Financial Institution & Market Upload

Financial Institution & Market
Asit Mohanty
XIMB

Overview
of
Indian Financial System

Basics.
Investment Ratio..I%
Incremental Capital Output Ratio(ICOR)
= ( Productivity)^-1P%
Projected GDP % = I% * P%
Saving & Investment
Trend
Projection of Saving Rate of India
Foreign Saving
Fund transfer from savers to
borrowers ---Direct and Indirect
Finance

Direct Finance :
borrowers borrow gets fund directly from the lenders in
the financial markets, by selling them securities ( also
called financial instruments). These are assets who buys
them and liabilities to those who sell( issue) them.

The Indirect Finance :
The intermediary borrows funds from the savers and then
using this fund makes loans to the borrower spenders.

INDIRECT FINANCE & DIRECT FINANCE

INDIRECT FINANCE

Financial
Institutions
&
Financial market

SAVERS

Households
Private Corporate
Govt/ PSU

BORROWERS
Government/PSU
Private Corporate
Households

DIRECT FINANCE

Financial Markets

Financial Intermediaries

Objective : To Intermediate funds from savers to Borrowers in the most risk free manner

INDIRECT FINANCE

Financial
Institutions

SAVERS

Households
Business

BORROWERS
Government
Business
Households

Financial Institutions.
Intermediaries
..are the markets in the economy that help to match one
persons saving with another persons investment.
. . . move the economys scarce resources from savers to
borrowers.
. . . are opportunities for savers to channel unspent funds into
the hands of borrowers.
Institutions that allow savers and borrowers to interact are
called financial intermediaries.

Saving and Investment in the National Income Accounts
Recall: GDP is both total income in an economy and the
total expenditure on the economys output of goods and
services:
Y = C + I + G + (X-M)..1

I + G + (X-M) = Y- C
National Saving or Saving is equal to:
I + G + (X-M) = S
I + G + X = S+M
For Closed Economy
I + G = S

Saving and Investment in the National Income Accounts

National Saving or Saving is equal to:
Y - C - G = I = S or
S = (Y - T - C) + (T - G)
where T = Taxes
Two components of national saving:
Private Saving = (Y - T - C)both HH & Pvt. Sector
Public Saving = (T - G)
Saving and Investment
Private Saving is the amount of income that
households have left after paying their taxes and
paying for their consumption.
Public Saving is the amount of tax revenue that the
government has left after paying for its spending.
For the economy as a whole, saving must be equal
to investment.
Basics National Income Accounting
GDP(@fc) using expenditure method
Y = C + I + G + (X-M)
External Demand & Exchange Rate
Domestic Demand
C = Private & Govt. Consumption Demand
I = Investment by both domestic corporate & foreign Investor(FDI)..Capital Formation
G = Investment by Govt.
% GDP Rate = ( I+G) to GDP Ratio/ ICOR

ICORIncremental Capital output Ratio
Lower ICOR is proxy for higher productivity of the
economy
1. How to finance
I+G. Saving or
borrowing or both?
2.How to reduce ICOR?
To achieve desired GDP
Growth indicated in
Budget
Objectives

Endeavour for faster, sustainable and more inclusive
growth
The objective is to achieve a GDP growth of
nearly 7.6% as against estimated growth rate
of 6.9% in 2011-12. In order to achieve this
following 2-point objective are laid down:

1. Focus on domestic demand driven growth
recovery;
2. Create conditions for rapid revival of high
growth in private investment

The Market For Loan able Funds
Financial markets coordinate the economys
saving and investment in
The Loan able Funds Market
The Supply of Loan able Funds comes from
people who have extra income that they want to
loan out.

The Demand for Loan able Funds comes from
those who wish to borrow to make investments.
The Market For Loanable Funds
Interest
Rate
Loanable Funds
Supply
Interest
Rate
Loanable Funds
Supply
Demand
Interest
Rate
Loanable Funds

Compensates for the lenders lost
opportunity to consume.
Real Rate of Interest
Supply
Demand
Interest
Rate
Loanable Funds
5%
$1,200

The Market For Loan able Funds
Supply
Demand
Interest
Rate
Loanable Funds
5%
$1,200
Movement to
equilibrium is
consistent with
principles of supply
and demand.
The supply and demand for loanable funds
depends on the real interest rate. Movement
to equilibrium is the process of determining
the real interest rate in the economy.
Saving represents the supply of loanable
funds, while investment represents demand.
Supply
Demand
Interest
Rate
5%
$1,200
Loanable Funds
Supply
Demand
Interest
Rate
Loanable Funds
5%
$1,200
Decrease in Taxes on
savings increases the
incentive to save
affecting the supply of
loanable funds
$1,200
Supply
Demand
Interest
Rate
5%
4%
$1,300
Loanable Funds
Supply
Demand
Interest
Rate
5%
$1,200
Loanable Funds
Supply
Demand
Interest
Rate
5%
$1,200
Loanable Funds
Tax Break on investment
would increase the
incentive to borrow
altering the demand for
loanable funds.
Supply
Demand
Interest
Rate
Loanable Funds
5%
$1,200
6%
$1,300
Supply
Demand
Interest
Rate
5%
$1,200
Loanable Funds
Supply
Demand
Interest
Rate
5%
$1,200
Loanable Funds
Government borrowing to
finance its budget deficit,
reduces the supply of
loanable funds.
Supply
Demand
Interest
Rate
Loanable Funds
6%
$1,000
5%
$1,200
Theory and Structure of Interest rates

