PROJECT REPORT ON FINANCIAL MARKETS

Prepared By: Sagar Gupta (50347) Shantnu Singh (50357)

ACKNOWLEDGEMENT

We take this opportunity to express our deep sense of gratitude to all our friends and seniors who helped and guide us to complete this project successfully. I am highly grateful and indebted to our project guide Dr. HK Porwal for his excellent and expert guidance in helping us in completion of project report.

Index

Serial No. 1

Particulars

Financials Market

Primary and Secondary Markets

Money Market

Capital market

Regulators

ADR/GDR

European Instruments

Indian Financial Markets and Global Integration

Financial Markets
A financial market is a market in which people and entities can trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and bonds, and commodities include precious metals or agricultural goods. There are both general markets (where many commodities are traded) and specialized markets (where only one commodity is traded). Markets work by placing many interested buyers and sellers, including households, firms, and government agencies, in one "place", thus making it easier for them to find each other. An economy which relies primarily on interactions between buyers and sellers to allocate resources is known as a market economy in contrast either to a command economy or to a non-market economy such as a gift economy. Financial markets facilitate the transfer of funds from savers to those who wish to invest in capital goods. For instance, companies that wish to undertake investment projects offer financial instruments to savers in exchange for funds to finance the projects.

Ways of classifying financial markets By the type of instrument, such as stocks, bonds, etc. Primary and Secondary Financial Markets By term to maturity, money markets and capital markets.

PrimaryMarket
Also called the new issue market, it is the market for issuing new securities. Many companies, especially small and medium scale, enter the primary market to raise money from the public to expand their businesses. They sell their securities to the public through an initial public offering. The securities can be directly bought from the shareholders, which is not the case for the secondary market. The primary market is a market for new capitals that will be traded over a longer period. In the primary market, securities are issued on an exchange basis. The underwriters, that is, the investment banks, play an important role in this market: they set the initial price range for a particular share and then supervise the selling of that share. Investors can obtain news of upcoming shares only on the primary market. The issuing firm collects money, which is then used to finance its operations or expand business, by selling its shares. Before selling a security on the primary market, the firm must fulfill all the requirements regarding the exchange. After trading in the primary market the security will then enter the secondary market, where numerous trades happen every day. The primary market accelerates the process of capital formation in a country's economy

The primary market categorically excludes several other new long-term finance sources, such as loans from financial institutions. Many companies have entered the primary market to earn profit by converting its capital, which is basically a private capital, into a public one, releasing securities to the public. This phenomena is known as "public issue" or "going public." There are three methods though which securities can be issued on the primary market: rights issue, Initial Public Offer (IPO), and preferential issue. A company's new offering is placed on the primary market through an initial public offer.

SecondaryMarket
It is the market where, unlike the primary market, an investor can buy a security directly from another investor in lieu of the issuer. It is also referred as "after market". The securities initially are issued in the primary market, and then they enter into the secondary market. All the securities are first created in the primary market and then, they enter into the secondary market. In the New York Stock Exchange, all the stocks belong to the secondary market. In other words, secondary market is a place where any type of used goods is available. In the secondary market shares are maneuvered from one investor to other, that is, one investor buys an asset from another investor instead of an issuing corporation. So, the secondary market should be liquid. Example of Secondary market: In the New York Stock Exchange, in the United States of America, all the securities belong to the secondary market. Secondary Market has an important role to play behind the developments of an efficient capital market. Secondary market connects investors' favoritism for liquidity with the capital users' wish of using their capital for a longer period. For example, in a traditional partnership, a partner cannot access the other partner's investment but only his or her investment in that partnership, even on an emergency basis. Then if he or she may breaks the ownership of equity into parts and sell his or her respective proportion to another investor. This kind of trading is facilitated only by the secondary market

Money Market and Its Instruments

Money Market: Money market means market where money or its equivalent can be traded. Money is synonym of liquidity. Money market consists of financial institutions and dealers in money or credit who wish to generate liquidity. It is better known as a place where large institutions and government manage their short term cash needs. For generation of liquidity, short term borrowing and lending is done by these financial institutions and dealers. Money Market is part of financial market where instruments with high liquidity and very short term maturities are traded. Due to highly liquid nature of securities and their short term maturities, money market is treated as a safe place. Hence, money market is a market where short term obligations such as treasury bills, commercial papers and bankers acceptances are bought and sold. Benefits and functions of Money Market: Money markets exist to facilitate efficient transfer of short-term funds between holders and borrowers of cash assets. For the lender/investor, it provides a good return on their funds. For the borrower, it enables rapid and relatively inexpensive acquisition of cash to cover short-term liabilities. One of the primary functions of money market is to provide focal point for RBIs intervention for influencing liquidity and general levels of interest rates in the economy. RBI being the main constituent in the money market aims at ensuring that liquidity and short term interest rates are consistent with the monetary policy objectives. Money Market & Capital Market: Money Market is a place for short term lending and borrowing, typically within a year. It deals in short term debt financing and investments. On the other hand, Capital Market refers to stock market, which refers to trading in shares and bonds of companies on recognized stock exchanges. Individual players cannot invest in money market as the value of investments is large, on the other hand, in capital market, anybody can make investments through a broker. Stock Market is associated with high risk and high return as against money market which is more secure. Further, in case of money market, deals are transacted on phone or through electronic systems as against capital market where trading is through recognized stock exchanges. Money Market Futures and Options: Active trading in money market futures and options occurs on number of commodity exchanges. They function in the similar manner like any other futures and options. Money Market Instruments: Investment in money market is done through money market instruments. Money market instrument meets short term requirements of the borrowers and provides liquidity to the lenders. Common Money Market Instruments are as follows:

