditionally the money market in India is understood to be the call money market. But now with the growth in commercial bills market and inter-bank deposit and inter corporate deposits markets; these other sub markets are also developed and are flourishing. 7

Que. 2 Characteristics of Money Markets Answer:

Money market is basically a market through which short term funds are dealt. It is the starting point for the development of the capital market and long term markets. Money markets have some special distinguishing characteristics as follows: 1) It is basically a short term funds market. 2) It is the first step in development of the financial system. A well developed and full fledged money market is indispensable (very important) for the development of the financial system. 3) Money markets provide a non inflationary way to finance government deficits (shortage). 4) They enable government to implement monetary policies through open market operations and provide a market based reference point for setting up interest rates. 5) It enables a development of competitive environment for banks and financial institution. 6) The main instruments of money market are treasury bills, government securities and inter bank deposit. 7) They are a source of funds for commercial banks and other institutions with limited branch networks. 8) It also enables discounting of bills and providing extremely short term loans to brokers and agents for security related transactions. 9) It is directly and indirectly controlled by RBI 10) It comprises two parts viz. (i) organized money markets and (ii) unorganized money markets

Que. 3 Role of RBI in Money market Answer:

The RBI plays the role of a statute (order) maker, legislature, facilitator and controller of money market. Money markets are of two types (i) organized money market and (ii) unorganized money markets. Unorganized money markets are under the indirect control of RBI. Technically speaking, the unorganized sector borrows funds from the organized sector and is nearly dependent upon the organized sector for its survival. The organized sector is under the direct control of RBI and therefore the unorganized sector can also be said to be under direct control of RBI. RBI frames rules and laws for the money market. It is the duty of the RBI to ensure that a prober interpretation of laws is doe and that they are dutifully (respectfully) observed in letter and spirit. For this purpose, the RBI has evolved an efficient delivery vehicle to ensure the under standing of laws by the money markets. The RBI has also created a mechanism to monitor the money markets to ensure that the rules are being observed. Deviations from rules are not allowed and suitable structure for penalty and fines have been created by RBI to punish defaulters. RBI ensures transparency in money market operations. It ensures fair dealings. RBI is also the lender of the last resort. It provides funds to money market to overcome the shortage of funds; similarly RBI sucks away funds from money market to maintain stability in money markets in times of excess supply. By this mechanism, RBI controls the interest fluctuations in money markets. It encourages the habit of savings amongst the people at large. RBI also encourages the integration of Indigenous bankers with the organized sector. The RBI maintains fiscal and monetary discipline in the money markets. RBI helps the banks and financial institutions to expand and extend their banking facilities even to remote areas. RBI also furnishes important information about the economic, political, fiscal policies, current trends etc. which facilitate the development of money markets. It also provides facilities for training 8

of market intermediaries and market participants. It directs investments and issues licenses for market operations. Thus the role of RBI is crucial to the successful functioning of money markets. The RBI has to first of all take steps to ensure that the money lenders or the indigenous bankers function within the purview of central and banking policy. Even before the RBI guidelines, their importance was realized to the extent that the central banking inquiry committee recommended this course of action. Some of the suggestions were as under: 1) 2) 3) 4) Indigenous bankers are linked with central banking institutions. They should be treated as members banks on the approved list of banks. Commercial banks must discount their bills more easily. License must be given to the indigenous bankers.

The RBI brought out many guidelines for this purpose and it has partially achieved this objective. The RBI is the central bank of the country. In order to exercise effective monetary management the bank has to introduce monetary discipline in the money market. In this connection, its first job is to consolidate (merge, combine) commercial banking and extend banking facilities in the country. Through this the RBI has achieved to a great extent. It is ensured that nationalized banks should be reorganized into viable units and the link between the state bank and commercial banks should be more penetrating (Sharpe). Again the RBI should guide and regulate the other financial institutions in the country, which substantially (considerably) influence the money market. The RBI ensures that direct link be established between organized and unorganized money market. Co-operative banks should be brought within the control of RBI. The central bank can implement its monetary policy more effectively for a country like India, with large geographical boundaries and with the large population by also having a large number of banking officers and by also regulating co-operative banks. It is necessary that there should be constituents (element) which should act under the overall control of RBI. RBI frames rules and regulations for the money market. It also ensures sufficient liquidity in the money market. It plays a role of a stabilizer in the money market.

Que. 4 Role of money Markets in an Economy Answer:

The financial markets are in the forefront of developing economies. Speedy economic development is possible due to a well developed and vibrant money market. This market facilitates the flow of savings into investment and vice versa. The long term market develops after the development of short term market. Usually the instruments of money markets are traded actively, which then provides impetus (force) to the development and increase in volumes in capital markets. Money market also provides a non inflationary way to fianc government deficits. They also allow government to implement monetary policies through open market operations and provide a market based reference point for setting interest rates. These markets are a source of funds to commercial banks and other financial institutions. These markets make corporate loan market more competitive and eliminate the monopoly of large banks. They also provide flexible means for managing liquidity in the economy. These markets provide bench marks for fixing interest rates. These markets provide for the integration of organized and unorganized markets. They thus extend the RBI influence to the unorganized sector also. They generate employment opportunities and contribute in a great way for the development of the economy as a whole. They can also remove imbalances in an economy and make the economy more vibrant and strong. 9

Que. 5 Explain organized and unorganized money markets. How they are complementary to each other? Answer:
Money market has been defined as an organization which deals in borrowed funds or loan money. However its precise definition is as follows: A money market is mechanism through which short term funds are borrowed and through which a large part of the financial transactions of a particular country or the world are cleared. Classification of money market: 1) Organized money market 2) Unorganized money market

1) Organized money market: The organized system includes a number of finance institutions, non banking finance company (NBFCs), mutual funds, scheduled and non schedule banks etc. The organized system of money market consist of the RBI, commercial banks, large sized joint stock companies, financial intermediaries such as LIC, UTI, Co-operative banks, general finance brokers and stock brokers. The organized money markets in India are broad based. They are mostly found in urban centers but they even have an impressive network in the rural areas. The organized money market in India does not operate at its fully efficiency due to a number of government rules and regulations. Regulatory harmonization (co-ordination) is needed between the various regulations to boost the growth of organized financial system. Most of the transactions in the system are done through the banks. Most of the transactions are transparent. Organized money market comprises approximately 82% to 85% of the total financial transactions of money markets. The organized sector of the Indian money market is comparatively well developed in terms of organized relationships and specialized set of functions. When India got independence in 1947, the organized sector was under developed and comprised nearly 40% of the total financial system but with the rapid industrialization and rapid strides (steps) made in development of the economy, the organized system grew at scorching (burning) pace (speed). The Indian economy has liberalized and decontrolled from 1992 and 1999. The Indian economy has globalised. All these have had a bearing on the organized money markets growth. The organized sector grew at a fast space, keeping stride with the globalization of the Indian financial system. It was but natural that the Indian financial system would get partly integrated with the International financial system due to the globalization effect. This boosted the organized system tremendously over the years. The structure of financial institutions in India has developed and become broad based. The system has developed in the areas of state, cooperative and private sectors. Rural and urban areas are well served by co-operative sectors as well as by corporate bodies with national status. There are more than 7, 50,000 institutions channelizing credit into the various areas of the economy.