As discussed, Market interest Rate is determined by the factors that control the
supply and demand for loan able funds . Loanable Funds Theory
Demand for Loanable Funds
Household demand
Business/ Corporate demand
Government To meet Deficit
Foreign demand .. Country A issues securities to investors of country B
Supply of Loanable Funds
Household sector is the largest followed by Government and Business Sector
At equilibrium interest rate, Supply = Demand of Loanable Funds
Theory and Structure of Interest rates ..Fisher Effect

Nominal Interest rate of Interest
- Compensates for reduced Purchasing Power
- Provides a premium for foregoing present consumption
i
r
+ E(i) = i
n

where
i
r
is Real interest rate
i
n
is nominal interest rate
E(i) is expected inflation rate
Since i
r
cannot be negative , higher inflation tends to push up interest rates
Key issues impacting Interest rates
Impact of Inflation
Impact of budget deficit
Impact of interest rates in foreign countries

More on Interest Rates
Expected Inflation
Inflation erodes the purchasing power of money.

Example: If you loan someone $1,000 and they pay it back one year later
with 10% interest, you will have $1,100.

But if prices have increased by 5%, then something that would have cost
$1,000 at the outset of the loan will now cost $1,000(1.05) = $1,050.
Conclusion
Financial Intermediaries through financial markets
and instruments. coordinate borrowing and
lending and thereby help allocate the economys
scarce resources efficiently.
The price in the loanable funds market - interest
rate Price discovery-process - is governed by the
forces of supply and demand of funds.
Lemon Problem

George Akerlof: The Market for Lemons: Quality,
Uncertainty and the Market Mechanisms (1970)

Potential buyer of a used car cant tell whether the car he
wants to buy is a good car that will run well peach or a
lemon that will give him continuous grief

The owner of the car is more likely to know whether the car
is a lemon or a peach

The used car market will then function poorly if the
buyer pays average price for bad used car

Problem of lemons
Lemons Problem is also important for Financial Market

The lender ( net savers) doesnt have exact idea about the risk of lending to the
borrower. However, the borrower knows about the risk associated with him.

Therefore, the lender will charge average rate of interest to the borrower.

At average rate of Interest , borrowing will be more attractive to sub prime
borrower than the prime borrower.

This implies, the rate of interest supposed to be charged (Risk Based Pricing) is
higher than this average rate of Interest.

If the borrower defaults because of high probability of default, then the lender
will stop lending.

Hence, there is a need of the financial Intermediary.

Information Asymmetry & Lemons

One party not having sufficient knowledge about the
other party involved in a transaction to make an
accurate decision

Adverse Selection

Asymmetric information problem which is there before the
transaction occurs leads to adverse selection

Belief: Potential bad credit risks are the ones who most
actively seek out loans

Fear of adverse selection prevents savers from lending, even
though there may be credit-worthy borrowers out there

Moral Hazard & Lemons in
Banking and Financial markets
Moral Hazard arises after the transaction occurs end use of borrowed
funds is used foe some other purpose

Hence the intermediary may decide not to lend

Lenders unable to distinguish between firms with high risk and
low risk
In case of Lemon Problem
Lenders will only get the price that reflects the average quality
The good firms will not want to come to the market at the average price,
only the bad firms will!
Hence the market will not function well

Tools to help solve the
Adverse Selection problem

If buyers can distinguish between a
peach and a lemon, they will be
willing to pay appropriate value for the peach
and the market will grow

How do we achieve this?

Tools to solve the Adverse Selection problem

An independent credit rating Agency
Govt. regulation:
- Stringent accounting standards and disclosure norms
- Make information available at zero cost
Financial Intermediation:

- Firms with average to low financial performance (low credit rating) end up with
Indirect finance and incur a higher cost of intermediation
- And Firms with good financial performance (high credit rating)
pursue direct finance and hence incur a lower cost of borrowing
In developing countries, financial intermediation, i.e. indirect finance, is
pursued more often (why?)

Moral Hazard in Debt
Instruments
Borrower takes on projects that are riskier is perceived by the lender

Tools to help solve moral hazard in debt contracts

Balance Sheet and P&L account/ accounting procedure

Debt to be proportionate to net-worth of the borrower

Obtain Financial Collateral / Mortgage

Financial Intermediaries.. Intermediaries perform six basic
functions
1.Denomination Intermediation
- Small amount of savings from individuals and others are pooled so
as to give loans of varying size
2. Default Risk intermediation
- Willingness to give loans to risky borrowers without hurting the
returns to savers
3. Maturity intermediation
- Ability to create loans whose maturities may mismatch with the deposit
maturity profile
4. Liquidity intermediation
- Claims from savers that are highly liquid while loans to borrowers
are relatively less liquid
5. Information intermediation
- Ability to gather and process information from the financial
marketplace far more effectively than the individual saver
6. Currency intermediation
- Ability to lend cross-currency

Rating Symbols and Definitions
CARE CRISIL FITCH ICRA
AAA AAA AAA AAA
AA AA AA AA
A A A A
BBB BBB BBB BBB
BB BB BB BB
B B B B
C C C C
D D D D
Seven
Categories
Financial Markets

Money Market
Bond / Debt Market
Corporate Debt/ Bond market
G sec / Bond Market
Stock Market
Foreign Exchange Market
Derivative Market
Commodity Market

Financial Markets
Classified according to the characteristics of participants and
securities involved.