Treasury Bills (T-Bills): Treasury Bills, one of the safest money market instruments, are
short term borrowing instruments of the Central Government of the Country issued through the Central Bank (RBI in India). They are zero risk instruments, and hence the returns are not so attractive. It is available both in primary market as well as secondary market. It is a promise to pay a said sum after a specified period. T-bills are short-term securities that mature in one year or less from their issue date. They are issued with three-month, six-month and one-year maturity periods. The Central Government issues T- Bills at a price less than their face value (par value). They are issued with a promise to pay full face value on maturity. So, when the T-Bills mature, the government pays the holder its face value. At present, the Government of India issues three types of treasury bills through auctions, namely, 91-day, 182-day and 364-day. There are no treasury bills issued by State Governments. Treasury bills are available for a minimum amount of Rs.25K and in its multiples. The Reserve Bank of India issues a quarterly calendar of T-bill auctions which is available at the Banks website. It also announces the exact dates of auction, the amount to be auctioned and

payment dates by issuing press releases prior to every auction.

Repurchase Agreements:
Repurchase transactions, called Repo or Reverse Repo are transactions or short term loans in which two parties agree to sell and repurchase the same security. They are usually used for overnight borrowing. Repo/Reverse Repo transactions can be done only between the parties approved by RBI and in RBI approved securities viz. GOI and State Govt Securities, T-Bills, PSU Bonds, FI Bonds, Corporate Bonds etc. Under repurchase agreement the seller sells specified securities with an agreement to repurchase the same at a mutually decided future date and price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed date at a predetermined price. Such a transaction is called a Repo when viewed from the perspective of the seller of the securities and Reverse Repo when viewed from the perspective of the buyer of the securities. Thus, whether a given agreement is termed as a Repo or Reverse Repo depends on which party initiated the transaction. The lender or buyer in a Repo is entitled to receive compensation for use of funds provided to the counterparty. Effectively the seller of the security borrows money for a period of time (Repo period) at a particular rate of interest mutually agreed with the buyer of the security who has lent the funds to the seller. The rate of interest agreed upon is called the Repo rate. The Repo rate is negotiated by the counterparties independently of the coupon rate or rates of the underlying securities and is influenced by overall money market conditions.

Commercial Papers: Commercial paper is a low-cost alternative to bank loans. It is a short term unsecured promissory note issued by corporates and financial institutions at a discounted value on face value. They are usually issued with fixed maturity between one to 270
days and for financing of accounts receivables, inventories and meeting short term liabilities. Say, for example, a company has receivables of Rs 1 lacs with credit period 6 months. It will not be able to liquidate its receivables before 6 months. The company is in need of funds. It can issue commercial papers in form of unsecured promissory notes at discount of 10% on face value of Rs 1 lacs to be matured after 6 months. The company has strong credit rating and finds buyers easily. The company is able to liquidate its receivables immediately and the buyer is able to earn interest of Rs 10K over a period of 6 months. They yield higher returns as compared to T-Bills as they are less secure in comparison to these bills; however chances of default are almost negligible but are not zero risk instruments.

Certificate of Deposit: It is a short term borrowing more like a bank term deposit account. It is a promissory note issued by a bank in form of a certificate entitling the bearer to receive interest. The certificate bears the maturity date, the fixed rate of interest and the value. It can be issued in any denomination. They are stamped and transferred by endorsement. Its term generally ranges from three months to five years and restricts the holders to withdraw funds on demand. However, on payment of certain penalty the money can be withdrawn on demand also. The returns on certificate of deposits are higher than T-Bills because it assumes higher level of risk. While buying Certificate of Deposit, return method should be seen. Returns can be based on Annual Percentage Yield (APY) or Annual Percentage Rate (APR). In APY, interest earned is based on compounded interest calculation. However, in APR method, simple interest calculation is done to

generate the return. Accordingly, if the interest is paid annually, equal return is generated by both APY and APR methods. However, if interest is paid more than once in a year, it is beneficial to opt APY over APR. Bankers acceptance It is a short term credit investment created by a non-financial firm and guaranteed by a bank to make payment. It is simply a bill of exchange drawn by a person and accepted by a bank. It is a buyers promise to pay to the seller a certain specified amount at certain date. The same is guaranteed by the banker of the buyer in exchange for a claim on the goods as collateral. The person drawing the bill must have a good credit rating otherwise the Bankers Acceptance will not be tradable. The most common term for these instruments is 90 days. However, they can vary from 30 days to180 days. For corporations, it acts as a negotiable time draft for financing imports, exports and other transactions in goods and is highly useful when the credit worthiness of the foreign trade party is unknown. The seller need not hold it until maturity and can sell off the same in secondary market at discount from the face value to liquidate its receivables.

Capital market
The capital market is the market for securities, where Companies and governments can raise long-term funds. It is a market in which money is lent for periods longer than a year. A nation's capital market includes such financial institutions as banks, insurance companies, and stock exchanges that channel long-term investment funds to commercial and industrial borrowers. Unlike the money market, on which lending is ordinarily short term, the capital market typically finances fixed investments like those in buildings and machinery.

Debt or Bond market

The bond market (also known as the debt, credit, or fixed income market) is a financial market where participants buy and sell debt securities, usually in the form of bonds. As of 2009, the size of the worldwide bond market (total debt outstanding) is an estimated $82.2 trillion , of which the size of the outstanding U.S. bond market debt was $31.2 trillion according to BIS (or alternatively $34.3 trillion according to SIFMA).