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2) Unorganized money market: India had an indigenous banking system with country wide institutions. This system was very well developed and comprises (involve) an impressive networks, having its branches almost in all parts of the country. This system has developed the HUNDI, a financial instrument, still in use, that is similar to commercial bill of the stern Europe. Indigenous bankers combined banking with other activities such as merchant banking, shroffs, etc. It was based upon an absolute and extensive network of personal relations that overcome the problems of dealing with a large number of customers. The unorganized money market is not in direct control of RBI like the organized money market. It comprises mainly money lenders, shroffs, lending pawn (trade in) brokers, landlords, indigenous bankers, certain co-operative banks etc. The unorganized financial system is usually prevalent in small towns and rural sectors. They occupied a very vital place at the time of independence, comprising nearly 60% of financial system transitions. However with the modern industrialization and growth, their importance has gradually declined and so also their sphere (area) of influence with the growth in e-banking, the role of unorganized sector has taken a great beating. It is assumed that by 2025, the unorganized sector should be 5% of the total money market. Most of the funds obtained by unorganized money market are from the organized sector. During the peak lending seasons, the unorganized sector borrows from the organized sectors and during the slack season, returns the money back to the organized sector. There is thus circular movement of funds between organized and unorganized sector. Since the unorganized sector is also governed by the relevant rules and statute, it comes within the indirect control of RBI.

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Call Money Market:

Que. 1 Concept of call money market Answer:
The money market is the market in which short term funds are borrowed and lent. The money market is not a single homogeneous market but it is composed of several sub markets, each one dealing in different types of short term credits, call money market is one such important sub market of money market. This market is a key segment of the money market in India. It deals in overnight funds. Normally the lending period is 2 to 14 days in this market. This market refers to a market for extremely short term period. Bill brokers and stock exchange dealers need financial accommodation for short period of time to finance their customers trading on margins and their own holdings of securities. This financial accommodation is provided by banks. Sometimes the period of the loan may be for 7 days or in some cases it may be just on overnight basis. The loan is also given on a day to day basis. These loans are called call loans and call money because of banks can call them at the shortest possible time. The money market in India was understood as the call money market, because this market was the most well developed component of the money market till 1992.

Que. 2 Evolution of Indian Money Market Answer:

Indian call money market is about 75 to 80 years old. In the early stage of its evolution, only individuals were the major players. It was the main stay (continue) of foreign exchange banks and the Indian banks did not participate on a big scale in this market. After 1950, the Indian banks started actively participating in it. In 1970, LIC and UTI were allowed to participate in the call money markets and the call money market became Inter Institutional call money market. Thus period individuals had stopped operations in the market. Still 1977, brokers were very active in the call money market. However by the end of 1977, RBI prohibited their participation. During 1973, the rate of call money market shot up to 39% reflecting shortage of funds, excessive credit squeeze (compress) and financial lightness everywhere. During this period the Indian Banks Association put a ceiling (upper limit, maximum) of 15% on the call money rate. After mid 1980, the call money market experienced a drastic change. The banks were facing a lot of pressure on their profitability due to restrictive credit policy of the RBI and therefore there banks started lending in the call money market heavily. It was against this back ground that the Vaghul working group on money market recommended the freeing (release) of call money rates for inter bank transactions. The RBI removed this ceiling on May, 1, 1989. The Reserve Bank also permitted financial institutions to operate in this market as lender with a view to broaden the market. The DFHI was created in April 1988. This had a very positive impact on the call money market. the RBI also permitted the banks to establish money market mutual funds through which cash rich corporate and even high net worth individuals could operate in the call money market. During the1RBI established full fledged liquidity adjustment facility (LAF) on June 5, 2000 which became an effective instrument to provide stability for the overnight call rate movement. The level of operations of average daily turnover was Rs. 35,144 crore in 2001-02 which was reduced to Rs. 29,857 crore in 2002-2003

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Que. 3 Importance of Call Money market: Answer

The call money market is an important segment of money market. It deals in overnight funds i.e. funds lent for a period of 2 to 3 days. The loans advanced in this market are Call loans or notice money because they can be demanded back at a short notice i.e. on call. The call money market provides an important outlet for temporary liquidity conditions in the market as well as it helps the traders, stock brokers, dealers, corporate sector and the financial institutions to avail of quick opportunities to make swift (fast, quick) returns. Call loans are risky but the potential of huge returns swiftly enables the dealers, traders etc, to seek call loans. Call money market also enable banks and financial institutions, which advance call loans to make good returns on their surplus funds, without compromising liquidity. The vitality (strength) of call money market can be summarizing as under. 1) A well organized call money market is essential for the smooth working of the economys credit system. 2) The call money market provides an excellent opportunity to traders, stock brokers etc, to earn extraordinary profits by making use of opportunities swiftly. 3) It also provides an opportunity to the banks and financial institutions to earn interest income on their temporary surplus funds. It does not affect the liquidity of the banks etc. because the loans under this system are call leans (bend) which are lent for an extremely short period and can be recalled at a short notice. 4) It also provides liquidity to other segments of the economy. 5) It generates self employment and other employment opportunities for various people and groups. 6) It solves the problem of the fiscal deficit of the Government by enabling the DFHI to subscribe to 182 days. Treasury bill of the government. 7) It enables banks to meet their daily cash requirement and also enables them to maintain their Cash Reserve Ration (CRR). 8) It motivates the general public to save by making than earn adequate returns in their savings in the form of interest. 9) It helps in the growth and stabilization of capital markets. 10) In general sense, it helps the economy to grew and prosper.

Que.4 Present Status of Call Money market Answer:

The Call Money Market which mostly deals in overnight funds is a key segment of the money market in India. The call money market in India has changed dramatically, since the mid 1980s. In recent years it has however undergone a virtual (effective, essential) metamorphosis (alteration, change). It is more orderly and a disciplined market today. There are bouts of volatility but such periods are less. The same holds true for inter bank or call money rates. The turbulence in the call money rates is also controllable and less due to the presence of DFHI in the call money markets. There is a comparative stability in the call money Market. The number of market participants is also huge and varied. Many financial institutions, public and private sector banks now operate in the call money market. The full fledged liquidity adjustment facility (LAF), which was introduced no June 5, 2000, with a view to modulating short term liquidity under diverse market condition has emerged as an effective instrument to provide a corridor (Passage) for the overnight call rate movement. The LAF combined with open market operations (OMOs) have been used to keep the volatility at day. The daily turnover has kept on expanding in the call money and is expected to double in coming years. 13

DFHI
Que. 1 Concept and Evolution of DFHI Answer:
Concept: The RBI set up Vaghul Committee as a working group to suggest ways to improve the functions of call market and the money market. This working group suggested in 1987 to set up the Discount and Finance House of India. The working group was of the opinion that the DFHI would be able to stabilize the short term liquidity imbalances and would lead to the integration of short term money markets. They believed that the short term money market would be activated and a greater flexibility would be imparted to the short term money market for short term money market instruments. Following this recommendation, the RBI created DFHI. Evolution: Discount and Finance House of India was created primarily by an act of parliament, by the central Government to develop an active secondary market in money market instruments and for this purpose, it was allowed to engage in secondary trading in government securities. DFHI entered the call money market in 1988, in the month of July. It was the biggest player in the call money market and all the transitions were routed through DFHI. It was actively involved I other money market even. The DFHI fixed the inter bank call money rates, the call money rates and brought stability to the call money market. The DFHI is actively controlled by the finance ministry of government of India. Its Board of Directors is nominated by the central Government and it consists of experts in money market operations related fields. The main promoters of DFHI were RBI, Public Sector Banks and other Financial Institution. It had an initial authorized capital of Rs. 250 crores, which was raised by Rs. 100 crores recently. In its early stage the DFHI used to trade in 182 day treasury bills and offered rediscounting facility of short term commercial bills but now it also engages in many other market operations. The DFHI entered the call money market at the end of July 1988. DFHI was not subject to the provisions to the ceiling (upper limit, maximum) imposed on the call, notice money, setout (start, begin) by the Indian Banks Association (IBA) from October 1988. This exemption is continuing till date. DFHI was allowed to borrow and lend and also arrange funds in the inter bank call notice market. DFHI lends funds that it receives from the central bank against repos of certain securities, specified as eligible for them with the active support of banks, UTI, and LIC. The DFHI played an effective role in the inter bank call / short notice money market. The DFHI was especially created as the watch dog of the call money market. Its main problem was quite clear in this regard. Its main objective is to prevent speculation in call money rates and to maintain liquidity in the call money market. It interferes in the call money market operations from time to time to prevent speculation. The DFHI also buys and sells 182 days treasury bills and selectively repurchases / resells the bills only from bank for short period up to 14 days at predetermined prices, giving depth to the market. The DFHI works in close coordination with RBI.