The Primary market is where deficit economic
units sell New Instruments.

The Secondary market is where investors trade
previously issued securities with each other.
SHORT TERM
MONEY
MARKET

55
Money/Short Term Market
The money market is a market for short-term financial assets/liabilities that
are close substitutes of money.
Original maturity of the instruments are less than one year and liquid in
nature..money market

The most important feature of a money market instrument is that it is liquid
and can be turned into money quickly at low est cost and provides an avenue
for equilibrating the short-term surplus/supply funds of lenders and the
requirements/demand of borrowers.

Short demand and short term supply of funds are equatedat a equilibrium
rate of interest
The process of accelerated economic and business
growth along with greater global integration has led to
the increased need for liquidity in the money market.

Call Money Market

http://www.rbi.org.in/scripts/BS_ViewBulletin
.aspx

Call / Notice Money Market
The call/notice money market forms an important segment of the
Indian Money Market.

Under call money market, funds are transacted on an overnight
basis and under notice money market, funds are transacted for a
period between 2 days and 14 days.
Participants: Mainly dominated by Commercial Banks..Inter Bank
Call Money Market
Also Primary Dealers
Provides an avenue for equilibrating the short-term
surplus funds of lenders and the requirements of
borrowers.Regulator is RBI

PD
In 1995, the Reserve Bank of India (RBI) introduced the
system of Primary Dealers (PDs) in the Government
Securities Market, which comprised independent entities
undertaking Primary Dealer activity.
In order to broad base the Primary Dealership system,
banks were permitted to undertake Primary Dealership
business departmentally in 2006-07.
Further, the standalone PDs were permitted to diversify
into business activities, other than the core PD business, in
2006-07, subject to certain conditions. As on 6
th
July, 2013,
there are 8 standalone PDs and 13 banks authorized to
undertake PD business departmentally.
Core activities of PD

Dealing and underwriting in Government securities
Dealing in Interest Rate Derivatives
Providing broking services in Government securities
Dealing and underwriting in Corporate / PSU / FI bonds/ debentures
Lending in Call/ Notice/ Term/ Repo/ CBLO market
Investment in Commercial Papers
Investment in Certificates of Deposit
Investment in Security Receipts issued by Securitization Companies/
Reconstruction Companies, Asset Backed Securities (ABS),
Mortgage Backed Securities (MBS)
Investment in debt mutual funds where entire corpus is invested in
debt securities
http://www.rbi.org.in/scripts/AboutUsDisplay.aspx?pg=PrimaryDeal
er.htm

Dealing Session
Deals in the call/notice money market can be done upto 5.00 pm on
weekdays and 2.30 pm on Saturdays or as specified by RBI from time to
time.

Call rates/Interest Rate
The interest rates charged on call money is known as the call rate. always
quoted on annualized basis.
Eligible participants are free to decide on interest rates in call/notice money
market.
Call Money Market in India is volatile.
http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=13326

Call / Notice Money Market
Day-to-day surplus funds are traded Wherein short term requirements of funds
are taken care of.maturity 1.14 Days

It is the core of Indian Money Market StructureLiquidity

FED funds in the US.Euro Overnight Index Average(EONIA) in EURO, overnight
rate in UK
Some Banks over leverage in the Call Money Market as a constant source of funds;
hence regulatory restrictions imposed
Lending to call money market cant exceed 25% of their net worth(NOF) of the
banks & borrowing cant exceed 100% of NW(NOF).On a fortnightly average
basis .Objective is Financial stability
Strictly speaking, in the call money market, funds are lent for overnight..repayable
on demand where as notice money deals with fund 2-14 days..here lender issues
a notice to the borrower to repay

SLR Instruments
CSGL (Constituent Subsidiary General Ledger)
accounts are a demat form of holding
government securities with the RBI
Like a bank account gets debited or credited
whenever the customer withdraws or deposits
money, CSGL account also gets debited or
credited on the sale or purchase of the
securities.
Repo Market
Overnight Repo market
Term Repo Market (more than 1 Day Transaction)
___________________________________

LAF( Liquidity Adjustment Facility) Repo
Market Repo
Corporate Bond Repo
delivery versus payment
DVP
Repo Seller
Revere Repo..Repo Buyer

Liquidity Adjustment Facility
LAF REPO

It is a transaction in which two parties agree to sell and repurchase the same
security. Under such an agreement the seller sells specified securities with an
agreement to repurchase the same at a mutually decided future date and a
price
REPO is a measure by which RBI injects liquidity (lend) into the system
7.25%
Part of the LAF(Liquidity Adjustment Facility)
Reverse REPO is a measure by which RBI absorbs liquidity ( borrow) from the
system6.25%
Both REPO and Reverse REPO are backed by Government Securities
RBI is one of the counterparties to every REPO and Reverse REPO transaction
Tenor is usually overnight, max up to four days
Bids will be submitted for a minimum amount of Rs.5 crore and in multiples of
Rs.5 crore thereafter.

75
All transferable Government of India dated securities and Treasury Bills
are eligible securities for Repo auctions

All Scheduled Commercial Banks (excluding Regional Rural Banks) and
Primary Dealers having SGL and Current Accounts with RBI, Mumbai will
be eligible to participate in the Repo auctions.