Market structure Bond markets in most countries remain decentralized and lack common exchanges like stock, future and commodity markets. This has occurred, in part, because no two bond issues are exactly alike, and the variety of bond securities outstanding greatly exceeds that of stocks. However, the New York Stock Exchange (NYSE) is the largest centralized bond market, representing mostly corporate bonds. The NYSE migrated from the Automated Bond System (ABS) to the NYSE Bonds trading system in April 2007 and expects the number of traded issues to increase from 1000 to 6000.

Stock marketA stock market or equity market is a public market (a loose network of economic transactions, not a physical facility or discrete entity) for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. Types of equity Common stock: Shares of corporate ownership that entitle the owner to vote on management issues but offer no guarantees of dividends or of market value in the event of corporate bankruptcy. Preferred stock: Shares of corporate ownership that entail no voting rights but entitle the owner to dividends if any are paid by the corporation and to any residual value of the corporation after other creditors have been paid.

Function and purpose 1. The stock market is one of the most important sources for companies to raise money. This allows businesses to be publicly traded, or raise additional capital for expansion by selling shares of ownership of the company in a public market. 2. History has shown that the price of shares and other assets is an important part of the dynamics of economic activity, and can influence or be an indicator of social mood. The stock market is often considered the primary indicator of a country's economic strength and development. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. 3. Exchanges also act as the clearing house for each transaction, meaning that they collect and deliver the shares, and guarantee payment to the seller of a security. This eliminates the risk to an individual buyer or seller that the counterparty could default on the transaction.

The smooth functioning of all these activities facilitates economic growth in that lower costs and enterprise risks promote the production of goods and services as well as employment. In this way the financial system contributes to increased prosperity.

Some Stock exchanges New York Stock Exchange (NYSE) The oldest (1792) and largest exchange where roughly half of the stock trading in the United States is doneshares of more than 3,000 companies are traded there. The number of NYSE membership positions, called seats, is fixed at 1366. Over-the-counter (OTC) stocks: Equity shares offered by companies that do not meet listing requirements for major stock exchanges, or choose not to be listed there, and instead are traded in decentralized markets. National Association of Securities Dealers Automated Quotation (Nasdaq): The electronic network of 500 dealers over which most over-the-counter stocks are traded. Microsoft, Intel, and Cisco trade on this exchange.

Capital market instruments

A capital market is a market for securities (debt or equity), where business enterprises and government can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets (e.g., the money market). The capital market is characterized by a large variety of financial instruments: equity and preference shares, fully convertible debentures (FCDs), non-convertible debentures (NCDs) and partly convertible debentures (PCDs) currently dominate the capital market, however new instruments are being introduced such as debentures bundled with warrants, participating preference shares, zero-coupon bonds, secured premium notes, etc. 1. SECURED PREMIUM NOTES SPN is a secured debenture redeemable at premium issued along with a detachable warrant, redeemable after a notice period, say four to seven years. The warrants attached to SPN gives the holder the right to apply and get allotted equity shares; provided the SPN is fully paid. There is a lock-in period for SPN during which no interest will be paid for an invested amount. The SPN holder has an option to sell back the SPN to the company at par value after the lock in period. If the holder exercises this option, no interest/ premium will be paid on redemption. In case the SPN holder holds it further, the holder will be repaid the principal amount along with the additional amount of interest/ premium on redemption in installments as decided by the company. The conversion of detachable warrants into equity shares will have to be done within the time limit notified by the company. Ex-TISCO issued warrants for the first time in India in the year 1992 to raise 1212 crore. 2. DEEP DISCOUNT BONDS A bond that sells at a significant discount from par value and has no coupon rate or lower coupon rate than the prevailing rates of fixed-income securities with a similar risk profile. They are designed to meet the long term funds requirements of the issuer and investors who are not looking for immediate return and can be sold with a long maturity of 25-30 years at a deep discount on the face value of debentures. Ex-IDBI deep discount bonds for Rs 1 lac repayable after 25 years were sold at a discount price of Rs. 2,700. 3. EQUITY SHARES WITH DETACHABLE WARRANTS A warrant is a security issued by company entitling the holder to buy a given number of shares of stock at a stipulated price during a specified period. These warrants are separately registered with the stock exchanges and traded separately. Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends. Ex-Essar Gujarat, Ranbaxy, Reliance issue this type of instrument.

4.

FULLY CONVERTIBLE DEBENTURES WITH INTEREST This is a debt instrument that is fully converted over a specified period into equity shares. The conversion can be in one or several phases. When the instrument is a pure debt instrument, interest is paid to the investor. After conversion, interest payments cease on the portion that is