Que. 2 Role of DFHI Answer:

The DFHI plays a proactive role in the call money markets. It began operations n the call money market in July 1988. The DFHI was given full freedom to frame its own laws and bylaws for the call money market operations. Further it was exempted from the ceiling of the call money / Notice money fixed earlier by Indian Bank Association. The DFHI was permitted to borrow, lend and arrange funds in the inter bank call notice market. The interest rates ceiling was eliminated by the RBIs new provision. This brought about some sort of stability in the call money market and created a level playing field for all the market participants. The inter call money rated were no longer subject to the 14

high and the low levels of ceilings imposed by the Indian Bank Associations. There were other government players like LIC, UTI etc who participated in the call money markets. However all the transactions were done through the medium of DFHI. The RBI further liberalized the conditions of the call money market. This gave a boost to the turnover and the transactional values in the call money markets. The turn over grew from Rs.4, 57,013 crores in 1992-1993 to Rs.5,91,432 crores in 1993-1994. The daily average lending by DFHI in the call money market increased to Rs. 1, 606 crores in 1993-1994. DFHI is a market lender in stabilizing the call money market. The DFHI provides a strong financial support and framework to the call money market operations. It interferes directly by sucking up the funds from the market incase of excess supply and it infuses (introduce) funds when funds are in short supply. This maintains stability in the call money rates. The DFHI works closely with RBI to forecast the need of funds in the call markets during peak and slack seasons. The RBI implements all its monetary and fiscal policies for the call money market through DFHI. Therefore the role of DFHI is very crucial for the survival of the call money markets.

Que. 3 Functions / Advantages of DFHI Answer:

1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) The presence of DFHI has ensured high turnover in the call money market. It promotes fair play and brings stability in the money market operations. It arranges compromises and arbitration between disputing parties and prevents unnecessary legal litigation. It creates equilibrium in the call money markets lending rates. The wild (natural) fluctuations in the interest rate during peak and slack seasons are controlled. It gives liquidity to call money markets in particular and to other money markets in general. The DFHI interprets the laws and the bylaws fame by the RBI and removes vagueness (imprecision) and misunderstanding of the law. It estimates the need and the value of funds from the call money market especially during peak and slack seasons. It thus facilitates removing the risk and uncertainty associated with call money market operations. It provides a smooth flow of funds from and into market. It helps in planning and integration of call money markets with other markets in the financial sectors. To discount, rediscount, buy, sell, underwrite or acquire and sell marketable securities and negotiable instruments including treasury bills, trade bills, bills of exchange etc. To arrange for the buy-back of trade and treasury bills as well as local authorities securities.

Que.4 Limitations of DFHI Answer:

1) Critics point out the role of DFHI is fore (front) bearing. 2) They argued that the DFHI provides a very strict frame work by which transparency and free market conditions are curtailed. 3) It interprets the RBI in a narrow in some cases. 4) It is bureau crating in nature. Much red tape in involved in the DFHI working which hampers the growth of call money markets. 5) It suffers competitions from primary dealers. 6) There is too much dependence on RBI. 7) The funds are scarce many a times. 15

BILLS MARKET
Que.1 Concept of Bills Market. Answer:
The bills market refers to the market were short dated bills and other papers are bought and sold. It is also called discount market. The Treasury bill is the most vital instrument of the bills market. It is a sub part of money market. In England, the bills market developed independently. The leading bills market of the word is London Bills Market. The coordinated and developed Bills marker are accelerated (go faster) resources for rapid development. It is the market which is also called commercial bills of exchange market. The government borrows funds for 3 months through Treasury bills. The Bills market act as a governor of the unorganized money market within the fold of the central bank control. It links the unorganized sector with the organized sector. It is indispensable to the functioning of the money system. The Bills markets smoothness the excess flow and short supply of funds i.e. volatility in the availability of funds with the commercial banks and therefore provides yeomans service to the banks. It is compromise between the convenience of banks and their borrowers on one hand and that of the Reserve bank and banking system on the other. Bills market is especially important in underdeveloped and developing countries like India where the unorganized market occupies a big share. The bills market by linking the two markets will enable the RBI to implement its monetary policy more effectively in the future market development.

Que.2 Characteristics of Bills Market Answer:

1) 2) 3) 4) 5) 6) 7) Bills markets are one of the important sub markets of money market. It is a short term money market, through not extremely short term as call money market. Treasury bills are the main instruments of the bills market. The bills market is mostly regulated by RBI. It frames its rules and regulations. The bills market also facilitates exports by discounting foreign bills/ invoices. The bills market is governed by the new bills markets scheme 1973s suggestions. The major operations of the bills market are in treasury bills. Main players in the bills market include the government departments, banks, financial institutions and lately even the mutual funds. 8) The bills market act as a link between organized and unorganized money markets and it integrates both the market.

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Que. 3 Importance of Bills Market. Answer:

The bills market is an important sub market of the money market. The coordinated and developed bills market provides resources for rapid development in developing underdeveloped economies such as India where the unorganized sector occupies an important place in the financial system. The bills market act as a channel for transferring funds from and to the unorganized market and to and from the organized market. This brings the activities of unorganized market within the direct control of RBI. Unorganized market can there fore be monitored. Similarly the bills market, with the new bills market scheme, seeks to integrate the unorganized sector with the organized sector more effectively. A well developed bills market provides funds to the government against treasury bills having a maturity of 3 months. This can help the government augment (supplement) its deficits and fulfills its liquidity requirements. The bills market controls the ebb (outgoing tide, flow) and the flows of funds from the financial system, thereby stabilizing the availability of funds. It also helps in fixing a reasonable rate on funds to be borrowed. It generates employment opportunities. It promotes exports by discounting foreign bills and providing loans at reasonable cost to exporters. Therefore it helps the country to earn foreign exchange. The banks services can be improved. Banks having a wide network can serve their customers well by handling documents, improving remitting procedure and provide other facilities related to bill financing. It gives a predictable means of cash budgeting to the enterprises which helps in proper working capital management. The cycle of the bills is normally of 2 to 4 months. This gives the bank confidence because it is a reasonably more secured mode of finance as the bank only guarantees the bills of reputed (supposed) persons. The chances of bad debts are therefore less and the banks can improve their funds management.