The bids will be submitted electronically in the Negotiated Dealing
System (NDS). NDS provides for submission of single or multiple bids.
However, members are advised that as far as possible they should
submit only one bid.
The Repo will be conducted as Hold-in-Custody type. A constituents
SGL Account called Repo Constituents (RC) SGL Account will be opened
with RBI as a custodial account.
Subsidiary General Ledger

76
Securities held Repo Sellers RC SGL Account
will be transferred to RBIs Subsidiary Account
during the period of Repo.
The Repo seller should hold sufficient
quantum of securities for the purpose of
collateral in his RC SGL which will be
automatically debited by RBI to the extent
required

REPO ACCOUNTING
The repo seller, i.e., borrower of funds in the first leg, shall not exclude
the securities sold under repo but continue to carry the same in his
investment account
On the other hand, the repo buyer, i.e., lender of funds in the first leg,
shall not include the securities purchased under repo in his investment
account
The repo seller shall continue to accrue the coupon on the securities sold
under repo even during the repo period
While the repo buyer shall not accrue the same
In case the coupon payment date of the security offered under repo falls
within the repo period, the coupons received by the buyer of the
security should be passed on to the seller of the security
Repo Buyer.Interest IncomeP&L
Repo Seller..Interest Expenses .. P&L
78
Repo Transaction by RBI
There will be margins for G Sec and Treasury Bills and
the amount of securities transferred from by the
successful Repo seller will be Rs.105, in terms of face
value, per Rs. 100 of repo amount borrowed from RBI
This 105 is the market value of securities
For instance, in a Repo auction where bid amount
accepted is Rs.500 crore at a Repo Rate rate of 7.25%
the calculations of inflow of cash in the first leg and
outflow of cash in the second leg will be as under:

79
Example. 3 days LAF Repo
Transaction
Leg 1: Amount Received Rs.500 Crore by Bank
Amount of scurrilities lent Dr. Rs.525 Crore (Amt.of
bid x 105/100)
lend securities to RBI
Leg 2: Amount of securities Refunded Rs.525 Crore by
RBI ..coupon.pass on to bank
Amount Paid by Bank 500*7.25%*3/365..ROI + 500

Get Back the securities
if there is any Coupon on the, RBI will collect the coupon
payment, if any, on the due date and credit the same to the
partys Current Account in the case of Repo.

Example. 2 days Reverse Repo
Transaction
Leg 1: Amount to be lend Rs.500 Crore by Bank
Amount of securities received by Bank Dr. Rs.525 Crore
(500x 105/100)
lend securities by RBI
Leg 2: Amount of scurities Refunded Rs.525 Crore by
Bank.Bank will pass on any coupon received
RBI will pay 500*6.25%*2/365 +500
Get Back the securities
if there is any Coupon on the, Bank will collect the coupon
payment, if any, on the due date and credit the same to the
RBIs Account

In a repo transaction, the securities should be sold in the first leg at market
related prices and re-purchased in the second leg at the same prices.
The consideration amount in the second leg would, however, include the repo
interest. The sale and repurchase should be reflected in the Repo Account.
____________________________________________________________

In a reverse repo transaction, the securities should be purchased in the first
leg at prevailing market prices and sold in the second leg at the same prices.
The consideration amount in the second leg would, however, include the
reverse repo interest.
The purchase and sale should be reflected in the Reverse Repo Account.

http://www.debtonnet.com/newdon/files/marketinformation/rbilafDateRa
nge.asp?nearDate=6/28/2012&farDate=5/30/2012&auctTenor=&auctType=
Repos&submit=View%20Data
82
Reverse Repo
Marginal Standing Facility
http://rbidocs.rbi.org.in/rdocs/PressRelease/P
DFs/IEPR239WS0813.pdf

Liquidity in the System
Repo Volume
The repo volumes increased by 43.5 per cent
in FY 13 over FY 12
http://www.rbi.org.in/scripts/BS_PressRelease
Display.aspx?prid=26548

http://rbidocs.rbi.org.in/rdocs/PressRelease/P
DFs/IEPR1874L0512.pdf

MSF
Under the facility, the eligible entities can avail overnight, up
to one per cent of their respective Net Demand and Time
Liabilities (NDTL) outstanding at the end of the second
preceding fortnight.

Requests will be received for a minimum amount of Rs. One
crore and in multiples of Rs. One crore thereafter.

Repo Rate + 100 bps
Revised to Repo Rate + 300 bpsJuly 16, 2013
http://www.rbi.org.in/scripts/NotificationUser
.aspx?Id=8246&Mode=0
http://rbidocs.rbi.org.in/rdocs/notification/PD
Fs/CMSFR16072013HC.pdf
http://rbidocs.rbi.org.in/rdocs/notification/PD
Fs/CLAF23072013F.pdf
Example

89
Recent Changes
16
th
July
Bank of India announced various measures
yesterday to address the exchange rate volatility.
As a part of the measures, it has been decided to
recalibrate the Marginal Standing Facility (MSF)
rate at 300 basis points above the policy Repo
rate under the Liquidity Adjustment Facility (LAF)

10.25 per cent

Recent Changes

17th July
Scheduled Commercial Banks (SCBs) may
borrow overnight up to 2 per cent of their
respective Net Demand and Time Liabilities
(NDTL) under the Marginal Standing Facility
(MSF) Scheme

July 17, 2013
With a view to enabling banks to meet the
liquidity requirements of mutual funds under the
RBIs Special Repo Window announced, it has
been decided to raise the borrowing limit below
the stipulated SLR requirement under the MSF
from 2 per cent of NDTL to 2.5 per cent of NDTL.
The higher MSF limit of 0.5 per cent of NDTL will
be available only for the Special Repo Window.
This additional limit will be available for a
temporary period until further notice

July 17, 2013
Special Repo Window for Liquidity Requirement
of Mutual Funds for 3-days
Special Repo window for a notified amount of Rs.
25,000 crore with a view to enabling banks to
meet the liquidity requirement of mutual funds.