converted. If project finance is raised through an FCD issue, the investor can earn interest even when the project is under implementation. Once the project is operational, the investor can participate in the profits through share price appreciation and dividend payments 5. EQUIPREF They are fully convertible cumulative preference shares. This instrument is divided into 2 parts namely Part A & Part B. Part A is convertible into equity shares automatically /compulsorily on date of allotment without any application by the allottee. Part B is redeemed at par or converted into equity after a lock in period at the option of the investor, at a price 30% lower than the average market price. 6. SWEAT EQUITY SHARES The phrase `sweat equity' refers to equity shares given to the company's employees on favorable terms, in recognition of their work. Sweat equity usually takes the form of giving options to employees to buy shares of the company, so they become part owners and participate in the profits, apart from earning salary. This gives a boost to the sentiments of employees and motivates them to work harder towards the goals of the company. The Companies Act defines `sweat equity shares' as equity shares issued by the company to employees or directors at a discount or for consideration other than cash for providing knowhow or making available rights in the nature of intellectual property rights or value additions, by whatever name called. 7. TRACKING STOCKS A tracking stock is a security issued by a parent company to track the results of one of its subsidiaries or lines of business; without having claim on the assets of the division or the parent company. It is also known as "designer stock". When a parent company issues a tracking stock, all revenues and expenses of the applicable division are separated from the parent company's financial statements and bound to the tracking stock. Oftentimes, this is done to separate a subsidiary's high-growth division from a larger parent company that is presenting losses. The parent company and its shareholders, however, still control the operations of the subsidiary. Ex- QQQQ, which is an exchange-traded fund that mirrors the returns of the Nasdaq 100 index 8. DISASTER BONDS Also known as Catastrophe or CAT Bonds, Disaster Bond is a high-yield debt instrument that is usually insurance linked and meant to raise money in case of a catastrophe. It has a special condition that states that if the issuer (insurance or Reinsurance Company) suffers a loss from a particular pre-defined catastrophe, then the issuer's obligation to pay interest and/or repay the principal is either deferred or completely forgiven. Ex- Mexico sold $290 million in catastrophe bonds, becoming the first country to use a World Bank program that passes the cost of natural disasters to investors. Goldman Sachs Group Inc. and Swiss Reinsurance Co. managed the bond sale, which will pay investors unless an earthquake or hurricane triggers a transfer of the funds to the Mexican government.

9.

MORTGAGE BACKED SECURITIES (MBS) MBS is a type of asset-backed security, basically a debt obligation that represents a claim on the cash flows from mortgage loans, most commonly on residential property. Mortgagebacked securities represent claims and derive their ultimate values from the principal and payments on the loans in the pool. These payments can be further broken down into different classes of securities, depending on the riskiness of different mortgages as they are classified under the MBS.

10.

GLOBAL DEPOSITORY RECEIPTS/ AMERICAN DEPOSITORY RECEIPTS A negotiable certificate held in the bank of one country (depository) representing a specific number of shares of a stock traded on an exchange of another country. GDR facilitate trade of shares, and are commonly used to invest in companies from developing or emerging markets. GDR prices are often close to values of related shares, but they are traded and settled independently of the underlying share. Listing on a foreign stock exchange requires compliance with the policies of those stock exchanges. Many times, the policies of the foreign exchanges are much more stringent than the policies of domestic stock exchange. However a company may get listed on these stock exchanges indirectly using ADRs and GDRs. If the depository receipt is traded in the United States of America (USA), it is called an American Depository Receipt, or an ADR. If the depository receipt is traded in a country other than USA, it is called a Global Depository Receipt, or a GDR. But the ADRs and GDRs are an excellent means of investment for NRIs and foreign nationals wanting to invest in India. By buying these, they can invest directly in Indian companies without going through the hassle of understanding the rules and working of the Indian financial market since ADRs and GDRs are traded like any other stock, NRIs and foreigners can buy these using their regular equity trading accounts! Ex- HDFC Bank, ICICI Bank, Infosys have issued both ADR and GDR

11.

FOREIGN CURRENCY CONVERTIBLE BONDS(FCCBs) A convertible bond is a mix between a debt and equity instrument. It is a bond having regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. FCCB is issued in a currency different than the issuer's domestic currency. The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock. Due to the equity side of the bond, which adds value, the coupon payments on the bond are lower for the company, thereby reducing its debt-financing costs. Advantages Some companies, banks, governments, and other sovereign entities may decide to issue bonds in foreign currencies because, as it may appear to be more stable and predictable than their domestic currency Gives issuers the ability to access investment capital available in foreign markets Companies can use the process to break into foreign markets

The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component Conversion of bonds into stocks takes place at a premium price to market price. Conversion price is fixed when the bond is issued. So, lower dilution of the company stocks Advantages to investors Safety of guaranteed payments on the bond Can take advantage of any large price appreciation in the companys stock Redeemable at maturity if not converted Easily marketable as investors enjoys option of conversion in to equity if resulting to capital appreciation Disadvantages Exchange risk is more in FCCBs as interest on bond would be payable in foreign currency. Thus companies with low debt equity ratios, large forex earnings potential only opted for FCCBs FCCBs means creation of more debt and a FOREX outgo in terms of interest which is in foreign exchange In case of convertible bond the interest rate is low (around 3 to 4%) but there is exchange risk on interest as well as principal if the bonds are not converted in to equity. If the stock price plummets, investors will not go for conversion but redemption. So, companies have to refinance to fulfill the redemption promise which can hit earnings It remains a debt in the balance sheet until conversion

13.

DERIVATIVES A derivative is a financial instrument whose characteristics and value depend upon the characteristics and value of some underlying asset typically commodity, bond, equity, currency, index, event etc. Advanced investors sometimes purchase or sell derivatives to manage the risk associated with the underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or decline. Derivatives are often leveraged, such that a small movement in the underlying value can cause a large difference in the value of the derivative. Derivatives are usually broadly categorised by: The relationship between the underlying and the derivative (e.g. forward, option, swap) The type of underlying (e.g. equity derivatives, foreign exchange derivatives and credit derivatives) The market in which they trade (e.g., exchange traded or over-the-counter) Futures A financial contract obligating the buyer to purchase an asset, (or the seller to sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are

standardized to facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. The futures markets are characterized by the ability to use very high leverage relative to stock markets. Some of the most popular assets on which futures contracts are available are equity stocks, indices, commodities and currency. Options A financial derivative that represents a contract sold by one party (option writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain period of time or on a specific date (exercise date). A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is called 'strike price'. It should be noted that while the holder of the call option has a right to demand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if the buyer wants to buy the asset, the seller has to sell it. He does not have a right. Similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer. Here the buyer has the right to sell and the seller has the obligation to buy. So in any options contract, the right to exercise the option is vested with the buyer of the contract. The seller of the contract has only the obligation and no right. As the seller of the

contract bears the obligation, he is paid a price called as 'premium'. Therefore the price that is paid for buying an option contract is called as premium.