Que. 4 salient features of old and new scheme of Bills Discounted. Answer:
Two schemes for bills market were made. The first scheme was made in January, 1952 by the Apex bank i.e. Reserve Bank. The salient features of the scheme are as follows. 1) The RBI gave demand loans at its banking offices in India to scheduled banks against their promissory notes which were supported by (usance) bills or promissory notes discounted by theme. These (usance) bills were kept in the custody of the RBI as collateral securities for loans given by the RBI to banks. 2) The RBI offered to make advances to banks at % lower rate than the rate charged by the banks from their customers to motivate the banks to popularize the bills as on instrument of credit. 3) At a further incentive, the borrowing banks were not to bear the cost of stamp duty incurred in converting demand bills into time bills. The RBI agreed to bear this cost. 4) The minimum value of individual bills tendered to the bank was foxed at R. 1 lakh each, while the maximum limit was at 25 lakh for a single advance at one time. The above scheme was discounted due to certain limitations. The biggest demerit was that this scheme did not provide for the discounting of indigenous (original) bankers Hundi i.e. promissory note, which was the most important credit instrument of the economy at that point of time. The above scheme also had certain advantages. It allowed some quantitative control by enabling RBI to check any particular packet or bills. It also allowed elasticity of funds during the peak lending season. In 1957 the RBI also included within the definition of bills, export bills. However it was a partial success. It did not develop a good bills market in India therefore the new bill market scheme 1970 was introduced. 17

Salient features of the new bill market scheme 1970: The Dehe a Committee set in motion, the introduction of a new bills market scheme. The report brought out the demerits of the old scheme and made a few new suggestions. A study group appointed by the RBI in February 1970, under the chairmanship of Shri M.Narasimhan, to enlarge the scope of Bills market, as a credit market submitted its report in June, 1970. On the basis of that report the RBI announced a New Bill Market scheme in November 1970, having the following salient features. 1) All eligible scheduled banks were eligible to offer bills of exchange for rediscount. 2) The bills of exchange should be genuine trade bills and should have arisen (happen, occur) out of the sale of goods. Accommodation bills were not eligible for this purpose. 3) The bill should not have a maturity time of more than 120 days and when it is offered to RBI for rediscounted its maturity should not be more than 90 days. 4) The bill should have at least two good signatures, one of which should be that of a licensed scheduled bank. 5) The minimum amount of the bill should be Rs. 5,000 and on one occasion, the bill for rediscount should be at least being Rs. 50,000.

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CAPITAL MARKET
Que. 1 Explain the concept of capital market. Role of Capital Market in capital formation and making the economy more competent and prosperous. Answer:
Concept: It is organized market mechanism for effective and efficient transfer of money capital or financial resources from the investing class (A body of individuals or institutional savers) to the entrepreneur class (individuals or institutions engaged in trade, industry, business or services) in the private and public sectors of the economy. Normally capital markets are understood as a market for long term funds because it provides long term debt and equity finance to the government and the corporate sectors. However in a very broad sense it includes the market for short term funds. Shri H.T.Parikh has referred to it as By Capital Market. It means the market for all the financial instruments, both short term and long term as also commercial, industrial and government paper Gold smith and Grand, the two financial experts have also given a very precise and exacting definition of capital markets. From the above definitions given by these experts the functions of the capital market can be understood as the mobilization of savings, and their distribution for industrial investment purposes. Capital market is the part of the organized financial system. It includes: 1) New Issue Market 2) Stock Market

It is a wide term and includes all long term claims of money lending and borrowing. It has got more 7,500 listed companies and 23 stock exchanges. It is the second biggest in the world after USA. Role of capital market is in capital formation and in making the economy developed and prosperous. The main function of the capital market is the mobilization of savings and their distribution for industrial investment. It collects savings from individuals and industrial investors and makes those funds available to the industrial and trading entities. That makes capital formation possible. The capital markets are the barometer of economic development. Consequently the relationship between the markets, instruments and services are integrated as well as interdependent. The capital market is directly responsible for the following activities. 1) Mobilization of national savings for economic development. 2) Mobilization and import of foreign capital and foreign investment capital and skill to fill up the deficit in the required financial resources to maintain the expected rate of economic growth. 3) Productive utilization of resources and 4) Directing the flow of funds to profitable avenue (opportunity) and also strive (attempt, try heard) for balanced and diversified industrialization. The capital market encourages a savings culture amongst the general public. It rewards the saver by enabling them to earn a return on their savings in the form of dividend interest and capital appreciations. It provides long term finance to the industry and the financial institutions at reasonable rates/ cost. It therefore provides liquidity to the economy as a whole. It generates competition by helping launch new enterprises. It creates new opportunities for growth. 19

It removes imbalances in the development by directing the funds to places which are less developed and are on the priority list of the government for development. It generates employment opportunities. It has been rightly observed by an author of finance that the strength of the capital market determines the strength of economy. It measures the inherent (natural, in born) strengths of the economy as well as its weaknesses. The market for credit (money and capital market) and business enterprises must go hand in hand to ensure quick industrialization in a developing democratic country. The pace of economic development is programmed by the rate of long term investment and capital formation. And capital formation is conditioned by the mobilization, augmentation (increase, growth) and channelization of investible funds. All the above activities are facilitated by capital market. The role of the capital market therefore in the development of the economy and capital formation is quite vital.

Que. 2 Characteristics of Capital Market: Answer:

Capital Markets are an effective market mechanism for a quick transfer of money / funds to the entrepreneur class from the providers of capital. The capital markets are an integral part of the financial system. It is a part of financial market. Shri H.T.Parikh has referred capital market as By Capital Market, I mean the market for all the financial instruments, short term and long term as also commercial, industrial and government paper In the words of Goldsmith The capital market of a modern economy has two basic functions, first the allocation of savings among users and investment; second the facilitation of the transfer of the existing assets, tangible and intangible among individual economic units. From the above definitions and other definitions given by the experts the characteristics of capital market can be summarized as follows: 1) It is along term market, from where the seed capital or ownership capital like equity shares is subscribed. 2) It comprises two market i) New issues market or primary market ii) Secondary market, where stocks are traded. It is also called Stock Exchange. 3) It mobilizes national savings and steers (push) such savings in the corporate sectors. 4) Its instruments include, amongst others i) Preference shares ii) Equity Shares iii) Debentures iv) Shares warrants (guarantees) v) Zero Coupon bonds vi) Units of mutual funds vii) American Depository Receipts (ADRs) viii) Euro Bonds ix) Global Depository Receipts (GDRs) x) Government paper/ securities including gilt edge (boundary) securities. xi) Other Commercial Paper / securities. 5) The number of market participants is very high, as compared to other markets. 6) It promoters capital formation. 7) It gives the benefit of both dividend and capital appreciation to the investors. 20

8) It is the barometer of the strength of the economy. 9) Securities are listed on bourses and only then can they be sold. 10) It facilitates speculation and price discovery.

Que.3 Types of Capital Market: Answer:

The Capital Market comprises two sub markets viz. A) Primary Market or New Issues Market B) Secondary Market or Stock Exchanges A) New Issues Market: The New Market deals with the raising of fresh capital for cash or consideration other than cash by the corporate sector, PSUs, government and semi government bodies, mutual funds, etc. The main functions of New issues market is to facilitate the transfer of resources from savers to corporate sectors and to help public companies and mutual funds to raise seed and other long term capital. Three operational procedures are done in this market. 1) 2) 3) Organizing the new issue Underwriting the issues Collection and distribution of funds to enterprises and share, security and unit certificates to investors.