The special repo window will be in addition to
the repo/reverse repo auctions conducted under
the Liquidity Adjustment Facility (LAF) and
Marginal Standing Facility (MSF) available to the
scheduled commercial banks
Recent Changes
24th July

the total quantum of funds available to a bank under
Liquidity Adjustment Facility (LAF) will be capped at 0.50
percent of the individual banks Net Demand and Time
Liabilities (NDTL).

Cap on overall allocation of funds at Rs. 75,000 crore under
LAF stand withdrawn

The allocation to individual banks will be made in
proportion to their bids

Liquid repo market is a necessary adjunct to having a
liquid domestic government securities market.
Liquid repo markets are necessary to raise funds at
short notice.
The repo market will help in raising liquidity at critical
junctures, particularly for a financial institution that is
going to come up with unexpected demands on its
liabilities.
This is one way of raising funds without much of a
problem and without having to sacrifice hugely in
terms of costs.
Repo is at an early stage in most of Asia.
It is estimated the size of the Asian market at
around 8% of GDP
compared with 50%60% of GDP for the
market sizes in the US and Europe.
As such, various jurisdictions are actively
trying to increase liquidity in their repo
markets.

Collateralized Borrowing and Lending Obligation (CBLO)
It is a money market instrument as approved by RBI, is a product
developed by CCIL.Clearing Corporation of India Ltd.

CBLO is for the benefit of the entities who have either no access to the
inter bank call money market or have restricted access in terms of ceiling
on call borrowing and lending transactions

The participants in this market are Nationalized Banks, Private Banks,
Foreign Banks, Co-operative Banks, Financial Institutions, Insurance
Companies, Mutual Funds, Primary Dealers, Bank cum Primary Dealers,
NBFC, Corporate, Provident/ Pension Funds etc
For participating in CBLO market borrow or lend funds against the
collateral of eligible securitieshave to CCIL Members

The participants open a Constituent SGL (CSGL) Account with CCIL for
depositing securities which are offered as collateral / margin for borrowing
and lending of funds
CCIL is the Central Counterparty.CCtri party

Membership to CBLO segment is generally extended to Repo eligible
entities as per RBI guidelines

CBLO
It is a tri party transaction
There is an underlying charge on securities held in custody (with
CCIL) for the amount borrowed/lent.
An obligation by the borrower to return the money borrowed, at a
specified future date;
An authority to the lender to receive money lent
Interest rates in CBLO and REPO markets, are lower than those in
the call market, due to lower risk levels involved.
The maturity period ranging from one day to ninety days
Usually Uniform yield based Auction system

http://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/IEPR43M0712

http://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/IEPR1M0712.

RBI
STCI
CCIL
FIMMDA
NSE
BSE
SEBI
Repo in Corporate Debt Securities
Only listed corporate debt securities which are rated AA or above by the
rating agencies, that are held in the security account of the repo seller, in
demat form, shall be eligible provided that residual maturity is more than
one year.
Eligible Participants
a. Any scheduled commercial bank
b. Primary Dealer
c. Any non-banking financial company registered with the Reserve Bank of India (other
than Government companies as defined in section 617 of the Companies Act, 1956);
d. All-India Financial Institutions, namely, Exim Bank, NABARD, NHB and SIDBI;
e. Any mutual fund registered with the Securities and Exchange Board of India;
f. Any housing finance company registered with the National Housing Bank; and
g. Any insurance company registered with the Insurance Regulatory and Development
Authority
h. India Infrastructure Finance Company Limited (IIFCL)
g. Any other entity specifically permitted by the Reserve Bank
102
Repos in corporate debt securities shall be for a minimum period of one
day and a maximum period of one year

Haircut on Market Price of Security( for one day)
Rating AAA AA A
Minimum haircut* 10 % 12% 15%
For arriving at the market value of the corporate debt security, the
participants undertaking repo in corporate bonds may refer to the credit
spreads published by the FIMMDA.

IDFC entered into a repo agreement to purchase National Housing Bank's
Triple AAAA-rated three-year bonds as the underlying paper.
The underlying value is Rs 25 crore, which is exclusive of the 10% haircut,
mandated by the Reserve Bank of India in repo trades in corporate bonds.

It is a two-day repo deal, which means the settlement takes place two
days after the effective date of buyback.

103
Market Repo/LAF Repo/Corporate Repo
https://www.ccilindia.com/Research/Statistics
/Pages/MoneyMarketReport.aspx

/Pages/CCILBusinessStatistics.aspx

Average Trade Volumes of Money Market
(Rs Crore)
Treasury Bills Market

T-Bill is short term govt. borrowing issued at a discount by RBI on behalf of the
Govt. (auction) ..91D.182D.364D
High liquidity, low/no default risk,assured yield, eligible for inclusion in SLR
portfolio (25%) . Also eligible for Repo
Treasury Bills are zero coupon securities and pay no coupon. They are issued at a
discount and redeemed at the face value at maturity.
Suppose the face value of 91 T-Bill is Rs. 100 with issue price of Rs.98.20with
Rs.1.80 discount.
What is the Yield ?
( 100-98.20)/98.20 *(365/91) = 7.352%
If the same T-Bill is traded at Rs. 99 after 40D.Yield
( 100-99)/99 *(365/51) = 7.229%
T-Bills are issued on Price Based Auction System
14 D T Bill is only meant for State.Govt to park their surplus fund..not based on
auction system