The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his/her contract.

14.

PARTICIPATORY NOTES Also referred to as "P-Notes" Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. These are issued by FIIs to entities that want to invest in the Indian stock market but do not want to register themselves with the SEBI. RBI, which had sought a ban on PNs, believes that it is tough to establish the beneficial ownership or the identity of ultimate investors.

15.

HEDGE FUND

A hedge fund is an investment fund open to a limited range of investors that undertakes a wider range of investment and trading activities in both domestic and international markets, and that, in general, pays a performance fee to its investment manager. Every hedge fund has its own investment strategy that determines the type of investments and the methods of investment it undertakes. Hedge funds, as a class, invest in a broad range of investments including shares, debt and commodities. As the name implies, hedge funds often seek to hedge some of the risks inherent in their investments using a variety of methods, with a goal to generate high returns through aggressive investment strategies, most notably short selling, leverage, program trading, swaps, arbitrage and derivatives. Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year. 16. FUND OF FUNDS A "fund of funds" (FoF) is an investment strategy of holding a portfolio of other investment funds rather than investing directly in shares, bonds or other securities. This type of investing is often referred to as multi-manager investment. A fund of funds allows investors to achieve a broad diversification and an appropriate asset allocation with investments in a variety of fund categories that are all wrapped up into one fund. 17. EXCHANGE TRADED FUNDS

An exchange-traded fund (or ETF) is an investment vehicle traded on stock exchanges, much like stocks. An ETF holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features, and single security can track the performance of a growing number of different index funds (currently the NSE Nifty) 18. GOLD ETF A gold Exchange Traded Fund (ETF) is a financial instrument like a mutual fund whose value depends on the price of gold. In most cases, the price of one unit of a gold ETF approximately reflects the price of 1 gram of gold. As the price of gold rises, the price of the ETF is also expected to rise by the same amount. Gold exchange-traded funds are traded on the major stock exchanges including Zurich, Mumbai, London, Paris and New York There are also closedend funds (CEF's) and exchange-traded notes (ETN's) that aim to track the gold price.

Hybrid financing instruments-

As hybrid source of financing has characteristics of both straight debt and straight equity falling somewhere in between. The important hybrid instruments of financing are1. Preference share capital It is a unique type of long term financing in that it combines some of the features of equity as well as debentures. As a hybrid form of financing, it is similar to debenture insofar as: 1. It carries a fixed rate of dividend. 2. It ranks higher than equity as a claimant to income/assets. 3. It normally does not have voting rights. 4. It does not have a share in residual earnings/assets.

It also partakes some of the attributes of equity capital namely-

1. Dividend on preference capital is paid out of divisible tax profit, that is, it is not tax deductible. 2. Payment of preference dividend depends on the discretion of management, that is, it is not an obligatory payment and non-payment does not force liquidation. 3. Irredeemable type of preference shares have no fixed maturity date.

Evaluation- preference share as a source of long term financing has merits and demerits from the point of view of investors as well as shareholders.

Merits1. No Legal Obligation for Dividend Payment: There is no compulsion of payment of preference dividend because nonpayment of dividend does not amount to bankruptcy. This dividend is not a fixed liability like the interest on the debt which has to be paid in all circumstances. 2. Improves Borrowing Capacity: Preference shares become a part of net worth and therefore reduces debt to equity ratio. This is how the overall borrowing capacity of the company increases. 3. No dilution in control: Issue of preference share does not lead to dilution in control of existing equity shareholders because the voting rights are not attached to issue of

preference share capital. The preference shareholders invest their capital with fixed dividend percentage but they do not get control rights with them. 4. No Charge on Assets: While taking a term loan security needs to be given to the financial institution in the form of primary security and collateral security. There are no such requirements and therefore the company gets the required money and the assets also remain free of any kind of charge on them.

Demerits-

1. Costly Source of Finance: Preference shares are considered a very costly source of finance which is apparently seen when they are compared with debt as a source of finance. The interest on debt is a tax deductible expense whereas the dividend of preference shares is paid out of the divisible profits of the company i.e. profit after taxes and all other expenses. For example the dividend on preference share is 9% and interest rate on debt is 10% with prevailing tax rate of 50%. The effective cost of preference is same i.e. 9% but that of the debt is 5% {10% * (1-50%)}. The tax shield is the main element which makes all the difference. In no tax regime, the preference share would be comparable to debt but such a scenario is just an imagination. 2. Skipping Dividend Disregard Market Image: Skipping of dividend payment may not harm the company legally but it would always create a dent on the image of the company. While applying for some kind of debt or any other kind of finance, the lender would have this as a major concern. Under such a situation, counting skipping of dividend as an advantage is just a fancy. Practically, a company cannot afford to take such a risk. 3. Preference in Claims: Preference shareholders enjoy similar situation like that of an equity shareholders but still gets a preference in both payment of their fixed dividend and claim on assets at the time of liquidation.