New issue can be classified in to four following types, 1) 2) 3) 4) Issues by New companies Issues by old companies in the form of right issues or new issues. New money issues New non money issues

Instruments dealt with may be: 1) 2) 3) 4) 5) 6) 7) 8) 9) Equity shares Units of mutual funds Public Deposits Debentures Preference shares Bonds of corporate sector, government, PSUs, etc Commercial Papers American Depository Receipts (ADRs) and Global Depositary Receipts (GDRs) Zero Coupon Bonds etc

The New Issues Market promotes capital formation. The velocity (speed) of circulation of money increases and money is created by this market. B) Secondary Market: This market is also called the stock exchange. It serves at an adjustment to the primary market. This market provides liquidity to the system. Even through the securities issued in the capital market are long term in nature, they can be short term in nature, from the view point of the investors, as he can deal with shares and other securities in the 21

short run. The securities issued and allotted in the primary market can be sold in the secondary market. The activities in these two markets are interlinked and the indicators are also related although separate in themselves. In the present scenario, the operations in the secondary market are done online, in transparent manner by electronic trading system. The same instruments, which are issued in the new issues market, are also traded in the secondary market. This market is regulated by SEBI; BSE is oldest market/ stock exchange. It is more then 100 years old. The important stock exchanges are: 1) 2) 3) 4) NSE (National Stock Exchange) BSE (Bombay Stock Exchange0 OTCEI (Over The Counter exchange of India) Certain Regional Stock Exchanges

Que. 4 Constituents of Capital Market: Answer:

The capital market comprises all the market participants, notably the following 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) Specialized Financial Institutions. Banks Merchant Banks Leasing Companies State Level Development Banks Financial Service Companies Foreign Institutional Investors (FIIs) Mutual Funds Other Institutions having own specialization Individuals in some cases Corporate bodies and government Institutions

All the above institutions play a specialized role in the capital market, mutual funds. For example, channel money of small and retail investors in to the debt market, bond markets and stock market. Brokerage houses facilitate trading in stocks. In recent years, there has been an accelerated growth in the capital markets and volumes have jumped as a sequence to it. A totally new brand of participants has also emerged. This spread of the market has also expanded covering even the rural and semi urban areas.

Que. 5 Instruments of Capital Markets: Answer:

The various instruments and securities traded in the capital market are as follows: 1) Equity Shares: Equity shares constitute the seed / ownership capital of the corporate sector. Though under companys Amendment Act 2000, a joint stock company is allowed to buy back its shares partially. 2) Preference Shares: They have the characteristics of both equity shares and debentures. They are debt bearing long term security. 22

3) Non Voting Equity Shares: Certain companies issue different classes of equity shares, some of which may not carry voting rights. 4) Cumulative convertible Preference shares: These shares can be converted into equity shares on the date of redemption, at the closing market price of the equity shares. 5) Company Fixed Deposits. Under company (deposit) rules, a company can issue deposits subject to the maximum interest rate fixed by RBI and subject to the prescribed rules. 6) Share Warrants: They are bearer instrument like currency notes. Shares warrants are equity shares are part of ownership capital. They can be converted into equity shares. 7) Debentures Bonds: These normally carry floating charge on the companys assets. Debentures are normally secured term debts. 8) Secured Premium Notes(SPNs): There are equal two equity shares issued in foreign countries by the Indian corporate sector.

Que. 6 New Issues Market OR Primary Market Answer:

New issue market is also called the Primary Market. It is the market for raising new capital for cash or other consideration by the Corporate Sector, mutual funds, PSUs, government banks, etc. The new issues market promotes capital formation. The new issues can be classified as follows: 1) Issues by old companies, either as right share capital or fresh capital. 2) New issues of fresh capital by new companies. 3) Money issues or Non money Issues. Instruments dealt with may be: 1) 2) 3) 4) 5) 6) 7) 8) Equity shares Units of mutual funds Public deposits Debentures Preference shares Bonds of corporate sector, government, PSUs, etc American Depository Receipts (ADRs) and Global Depositary Receipts (GDRs) Zero Coupon bonds etc

The New Issues Market promotes capital formation. The velocity (speed) of circulation of money increases and money is created by this market. The main functions of this market are to facilitate the new issues, to underwrite the new issues and to provide allocation and allotment of shares / securities. This market regulated by SEBI. 23

SECTION II
Que. 1 Concept of Foreign Exchange market: Answer:
The foreign exchange market is the important component of international financial system, especially for the developing economy, like India. The foreign exchange market is necessary for the conversation of currencies for short term capital flows or long term investments in the financial physical assets of another country. The services of the foreign exchange markets are necessary not only for trade transactions but also for other financial receipts or payments between countries involving the foreign exchange transactions. The foreign exchange market in India s a three tire structure comprising (i) (ii) (iii) The reserve bank at the apex Authorized dealers licensed by the reserve Bank and Customers such as exporters and importers, corporate and other foreign exchange dealers.

Apart from these main market players, there are foreign exchange money changers, who bring buyers and sellers together but are not permitted to deal in foreign exchange on their own account. The authorized dealers are governed by the guidelines framed by the Foreign Exchange Dealer Association of India (FEDAI). Each economy has a foreign sector which is representative of its economys external transactions. These transactions may be commercial, financial or otherwise but they result in movement of funds from and to the country concerned. These transactions are routed through a exchange market which can be aptly (suitably) described as foreign exchange market.

Que. 2 Instruments of foreign Exchange Markets: Answer:

In addition to conversion of foreign currency notes and cash, a number of instruments of credit are used for effecting conversion in the foreign exchange market. These instruments are as follows: (1) (2) (3) (4) (5) (6) (7) (8) (9) Gold / silver / other important metals. Bills of Exchange Internet Banking Indian and Foreign Currencies. Drafts and cheques Mail Transfers Multi Media E- mail Transfers Telegraphic Transactions

Que. 3 Components of Foreign Exchange Market:

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Answer:
There are three major components in the market. These components are determined depending upon the transactions types. They are as follows: (a) Transaction between the public and the bank at the base level: These transactions are the routine and normal transactions in the foreign exchange market. These transactions include conversion of currencies, getting license from the bank, guarantee from the bank and other normal routine activities. (b) Transaction between the banks dealing in foreign exchange involving conversion of currencies: Banks collects the currencies from individuals, corporate and non corporate customers, authorized dealers and money changes and supply those currencies to schedule and non scheduled banks, requiring those currencies at the going market rates. (c) Transactions between the Banks and Reserve Bank involving the purchase and sale of foreign currency: The currencies lying in excess with the bank at the end of stipulated period are transferred at the predetermined purchase rate to the RBI. Similarly when the banks are unable to get the required foreign currencies from the individuals or other banks it approaches RBI for the purchase of such currencies.

Que. 4 Functions of Foreign Exchange: Answer:

Foreign Exchange Market performs vital functions for the economy. These functions can be grouped as follows: (1) Foreign Exchange Market (FEM) represents the dealing I foreign currencies. All foreign currencies brought to India or take out through India are routed through foreign exchange market at the prevailing market prices or quotes available for different currencies. (2) All the capital account transactions of the government of India i.e. purchase of oil, defense equipment export of capital goods etc. is done through Foreign Exchange Market. (3) All investments whether it may be Foreign Direct Investment, direct investment in the stock markets or debt markets in India and by Indian Instruments abroad is done through Foreign Exchange Markets. (4) Foreign Exchange Markets provides guidelines to the government in formulating fiscal and monetary policies having an economic bearing of the country. (5) One of the main functions of Foreign Exchange Market is it boost foreign investors confidence in the Indian economy to facilitate smooth flow of funds in the markets. (6) It advices the ministry of financial affairs of the prevailing global situation in respect of monetary matters. (7) It gives information about foreign dealers; foreign markets etc, to the local exporters and importers. It also gives other information in matters which has an advance or positive impact for a particular industry due to some global happening. (8) It determines the level of Foreign Exchange (research) resources needed for a country. (9) It determines a basket rate for the purchase / sale of basket of currencies.