Treasury Bills Market Price Based
Auction System
Notified amount is Rs. 1000 Cr.
Details of bids received in the decreasing order of bid price
Price Amt Implicit Cumulative
of Bid (in Rs.Cr) yield Amount
1 99.90 300 0.396% 300
2 99.85 200 0.594% 500
3 99.80 250 0.792% 750
4 99.75 150 0.991% 900
5 99.70 100 1.190% 1000
6 99.70 100 1.190% 1100
7 99.65 100 1.389% 1200

The issuer would get the notified amount by accepting bids up to 5.
Since the bid number 6 also is at the same price, bid numbers 5 and 6 would get allotment in
proportion/pro rata so that the notified amount is not exceeded.
In the above case each would get Rs. 50 crore.
Bids(7) which are below the cut-off price are rejected.

Treasury Bills Market Price Based
Auction System
Uniform Price based
Here, all the successful bidders are required to pay at the auction cut-off
price, irrespective of the rate quoted by them.in this example all the six
successful bidders will pay Rs.99.70

The competitive bids for the auction should be submitted in electronic
format on the Negotiated Dealing System (NDS)
Notification/ Results
91 Days
Notification
http://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/IEPR45TB0713.pdf
results
364 Days
Notification
results
http://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/IEPR69TL0713.pdf
182 Days
Notification
Results
http://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/IEPR24TBF0713.pdf

Yield Based Auction System
Details of bids received in the increasing order of Yield
Yield Amt Issue Price Cumulative
(in Rs.Cr) Amount
1 8.18 300 97.974 300
2 8.19 200 97.930 500
3 8.20 250 97.927 750
4 8.21 150 97.967 900
5 8.22 100 97.965 1000
6 8.22 100 97.965 1100
7 8.23 150 97.962 1250
8 8.23 100 97.962 1350
Since the bid number 6 also is at the same yield, bid numbers 5 and 6 would get allotment
in proportion so that the notified amount is not exceeded.
In the above case each would get Rs. 50 crore.
Bids( 7 & 8) which are above the cut-off yield are rejected.
The corresponding price of the respective yield will be accordingly calculated

Types of Bidding
Competitive Bidding: Here, the buyer bids at a specific price / yield and is allotted T-Bills if
the price / yield quoted is within the cut-off
price / yield.
Competitive bids are made by well informed investors such as banks,
financial institutions, primary dealers, mutual funds, and insurance companies.
Non-Competitive Bidding: Investors apply for a certain amount of securities in an auction
without mentioning a specific price / yield.
It will enable individuals, firms and other mid segment investors who do not have the
expertise to participate in the auctions
This provides retail investors an opportunity to participate in the auction process.
However, non-competitive bidding in Treasury Bills is available only to State
Governments.
The amount is over and above the issue sizeat cut off price/yield
Usually, in T Bill entire non competitive is retained.no ceiling

Players in T-Bill
Banks, Primary Dealers, State Governments,
Provident Funds, Financial Institutions, Insurance
Companies, NBFCs, FIIs (as per prescribed norms),
NRIs & OCBs can invest in T-Bills.

Trends in outstanding auction T-Bills
Trends on details of outstanding
Treasury Bills

Repayments and Issuance of Treasury Bills in Jan-Mar 2013

91 Days TBill
Notification
http://rbidocs.rbi.org.in/rdocs/PressRelease/PDF
s/IEPR86TB0713.pdf

Results

s/IEPR120T0713.pdf

RBI
STCI
CCIL
FIMMDA
SEBI
NSE
BSE
RBI failed to sell treasury bills (t-bills) worth Rs.7,000
crore at Wednesdays auction after investors
demanded yields/ high discount
The refusal to reject all bids in a government bond
auction is rare. Such bond auctions are usually called
off before the auctions have taken place.
If RBI is not comfortable with yields sought by
investors, the central bank typically allots some papers
to the lowest-yield bidders and the rest is sold to
underwriters of the auction, known as primary dealers.
However, the cancellation, despite heavy demand,
showed there were no bids at yields that would satisfy
RBIs expectations.
14 Day T Bill
14-days Intermediate Treasury Bills are used
by Central Government for deployment of
short term cash surpluses available with State
Governments at the end of their daily
transactions.
14 Days Treasury Bills
Cash Management Bill
During 2009-10 the Government of India, in
consultation with the Reserve Bank of India, has
introduced a new short-term instrument, known
as
Cash Management Bills (CMBs), to meet the
temporary cash flow mismatches of the
Government. The Cash Management Bills are
nonstandard, discounted instruments issued for
maturities less than 91 days
http://www.rbi.org.in/scripts/BS_ViewBulletin.as
px
Concept.Day Count Conventionaccrued interest
Day count convention refers to the method as to how the number of days are counted for
calculation of ROI of the Securities
Actual/360... Here Denominator is always set at 360 days
Example: Start Date :March 15, 2009
End Date : July 15,2009
Then numerator will be = 360*(2009-2009) + 31+30+31+30 = 122 DaysIf Annual is r%...ROI
for this period = r%* 122/360
Actual / 365..Here Denominator is always set at 365 DaysMoney Market
Then numerator will be = 360*(2009-2009) + 31+30+31+30 = 122 DaysIf Annual is r%...ROI
for this period = r%* 122/365
30/360.Each month is considered as 30 Days Securities Market
Then numerator will be = 360*(2009-2009) + 30 ( 7-3) +(15-15) = 120 Days If Annual is
r%...ROI for this period = r%* 120/360
Actual / ActualNumerator and Denominator is actual number of Days between start Date
and End Date
Example : One Instrument was issued in 15
th
July 2009 and maturing on 15th July 2020 with semi annual
coupon..hence coupon will be paid on 15
th
Jan & 15
th
July of Each yearSppose todays date is 25th
July,2009..Here.. N is 174 Days and D is 184 Days(r/2)%*(174/184)