Convertible debentures/ bondsA type of loan issued by a company that can be converted into stock by the holder and, under certain circumstances, the issuer of the bond. By adding the convertibility option the issuer pays a lower interest rate on the loan compared to if there was no option to convert. These instruments are used by companies to obtain the capital they need to grow or maintain the business. Convertible debentures are different from convertible bonds because debentures are unsecured; in the event of bankruptcy the debentures would be paid after other fixed income holders. The convertible feature is factored into the calculation of the diluted per-share metrics as if the debentures had been converted. Therefore, a higher share count reduces metrics such as earnings per share, which is referred to as dilution. Valuation-

The convertible debentures in india can be of three types: 1. Compulsory convertible within 18 months. 2. Optionally convertible within 36 months. Convertible after 36 months with call and put features. However only the first two are popular. Regulation ofthe CapitalMarket

Every capital market in the world is monitored by financial regulators and their respective governance organization. The purpose of such regulation is to protect investors from fraud and deception. Financial regulatory bodies are also charged with minimizing financial losses, issuing licenses to financial service providers, and enforcing applicable laws. The Securities and Exchange Board of India (frequently abbreviated SEBI) is the regulator for the securities market in India. It was established on 12 April 1992 through the SEBI Act, 1992. The SEBI is managed by its members, which consists of following: a) The chairman who is nominated by Union Government of India. b) Two members, i.e. Officers from Union Finance Ministry. c) One member from The Reserve Bank of India. d) The remaining 5 members are nominated by Union Government of India, out of them at least 3 shall be wholetime members.

Functions and responsibilities

SEBI has to be responsive to the needs of three groups, which constitute the market: The issuers of securities The investors The market intermediaries. SEBI has three functions rolled into one body: quasi-legislative, quasi-judicial and quasiexecutive. It drafts regulations in its legislative capacity, it conducts investigation and enforcement action in its executive function and it passes rulings and orders in its judicial capacity. Though this makes it very powerful, there is an appeal process to create accountability. There is a Securities Appellate Tribunal which is a three-member tribunal and is presently headed by a former Chief Justice of a High court - Mr. Justice NK Sodhi. A second appeal lies directly to the Supreme Court.

Powers
For the discharge of its functions efficiently, SEBI has been vested with the following powers: to approve bylaws of stock exchanges. to require the stock exchange to amend their bylaws. inspect the books of accounts and call for periodical returns from recognized stock exchanges. inspect the books of accounts of a financial intermediaries.

compel certain companies to list their shares in one or more stock exchanges. levy fees and other charges on the intermediaries for performing its functions. grant license to any person for the purpose of dealing in certain areas. delegate powers exercisable by it. prosecute and judge directly the violation of certain provisions of the companies Act. power to impose monetary penalties.

What is ADR ADR is the full form of American Depository Receipts. This is the recent method adopted by many large and well respected companies from India to raise funds from American Markets. How ADR Operates Indian companies have direct access to raise funds from Indian public by way of issuing Shares, Debentures etc. However Indian companies cannot do so, in such a direct manner, when it comes to raising funds from American people. That would entail the Indian companies to adopt US Accounting Norms which is also called as GAAP, maintain accounting practices as per American Financial Year (Which starts in January and ends in December of any particular year), as also follow variety of stringent standards as per American norms. Effectively, it would mean that the Indian company would have to follow two different set of rules simultaneously, one to comply with the laws of Indian Companies Act, and the other to comply with the American Laws. The method to circumvent the American norms, but still raise funds from American people is available by way of ADR or American Depository Receipts. In this system, the Indian company deposits certain amount of its Indian shares with designated American Banks. The banks, in turn, issues receipts that are equivalent in values (And also based on the intrinsic value the Indian Companys shares would fetch in the American market) to the Indian Company. These receipts essentially would be in number of receipts. Then these Indian Companies can trade these ADRs or American Depository Receipts with the American public. These ADRs can be purchased and traded freely without any encumbrances in the American Stocks and Shares Market. This way the Indian company is able to enter into the American Stocks and Shares market, and raise funds from the American public. The role of the American bank which has issued these receipts is very crucial, since it is they who stand guarantee to the issued receipts. Hence they do exhaustive study of the Indian company from all perspectives, and only then issue the ADR to the Indian company. What is GDR and how it operates

The full form of GDR is Global Depository Receipt. It is not a different financial instrument, as it may sound, from that of ADR. In fact if the Indian Company which has issued GDRs in the American market wishes to further extend it to other developed and advanced countries such as Europe, then they can sell these ADRs to the public of Europe and the same would be named as GDR.

Indian Companies with ADR & GDR There are quite a lot of successful Indian companies that have now issued ADRs and GDRs. Some such companies are given underneath. Dr. Reddys HDFC Bank ICICI Bank Infosys Technologies MTNL VSNL WIPRO

Eurocurrency market
A Eurocurrency market is a money market that provides banking services to a variety of customers by using foreign currencies located outside of the domestic marketplace. The concept does not have anything to do with the European Union or the banks associated with the member countries, although the origins of the concept are heavily derived from the region. Instead, it represents any deposit of foreign currencies into a domestic bank. For example, if Japanese yen is deposited into a bank in the United States, it is considered to be operating under the auspices of the Eurocurrency market.

This market has its roots in the World War II era. While the war was going on, political challenges caused by the takeover of the continent by the Axis Powers meant that there was a limited marketplace for trading in foreign currency. With no friendly government operations within the European marketplace, the traditional economies of the nations were displaced, along with the currencies. To combat this, especially due to the fact that many American companies were tied to the well-being of business behind enemy lines, banks across the world began to deposit large sums of foreign currency, creating a new money market.

Euro commercial paperAn unsecured, short-term loan issued by a bank or corporation in the international money market, denominated in a currency that differs from the corporation's domestic currency. For example, if a U.S. corporation issues a short-term bond denominated in Canadian dollars to finance its inventory through the international money market, it has issued euro commercial paper.