Que. 5 Role of RBI in Foreign Exchange Market:

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Answer:
The RBI, as the Central banking Authority controls foreign currency operations. As pound (better), the sterling (genuine, true) continues to remain as a currency of intervention, the Reserve Bank fixes the buying and selling exchange rates from time to time based on the parity (equivalence) of unspecified currency basket of currencies. While the Reserve Bank does not enter the foreign exchange market to support the Indian Rupee. It buys spot and forwards sterling up to a month forward and sells only spot sterling. Thus Reserve Bank continues to maintain the external value of the Indian Rupee. Also the Reserve Bank buys major currencies like US dollar, Deutsche market and Japanese Yen, both spot and forward up to 6 months, at exchange rates based on the previous days rate in the foreign exchange market for the respective currencies. The Reserve Banks role in the Indian Foreign Exchange Market has been more towards guiding the banks in their exchange operations and development of the exchange markets by giving appropriate directions from time to time. The Reserve Bank has so far not found it necessary to operate directly in the foreign exchange market with a view to stabilizing the external values of the Indian Rupee.

Que. 6 Asian Clearing Unit/ Union: Answer:

Since a number of years, regional co-operation for benefiting trade and payment s have been subject of serious consideration all over the world. In the Asian region the initiative on these matters was taken by the Economic and Social Council for Asia and Pacific and as a consequence took steps for securing regional co-operation is given by the amongst its members. The Asian Clearing unit (ACU) was established on 9th December 1974. There are 6 members viz. Bangladesh, Nepal, India, Srilanka, Pakistan and Iran. The central banks of these countries are the participating members of the ACU. Asian Monetary Unit (AMU) is the common unit of account of ACU. The RBI is onr of the founder members of ACU. ACUs head quarters are based on Tehran. The clearing operations began on 1 st November, 1975. Objectives of ACU: (i) (ii) (iii) (iv) Facilitating payments for current international transactions within the ECAFE on a multilateral (multiside, joint) basis. Reducing the use of extra regional reserve currency to settle such transactions by promoting the use of the participants currencies or AMU (Asian Monetary Unit). Affecting thereby economics in the use of foreign exchange and a reduction in the cost of making payments for such transitions. Contributing to the expansion of the trade and promotion of monetary co-operation among the countries of the region.

Que. 7 Operations / Dealings in Foreign Exchange Markets: Answer:

Settlements of international trade transactions take place in dominated currencies which are well are accepted by the international trading community. In the process, currencies are traded. For example, if a US exporter sales goods to Germany, he may want payment in dollars and for this; the importer will have to secure dollars by exchanging it with DM (German Currency). This makes it necessary for the creation of foreign exchange market which will reflect the interactions between the suppliers and the demand for currencies. Foreign exchange market functions through a 26

sophisticated network of communication. These markets are located in major world trade centers such as New York, London, and Tokyo etc. these markets do business for 24 hours, and the turnover is in billions of dollars on a daily basis. The market participants are normally dealers speculators. The official monetary authorities like RBI in India are also important participants as they intervene (interfere) in the market to remove volatility in the exchange rates. Transactions are done on spot and forward basis. Short term rates are determined by the market. i.e. the demand and the supply position. Long range rates are determined by the relative economic fundamentals including inflation, interest rates, current account positions in the balance of payments, real income, etc. The monetary authorities interfere with the market mechanism to arrest wild fluctuations in the exchange rates. The exchange rate margin (ERM) is part of this physical measure. Currencies received as se deposits by authorized bank can either be lent in the same currency or converted by bank into another currency. In India, buying and selling of currency is mostly done by authorized dealers and money changers who authorized to deal in foreign currencies either with general or special permission of RBI.

Que. 8 What does the role RBI plays in Foreign Exchange Market? Answer:
The RBI is the central banking authority. It also controls the foreign currency operations. Pound sterling continues to remain as a currency of intervention. The RBI fixes the buying and selling exchanges rates from time to time based on the parity of unspecified currency Basket of Currencies. While the RBI does not enter the foreign exchange market for the support of the Indian rupee like the bank of England, it buys spot and forward sterling up to a month forward and sells only spot sterling. Thus RBI continues to maintain the external value of the Indian rupee. Also the RBI buys major currency like US dollar, deutsche mark and Japanese (yen), both spot and forward up to 6 months, at a exchange rate based on the previous base closing rate in the London exchange market for the respective currencies. The RBI is the main statutory (constitutional, legal) body for the foreign exchange market in India. It frames rules and regulations for the foreign exchange market. It has got a direct control over the foreign exchange market. Unlike some other markets with it controls through other statutory bodies. The RBI has been given wide discretionary (optional) powers by the Central Government to control the foreign market operation. The RBI appoints the money charges and the authorized dealers, who deal in foreign exchange. Authorized dealers are mostly public and private sector banks which have a wide network or business. All operations in foreign exchange market are done either with general or special permission from RBI. In spite of the foreign exchange market being liberalized, the role of RBI has not diminished. The RBI has specially authorized. (1) (2) (3) (4) (5) To ensure stability in Foreign Exchange Operations. To prevent a huge ebb (out going flow) and flow of funds from the foreign market to the other market. To ensure that currencies are bought and sold at prevailing market rates. To prevent frauds and manipulations in the buying and the selling rates. To prevent a huge depreciation in the rupee and other currencies.

The RBI supports the rupee especially when the rupee is weak by releasing dollars in the market or by buying up the rupee from the market.

Que. 9 Instruments of foreign exchange market. Answer:

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Foreign exchange market is one of the most important components of the financial system because it integrates the financial system with the global financial system. Varied instruments are traded in foreign exchange markets are as follows: (1) Foreign Currency notes and Indian Currency notes: Foreign exchange currency notes such as dollars, lira pounds, francs, etc are actively traded, that is bought and sold in foreign exchange markets. Currency notes are generally converted into Indian or other currency by individuals, tourists and other persons. (2) Telegraphic Transfer: This is one of the oldest methods of training of foreign exchange market. Money was sent by telex, in the earlier times. But now days with the advancement of technology, internet and e-mail are a preferred mode than telex. (3) Mai transfer: This is also one of the oldest methods of transferring money through post offices situated in different countries but now a day this instrument is hardly used because it is slow and expensive. (4) Drafts and cheques: This is the most common instruments in the commercial world. Parties prepare draft and cheques and sent them to the creditors or suppliers in other countries who then get the cheques, draft, etc, realized with their local banks. (5) Bills of Exchange: Some trades in foreign exchange market are also done through hundies, promissory notes, bills of exchange etc.

Que. 10 Euro Bonds: Answer:

The present capital market conditions facilitate the issue and sale of a number of securities. The scope and the variety of securities available as options is tremendously (extremely) varied. These securities have different risks, returns and costs attached to them. Euro bonds are the latest in a series of securities put up for sale by public listed companies in India. Like the name suggests, these securities are floated in the European Union countries. They are part of owners capital. The issue price of Euro bonds depend upon the equity prices of the particular company, prevailing in Indian capital market, at the time of issue of euro bonds. Euro bonds price is normally fixed at a premium to the local price. Euro bonds are floated on the same basis as ADR (American Depository Receipt). One Euro bonds is equal to two equity shares. It carries voting rights, but Euro bonds are not bearer instruments. They are traded on the stock exchange/ bourses of European Union Countries.