Commercial PaperDirect Finance
Short term promissory negotiable note with fixed maturity issued by leading
highly rated corporateintroduced in 1990

CPs are unsecured borrowing by Corporate with a view to enable highly rated
corporate borrowers to diversify their sources of short-term borrowings and
provide an additional instrument to the investors.
Commercial Paper is a low-cost alternative to bank loans

CP to be rated by Rating Agency

Subsequently, primary dealers (PDs) and all-India financial institutions were also
permitted to issue CP to enable them to meet their short-term funding
requirements.

Banks are the dominant investors in the CP market

Commercial PaperDirect Finance
Discount at face value, negotiableShift ability transferable. imparts
liquidity
CPs have a minimum maturity of
7 days and maximum of 1 year.in India
in US it cant be more than 270D
in UK 7D-1 Y
Benefits
It has flexibility in terms of maturity so that the borrower is able to choose the
period to maturity for any issuetailor made maturities..also it can issue when ROI
is favorable
Lower interest rates by issuing CP vs ROI on Short Term Bank Borrowing

A CP program can be arranged quickly as compared to Bank Loan
High Liquidity.Transferability..Commercial Papers are actively traded in the
secondary market
Chances of default are almost negligible but are not zero risk instruments
Cash Flow of Commercial Paper (CP)
CPs are also discount instruments (face value > issue Price)

The issue price is calculated as follows :

P =
F = Face Value
P = Issue Price of CP
r = yield
M = maturity

1.Example F = 2,00,000, ROI =6.5%, m =120 days

Issue price (P) = 2,00,000/ 1+(6.5*120)/100*365 = 1,95,815

2.Example.M=180D, F= 5,00,000..D(Discount Rate) = 8%...IP=?....Current Yield = ?

Discount amount = 5,00,000*8%*180/365 = 19,726.IP = 5,00,000 19726 = 4,80,274
Y = (19726/480274)*(365/180) = 8.33%....from Investor point of view
Discount Rate.Issuer Point of View
YieldInvestor Point of View

365 100
1
x
rxM
F
+

Eligibility for issue of CP

The tangible net worth of the company, as per the latest audited balance sheet.is
not less than Rs. 4 crore;
the company has been sanctioned working capital limit by banks for meeting the
working capital requirements
The borrowal account of the company is classified as a Standard Asset by the
financing bank/s.
All eligible participants should obtain the credit rating for issuance of Commercial
Paper.
The minimum size of issue is Rs.25 lakh
Amount invested by a single investor should not be less than Rs.5 lakh (face value)
.5000 nos. of CPs
CP can be issued in denominations of Rs.5 lakh or multiples thereof.
The total amount of CP proposed to be issued should be raised within a period of two
weeks from the date on which the issuer opens the issue for subscription
http://www.careratings.com/Portals/0/CareAdmin/CompanyF
iles/PR/Essar%20Steel%20India%20Ltd.-07042012.pdf
http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx

Rating Requirement..CP

All eligible participants shall obtain credit rating for issuance of Commercial Paper
from either the Credit Rating Information Services of India Ltd. (CRISIL) or the
Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit
Analysis and Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd. or such other
credit rating agencies as may be specified by the Reserve Bank of India from time
to time, for the purpose.

The minimum credit rating shall be A2 by any rating agencies.

The issuers shall ensure at the time of issuance of the CP that the rating so
obtained is current and has not fallen due for review.
http://www.careratings.com/RATING/RatingR
esources/OutstandingRating.aspx

INTER-CORPORATE DEPOSITS MARKET

What about less credit worthy/low rated Corporate?

Apart from CPs, Corporate also have access to another market called the Inter-
Corporate Deposits (ICD) market.
An ICD is an unsecured loan extended by one corporate to another.
Those corporate who can not participate in CP market..Participate in ICD.. Low
rated corporate
This market allows funds surplus corporate to lend to other corporates.
Also the better-rated corporate can borrow from the banking system and lend in
this market.
As the return in ICD for an investor is higher than cost of CP for issuer corporate
High Rated Corporate earn a spread
And Low rated corporate can meet the requirement of surplus fund.