Eurocurrency depositsA short-term certificate of deposit with a fixed interest rate made in a currency outside the jurisdiction of the issuing central bank. For example, one may purchase a CD in U.S. dollars and deposit it in a bank in Great Britain. Eurocurrency deposits help persons and businesses hedge against short-term fluctuations in exchange rates.

Indian Financial Markets and Global Integration

Indias growth story has important implications for the capital market, which has grown sharply with respect to several parameters amounts raised number of stock exchanges and other intermediaries, listed stocks, market capitalization, trading volumes and turnover, market instruments, investor population, issuer and intermediary profiles. The capital market consists primarily of the debt and equity markets. Historically, it contributed significantly to mobilizing funds to meet public and private companies financing requirements. The introduction of exchange-traded derivative instruments such as options and futures has enabled investors to better hedge their positions and reduce risks. Indias debt and equity markets rose from 75 per cent in 1995 to 130 per cent of GDP in 2005. But the growth relative to the US, Malaysia and South Korea remains low and largely skewed, indicating immense latent potential. Indias debt markets comprise government bonds and the corporate bond market (comprising PSUs, corporates, financial institutions and banks). India compares well with other emerging economies in terms of sophisticated market design of equity spot and derivatives market, widespread retail participation and resilient liquidity. SEBIs measures such as submission of quarterly compliance reports, and company valuation on the lines of the Sarbanes-Oxley Act have enhanced corporate governance. But enforcement continues to be a problem because of limited trained staff and companies not being subjected to substantial fines or legal sanctions. Indias stock market rose five-fold since mid-2003 and outperformed world indices with returns far outstripping other emerging markets, such as Mexico (52 per cent), Brazil (43 per cent) or GCC economies such as Kuwait (26 per cent) in FY-06. In 2006, Indian companies raised more than $6 billion on the BSE, NSE and other regional stock exchanges. Buoyed by internal economic factors and foreign capital flows, Indian

markets are globally competitive, even in terms of pricing, efficiency and liquidity.

USsubp rime crisis: The financial crisis facing the Wall Street is the worst since the Great Depression and will have a major impact on the US and global economy. The ongoing global financial crisis will have a domino effect and spill over all aspects of the economy. Due to the Western worlds messianic faith in the market forces and deregulation, the market friendly governments have no choice but to step in. The top five investment banks in the US have ceased to exist in their previous forms. Bears Stearns was taken over some time ago. Fannie Mae and Freddie Mac are nationalised to prevent their collapse. Fannie and Freddie together underwrite half of the home loans in the United States, and the sum involved is of $ 3 trillionabout double the entire annual output of the British economy. This is the biggest rescue operation since the credit crunch began. Lehman Brothers, an investment bank with a 158 year-old history, was declared bankrupt; Merrill Lynch, another Wall Street icon, chose to pre-empt a similar fate by deciding to sell to the Bank of America; and Goldman Sachs and Morgan Stanley have decided to transform themselves into ordinary deposit banks. AIG, the worlds largest insurance company, has survived through the injection of funds worth $ 85 billion from the US Government.

The question arises: why has this happened?

Besides the cyclical crisis of capitalism, there are some recent factors which have contributed towards this crisis. Under the so-called innovative approach, financial institutions systematically underestimated risks during the boom in property prices, which makes such boom more prolonged. This relates to the shortsightedness of speculators and their unrestrained greed, and they, during the asset price boom, believed that it would stay forever. This resulted in keeping the risk aspects at a minimum and thus resorting to more and more risk taking financial activities. Loans were made on the basis of collateral whose value was inflated by a bubble. And the collateral is now worth less than the loan. Credit was available up to full value of the property which was assessed at inflated market prices. Credits were given in anticipation

that rising property prices will continue. Under looming recession and uncertainty, to pay back their mortgage many of those who engaged in such an exercise are forced to sell their houses, at a time when the banks are reluctant to lend and buyers would like to wait in the hope that property prices will further come down. All these factors would lead to a further decline in property prices.

Effect of the subprime crisis on India:

Globalization has ensured that the Indian economy and financial markets cannot stay insulated from the present financial crisis in the developed economies.

In the light of the fact that the Indian economy is linked to global markets through a full float in current account (trade and services) and partial float in capital account (debt and equity), we need to analyze the impact based on three critical factors: Availability of global liquidity; demand for India investment and cost thereof and decreased consumer demand affecting Indian exports. The concerted intervention by central banks of developed countries in injecting liquidity is expected to reduce the unwinding of India investments held by foreign entities, but fresh investment flows into India are in doubt. The impact of this will be three-fold: The element of GDP growth driven by off-shore flows (along with skills and technology) will be diluted; correction in the asset prices which were hitherto pushed by foreign investors and demand for domestic liquidity putting pressure on interstates. While the global financial system takes time to nurse its wounds leading to low demand for investments in emerging markets, the impact will be on the cost and related risk premium. The impact will be felt both in the trade and capital account. Indian companies which had access to cheap foreign currency funds for financing their import and export will be the worst hit. Also, foreign funds (through debt and equity) will be available at huge premium and would be limited to blue-chip companies. The impact of which, again, will be three-fold: Reduced capacity expansion leading to supply side pressure; increased interest expenses to affect corporate profitability and increased demand for domestic liquidity putting pressure on the interest rates. Consumer demand in developed economies is certain to be hurt by the present crisis, leading to lower demand for Indian goods and services, thus affecting the Indian exports.The impact of which, once again, will be three-fold: Export-oriented units will be the worst hit impacting employment; reduced exports will further widen the trade gap to put pressure on rupee exchange rate and

intervention leading to sucking out liquidity and pressure on interest rates.