Que. 11 Determination of exchange rate for different currencies in the foreign market. Answer:
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The foreign exchange market is one of the important components of the international financial system, especially for the developing economy like India. The foreign exchange market is necessary for the conversion of currencies for short term capital flows or long term investments in the financial physical assets of another country. The services of the foreign exchange market are necessary not only for trade transaction but also for other financial receipts or payments between countries involving foreign exchange transactions. The foreign market in India is a three structure comprising: (1) The Reserve Bank at apex. (2) Authorized dealers licensed by reserve bank (3) Customers such as exporters and importers corporation and other foreign exchange dealers Apart from these main market players, there are money changers, who beings buyers and sellers together but they can not deal in foreign exchange on their own account. Dealings in foreign exchange market are between: (1) (2) (3) (4) (5) Authorized dealers and exporters Importers and their customers Between authorized dealers themselves Transactions with overseas bank Between authorized dealers and RBI

Determination of exchange rate in foreign exchange market: In the Indian foreign exchange market, number of factors affects the determination of currency rate. These factors are of short term feature and long term feature. Short term factors include the demand and supply of a particular currency in market, the state of economy of the country concerned global factors, the state of the economy of the countries whose currencies are dealt with government economic and fiscal policy, stability of the government, etc. The long term factors include the stability in the government, fiscal and monetary policy, stability of the economy, fiscal deficit position, growth in the economy including GDP (Gross Domestic Product) and NPG (Net Product Growth), global factors etc. The exchange rate may also be determined by central bank when it interferes in market to prevent wide fluctuations in the market on a intraday basis. There are two rates for currency transaction. (1) The spot rate or current rate (2) Forward rates There is a derivatives market also in the foreign exchange market. This market also determines the currency rate for short term period. Current interest rate also determines the short term fluctuation in the exchange rate even through full convertibility of Indian rupee has not been made.

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STOCK EXCHANGE
Que.1 Introduction and characteristics of stock exchanges. Answer:
Stock Exchanges are a part of capital market. It is also called secondary market. It is a market where securities are bought and sold. The Securities Contract (Regulation) Act, 1956, defines Stock Exchange as follows: It is an association, organization or body of individuals whether incorporated (included) or not, established for the purpose of assigning, regulating and controlling of business in buying, selling and dealing in securities. A stock exchange performs vital functions for the economy. It is considered as the engine of capitalist economy. It brings together savers and provides of capital and corporate sector. Government and other institutions who required capital. It is refreshment (refreshment) of business activity. It is a place where the stocks and securities of corporate sector, government and semi government institutions, mutual funds, etc are sold and bought. It provides liquidity to the financial system. It is independent of the primary market, bur=t the primary market can not survive without the stock exchange and vice versa. All transactions are done online in electronic form in the stock exchanges. Classification: The Stock Exchange can be classified as follows: (1) (2) (3) (4) National Stock Exchange (NSE) Bombay Stock Exchange (BSE) Important Regional Stock Exchanges such Ahmadabad Stock Exchange, Kolkata Stock Exchange, etc. Over The Counter Exchange of India (OTCEI)

Out of the above stock exchanges the Bombay Stock Exchange is the oldest. It is more than 100 years old. It deals in more than 2500 scripts. However in recent years the daily turnover on the National Stock Exchange has the BSE daily turnover.

Que. 2 recognition of Stock Exchanges: Answer:

The Central government may give recognition to the stock Exchange concerned, if it is satisfied that the stock exchange has supplied all the necessary information and if the following conditions are satisfied. (1) The rules and bylaw of the stock exchange are in consonance with the conditions specified to ensure fair operations and investor protection. These conditions may relate to the procedure of setting disputes between stock exchange members. Representatives of central Government to Stock Exchanges, maintenance of books of accounts by members and then audit. (2) That the Stock exchange has complied with the other terms and conditions of the Central Government in Specified matters. (3) It would be in the public and trade interest to give recognition to stock exchanges. The recognition once again will be published in the Gazette of India and also in the Official Gazette of the State where the main office of the stock exchange is situated. If the recognition is not granted then the stock exchange concerned must be given an opportunity to be heard. The stock exchange once recognized by the central government, has to furnish the annual report having prescribed particulars to the Central Government. The recognition once given can also be withdrawn by the Central Government in trade of public interest. 30

Que.3 Functions of Stock Exchange: Answer:

The stock exchanges perform some vital functions for the economy at a whole. These functions are as follows: 1) 2) 3) 4) 5) 6) 7) It provides a ready market for buying and selling of securities. It provides liquidity to small investors on their investments which are basically long term in their scope. It helps in capital formation. It helps in providing funds for capital expenditure proposals and seed capital. It provides a market to big ticket investors to hedge (get around, enclose) their risks. It promotes a Savings culture amongst the general public. It provides employment by providing a conducive (favorable, helpful) atmosphere for enterprises to raise capital and establish industries. 8) it acts as a barometer for measurement of the economys health

Que. 4 Objective of NSE (National Stock Exchange) Answer:

The main objectives of the NSE are 1) 2) 3) 4) 5) To establish a nation wide training facility for equities debt instruments and hybrids (mixture). To ensure equal access to investors all over the country through an appropriate communication network. To provide a fair, efficient and transparent securities market to investors using electronic trading system. To enable shorter settlement cycle and book entry settlement system. To meet the current international standard of securities market.

The establishment of NSE is an important step in upgrading trading facilities for investors and bringing Indian financial market in line with international markets. The NSE market is a fully automated screen based trading system. The emphasis of secondary markets in India has been primarily on equity trading. Trading in corporate debt and government securities has not picked up as in the case of equity markets. The NSE is expected to play an effective role in providing infrastructure and trading facilities for developing an efficient secondary market for both debt and equity instruments. The NSE is thus a stock exchange with a difference besides the traditional retail market for equities; debentures, etc are also traded in the capital market. The NSE, following its inception (setting up) is operating for the first time in the country; by introducing the screen based trading facilities for the wholesale debt Market (WDM). Due to NSE, the stock market has got wide exposure. NSE ensures various benefits to the market participants. The turnover on NSE, on certain days is more then BSE turnover.

Que.5 National depository. Answer:

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With the present changes made in the stock market by SEBI, shares are held in electronic forms and the physical delivery and custody of shares is a thing of the past. National depositing acts like a bank for shares and other securities. The stock holding corporation of India is one of the most prominent (famous) national depositories in India. It offers 1) A national clearing and settlement system for the security traded on stock exchanges. 2) It facilitates Support Corporation for securities. The national depositories provide infrastructural facilities international standard in trading clearance and settlement service in the secondary market for securities and monetary instruments. It provides custodial services for an investors shares and securities. From the year 2005, they have also started offering the services of buying and selling of selling of securities on behalf of the investor. Every holder of the account is given a statement showing his position of securities held on a regular basis.

Que. 6 Over the Counter Exchange of India (OTCEI) Answer:

The OTCEI is one of the multi tire market to benefit the securities OTCEI was recognized by the government of India as a recognized stock exchange under Section 4 of the Securities Contract Regulation Act, 1956. It was incorporated in 1990 as a company under the companies act, 1956. It became fully operational on 1 st September 1992, by starting operations in Mumbai. It provides trading services to small business which does not fulfill the criteria of listing on the stock exchanges. Small and medium size companies with a paid up capital of RS.30 Lakhs to 25 crores can be listed on OTCEI. OTCEI deals in equity shares, preference shares, bonds, debenture and share warrants. Trading is done by negotiated bidding. Trading is done screen based mode. A company listed on OTCEI can not be listed on any other stock exchange in India. It has been promoted by UTI, ICICI, IDBI, SNI, Capital Market Limited, IFCI, and LIC, GIC and its subsidiaries and Can Bank Financial services Limited. It offers various advantages to the investors and the company by giving a nation wide listing and by enabling raising of funds immediately.

Que. 7 Asian Currency Unit Answer:

The term Asian Currency unit refers to the deposits with bank in Singapore, which are specially licensed by the Monetary Authority of Singapore to operate in the Asian Dollar market. The deposits are usually non resident US dollar deposits but deposits in market Dutch, Swiss, France and Japanese Yen are also transacted. The Market for Asian Currency unit has grown up fast making Singapore a prominent world financing center. Singapores geographical location, liberal monetary policy and wide range of international banking facilities have helped the centre to gain this position. The monetary Authority of Singapore has recently commenced issuing licenses to foreign banks to exclusively (fully) operate as off share units, dealing in the inter bank Asian dollar market. 32

This step is likely to induce further development of Asian dollar market.

Que. 8 Benefits OR Advantages of Stock Exchange. Answer:

(A) Benefits to the community: 1) A stock exchange encourages people to save and invest their savings in shares and debentures. 2) By encouraging people to save and invest, the stock exchange helps capital formation which is essential for quicker industrial development. 3) Through capital formation, the stock exchange enables the companies to undertake expansion and modernization schemes. 4) Stock exchange encourages several closely held companies to go public. 5) Supervisors performance of company is reflected through stock exchange. E.g. Bajaj Auto, TISCO, ACC 6) Stock Market acts as a minor through which general economic condition is clearly reflected. (B) Benefits to investors: 1) Stock exchange offers ready market for buying and selling securities. 2) The interest of investors is safeguard by strict rules and regulations. 3) Most important fact is that stock exchange is powerful hedge against infection. (C) Benefits to Companies: 1) Stock exchange offers wide market for shares and debentures. 2) The image of the company goes up when the shares are listed on stock exchange, 3) Quicker response from investor to listed securities. 4) Market rates of shares and debentures will be higher because of daily dealing on stock exchange.

Que. 9 Objectives of SEBI Answer:

SEBI has entrusted with the complex task of managing and regulating the stock market in country. The main objectives of SEBI are as follows: 1) Investors protection: SEBI educates investors and makes them aware of their rights. It provides investor with information about market operations and it has framed rules and regulations to see that investors interest are protected. 2) Steady flow of savings: SEBI created a proper and conductive atmosphere required for raising money from the capital market. it has tries to restore the confidence of investors which facilitates the steady flow of savings in the capital markets. These savings are absorbed by the corporate sector as long term fund. 3) Fair practices by the issuers: 33

SEBI frames appropriate rules and regulation and has laid down a code of conduct for market participants including the issuers of securities to be followed to ensure smooth working which makes it possible to practice fair trade practices. 4) Promotion of efficient services: SEBI created a proper infrastructure so, that the markets automatically facilitate the expansion and growth of business. This has made possible for the market players to provide good and efficient services to their clients. 5) Transparency in work: SEBI has created a frame work for more open, orderly conduct in market activity including merger and takeovers.

Que. 10 SEBI Introduction: Answer:

Since 1990, the Indian economy has opened up & the air of liberalization & globalization has been following in the Indian economy. This has been marked by a giant (huge) leap (jump) in the corporate growth. This has enabled the Indian economy to grow at a vey fast space. The capital markets have also grown due to this drastic changes taking place in the Indian economy. The government of India felt the necessity to set up a superior body for the protection of present of present of preset and prospective investors. This prompted the government to create SEBI, through an act of parliament on April -12 1992. This body was to work under Union finance ministry. With the establishment of SEBI and SEBI act, there have been several changes in the regulatory frame work for the security markets in India. The SEBI act was passed in 1992; SEBI also issued disclosures and investors protection guidelines in 1993. These guidelines laid down the frame work for issue of capital by certain categories of companies.

Que. 11 functions of SEBI. Answer:

The SEBI has got onerous (heavy, difficult) duties to be performed. The main duties of SEBI can be summarized as follows: 1) SEBI should create a proper and conductive atmosphere required for raiding money from the capital markets. The atmosphere includes rules and regulations made by the SEBI. It also includes trade practices, custom and relations amongst institutions, brokers, investors and companies. 2) SEBI should educate investors as to what is a fair practice. It can also provide the investors with information regarding their rights. It shall ensure that the market contains liquidity, safety and profitability of the security which are crucial for any investment. 3) SEBI shall encourage capital formation by encouraging industrial unit to raise funds through issues in the primary market smoothly and at optimum cost. 4) SEBI should develop a proper infrastructure so that the business of the capital markets grow and more employment opportunities are created for brokers, jobbers, commercial banks, merchant bankers, mutual funds, etc. 5) SEBI should make the present laws more effective especially if they relate to mutual funds, LIC savings plans, security issued by housing, industrial societies and other related matters. 34

6) SEBI shall take the system more transparent and shall facilitate mergers and acquisition in an orderly manner to promote efficiency in operations. 7) It shall make the accounting and auditing standards more effective in consultation with the institute of Chartered Accountants of India. 8) It shall introduce a system for the companies to make proper disclosures at the time of new or right issue. 9) It shall supervise the workings of the market intermediaries and other market players. 10) It shall that there is no insider trading in securities. 11) It shall register and regulate the workings of stock brokers, share transfer agents, portfolio managers and other intermediaries prohibiting fraudulent and unfair trade practices. 12) It shall promote investors education and train market intermediaries. 13) It shall provide all the necessary information useful to market participants.

Que. 12 evolution of SEBIs performance. Answer: SEBI has been given wide powers under SEBI Act 1992 to regulate the capital market to ensure its smooth functioning. The main objectives of SEBI are 1) 2) 3) 4) 5) Investor protection Steady flow of savings Fair practices by the issuers Promotion of efficient services Transparency in work

SEBI has performed quite well in dealing with market crises. It 1995-96 when Harshad Mehtas scam (cheat) broke out, SEBI did excellent job by conducting a through probe (search) in to the dealings during such market scam. It analyzed the reason for a sudden spurt in the share prices through the government in India had been quite indifferent to the workings complaints from the investors and other market players. It has also introduced automatic complaints handling system. It has created awareness in the issuers and intermediaries to redress (restore) the grievance of the investors immediately. It has provided necessary information to market players about market operations. Stock dealings have been made more transparent and transactions are done in real time mode. SEBI has abolished the badla system of trading. It has introduced the derivatives market. It has also introduced T+2 system of trade settlement. Fluctuations in the script prices have been reduced. Registrations of all dealers and sub dealers have been made compulsory. All receipts and payments are done through bank cheques. It has also introduces higher margin to speculation in stocks. It also thoroughly investigated the Ketan Parekhs scam, however in spite of all the steps taken in the right direction in this field. It has failed on certain fronts. It could not prevent insider trading and unfair trade practice to a great extent. Due to SEBIs excellent investigative work Ketan Parekh has been sentenced to 1 year rigorous (accurate) imprisonment (custody) by the economics using of the trial court. Harshad Mehta Scam (1995-1996) Ketan Parekh Scam (1998-2000) 35

It has also been a bit unsuccessful preventing (prevent) the ramping up of prices on speculation (rumor) but overall SEBI has acted wisely and effectively imposing penalties on wrong doers and has efficiently monitored the stock exchanges. Still a lot remains to be done.

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