The impact on the financial markets will be the following: Equity market will continue to remain in bearish mood with reduced off-shore flows, limited domestic appetite due to liquidity pressure and pressure on corporate earnings; while the inflation would stay under control, increased demand for domestic liquidity will push interest rates higher and we are likely to witness gradual rupee depreciation and depleted currency reserves. Overall, while RBI would inject liquidity through CRR/SLR cuts, maintaining growth beyond 7% will be a struggle. The banking sector will have the least impact as high interest rates, increased demand for rupee loans and reduced statutory reserves will lead to improved NIM while, on the other hand, other income from cross-border business flows and distribution of investment products will take a hit. Banks with capabilities to generate low cost CASA and zero cost float funds will gain the most as revenues from financial intermediation will drive the banks profitability. Given the dependence on foreign funds and off-shore consumer demand for the India growth story, India cannot wish away from the negative impact of the present global financial crisis but should quickly focus on alternative remedial measures to limit damage and look in-wards to sustain growth. Role of capital market during present crisisIn addition to resource allocation, capital markets also provided a medium for risk management by allowing the diversification of risk in the economy. The well-functioning capital market improved information quality as it played a major role in encouraging the adoption of stronger corporate governance principles, thus supporting a trading environment, which is founded on integrity. For a long time, the Indian market was considered too small to warrant much attention. However, this view has changed rapidly as vast amounts of international investment have poured into our markets over the last decade. The Indian market is no longer viewed as a static universe but as a constantly evolving market providing attractive opportunities to the global investing community.

Now during the present financial crisis, we saw how capital market stood still as the symbol of better risk management practices adopted by the Indians. Though we observed a huge fall in the Sensex and other stock market indicators but that was all due to low confidence

among the investors. Because balance sheet of most of the Indian companies listed in the Sensex were reflecting profit even then people kept on withdrawing money.

While there was a panic in the capital market due to withdrawal by the FIIs, we saw Indian institutional investors like insurance and mutual funds coming for the rescue under SEBI guidelines so that the confidence of the investors doesnt go low. SEBI also came up with various norms including more liberal policies regarding participatory notes, restricting the exit from close ended mutual funds etc. to boost the investment.

While talking about currency crisis, the rupee kept on depreciating against the dollar mainly due to the withdrawals by FIIs. So , the capital market tried to attract FIIs once again. SEBI came up with many revolutionary reforms to attract the foreign investors so that the depreciation of rupee could be put to hault.

Factors affecting capital market in IndiaThe capital market is affected by a range of factors. Some of the factors which influence capital market are as follows:-

A) Performance of domestic companies:-

The performance of the companies or rather corporate earnings is one of the factors which has direct impact or effect on capital market in a country. Weak corporate earnings indicate that the demand for goods and services in the economy is less due to slow growth in

per capita income of people . Because of slow growth in demand there is slow growth in employment which means slow growth in demand in the near future. Thus weak corporate earnings indicate average or not so good prospects for the economy as a whole in the near term. In such a scenario the investors ( both domestic as well as foreign ) would be wary to invest in the capital market and thus there is bear market like situation. The opposite case of it would be robust corporate earnings and its positive impact on the capital market.

B) Environmental Factors :Environmental Factor in Indias context primarily means- Monsoon . In India around 60 % of agricultural production is dependent on monsoon. Thus there is heavy dependence on monsoon. The major chunk of agricultural production comes from the states of Punjab , Haryana & Uttar Pradesh. Thus deficient or delayed monsoon in this part of the country would directly affect the agricultural output in the country. Apart from monsoon other natural calamities like Floods, tsunami, drought, earthquake, etc. also have an impact on the capital market of a country.

C) Macro Economic Numbers :-

The macroeconomic numbers also influence the capital market. It includes Index of Industrial Production (IIP) which is released every month, annual Inflation number indicated by Wholesale Price Index (WPI) which is released every week, Export Import numbers which are declared every month, Core Industries growth rate ( It includes Six Core infrastructure industries Coal, Crude oil, refining, power, cement and finished steel) which comes out every month, etc. This macro economic indicators indicate the state of the economy and the direction in which the economy is headed and therefore impacts the capital market in India.

D) Global Cues :-

In this world of globalization various economies are interdependent and interconnected. An event in one part of the world is bound to affect other parts of the world , however the magnitude and intensity of impact would vary. Thus capital market in India is also affected by developments in other parts of the world i.e. U.S. , Europe, Japan , etc. Global cues includes corporate earnings of MNCs, consumer confidence index in developed countries, jobless claims in developed countries, global growth outlook given by various agencies like IMF, economic growth of major economies, price of crude oil, credit rating of various economies given by Moodys, S & P, etc. An obvious example at this point in time would be that of subprime crisis & recession. Recession started in U.S. and some parts of the Europe in early 2008 .Since then it has impacted all the countries of the world- developed, developing, less- developed

and even emerging economies.

E) Political stability and government policies:-

For any economy to achieve and sustain growth it has to have political stability and progrowth government policies. This is because when there is political stability there is stability and consistency in governments attitude which is communicated through various government policies. The vice- versa is the case when there is no political stability .So capital market also reacts to the nature of government, attitude of government, and various policies of the government.

F) Growth prospectus of an economy:-

When the national income of the country increases and per capita income of people increases it is said that the economy is growing. Higher income also means higher expenditure and higher savings. This augurs well for the economy as higher expenditure means higher demand and higher savings means higher investment. Thus when an economy is growing at a good pace capital market of the country attracts more money from investors, both from within and outside the country and vice -versa. So we can say that growth prospects of an economy do have an impact on capital markets.