Certificate of Deposits

With a view to further widening the range of money market instruments and give
investors greater flexibility in deployment of their short-term surplus funds,
Certificates of Deposit (CDs) were introduced in India in 1989
CDs are Banks obligations/liability.Issuers are Bank just as CPs are obligations of
Corporate negotiable instrumenttransferability

In the US, CD was introduced to counter to traditional Bank deposits..which was
moving away to T-Bills, CPs etc..Introduced in 1961
CDs can be issued by all scheduled commercial banks and All India Financial
institutions.
The certificate bears the maturity date, the fixed rate of interest and the value
Minimum period 7 days & Maximum period 1 year

Minimum Amount Rs 1 lac and in multiples of Rs. 1 lac
CDs are discount instruments and issued at a discount to their maturity value, and
thus provide an yield to the investor in the form of a capital appreciation.trade able
in the Market

CD has advantage over Bank depositsit has a secondary market

Cash FlowCertificate of Deposit ( CDs)

Where P is the Issue price & F is the Face value.y is the yield on
the CDM is the number of days to maturity

Same as Cash flow calculated in case of CPas it is issued on
Discount Basis
365
M y x
1
F
P
+
= DC
Cash flowCertificate of Deposit ( CDs)Issued with ROI
Example : A three month CD is issued on 6 September 1999, and matures
on 6 December 1999 ( Maturity 91 days). The issue size of CD is
Rs.20,000,000 interest rate of 5.45% to be paid at maturity along with
the principal.

What should be the secondary market yield for the CD on 11 October if
the yield for short 60 -day paper is 5.60%? (Day count = actual/365)

Solution:
Maturity value = 20 million x(1 + 0.0545 x91/365) = 20,271,753
No of days from 6 Sep to 11 Oct =35. Therefore remaining days to maturity
= 56 days
P on 11 October =20,271,753/(1+0.056 x 56/365)=20,099,066

Cash flow.Certificate of Deposit ( CDs)Issued on ROI Basis
Example :
A CD is issued for Rs. 1 million with a term to maturity of 91 days. At the end of this
term, accumulated interest rate will be Rs.16,000. Find the money market yield of the
CD.

If the initial buyer sells the CD, just 7 days after the issue when the yield of similar
securities is 6.25% per annum find the yield from that sale?

If the second buyer sells the CD after another 38 days when the yield for similar
securities is 6.1% per annum, find his return over this holding period of 38 days.

Solution:
Maturity value..face value = 10,00,000(issue price) + 16,000 = Rs.10,16,000
yield = ((1,016,000/1,000,000)-1)x365/91=6.4176%
P after 7 days( RM..84) = 1,016,000/(1+ 0.0625x84/365)=1,001,594.
P after another 38 days (38+7)45 days from issueRM..46 days
=1,016,000/(1+0.061x46/365)= 1,008,248,914

Return to this investor will be
= ((1,008,248,914/1,001,594)-1)x365/38=6.38%......Annualised
More About CD
Banks have the freedom to issue CDs depending on their requirements.
Minimum amount of a CD should be Rs.1 lakh, i.e., the minimum deposit that
could be accepted from a single subscriber should not be less than Rs.1 lakh
and in the multiples of Rs. 1 lakh thereafter.
CDs can be issued to individuals, corporations, companies, trusts, funds,
associations
The FIs can issue CDs for a period not less than 1 year and not exceeding 3
years from the date of issue
Banks have to maintain appropriate reserve requirements, i.e., cash reserve
ratio (CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs
Banks / FIs cannot grant loans against CDs..not eligible collateral if issuer
bank and lending Bank are same
Furthermore, they cannot buy-back their own CDs before maturity.no call
option
http://www.careratings.com/RATING/RatingResources/OutstandingRating.asp
x?SID=11&byLetter=0&SSID=0
http://www.rbi.org.in/scripts/BS_ViewBulletin.aspx

Advantages of Certificate of Deposit as a money
market instrument:
Since one can know the returns from before, the
certificates of deposits are considered much safe.
One can earn more as compared to depositing money
in savings account.
Disadvantages of Certificate of Deposit as a
Money Market instrument:
The money is tied up along with the long maturity
period of the Certificate of Deposit. Huge penalties
are paid if one gets out of it before maturity.

CPR = f(CDR)
Bills Market
Trade & Commerce
Bill financing is an important mode of meeting the credit needs of trade and industry in
developed economies because it facilitates an efficient payment system being self-
liquidating in nature
Under this scheme, all scheduled commercial banks are eligible to discount genuine
trade bills arising out of sale/purchase of
Bill of Exchange : Used for financing a transaction involving goods, that takes some
time to complete
Classification:
Demand/Sight Bill : a bill payable upon presentationpaid immediately after
presenting the documents by the seller to the Financial intermediarysight
billjust after the acceptance
Usance Bill /Time Bill : Payable at a later date by the buyer to the seller through
the Financial intermediary..Bill has a maturityCredit Bill
Inland Bill : Payable in domestic country / Buyer belongs to the domestic
CountryInland TransactionBoth buyer and seller belong to Domestic
Country
Foreign Bill : Drawer and drawee belong two different country.Bills
drawn in foreign country / Either Buyer or seller belong to foreign
country

http://www.fimmda.org/modules/bonds/corpora
te-bonds.aspx?m=cpcda_dbmig
http://www.fimmda.org/modules/bonds/corpora
te-bonds.aspx?m=cpcda_dbmig
https://www.ccilindia.com/Research/Statistics/Pa
ges/TradeAnalysisReport.aspx
https://www.ccilindia.com/Research/Statistics/Pa
ges/MoneyMarketReport.aspx
http://www.nseindia.com/products/content/debt
/wdm/homepage_wdm.htm

A
Seller
B
Buyer
Issuing
Bank
(Bs bank)
Accepting Bank
(As bank)
1. Sale agreement
2. Goods Sold
& Bill/ Invoice
4. Acceptance
Invoice/Bill / sale
Document
6. Acceptance Invoice/Bill / sale
Document
7.Acceptance
Invoice/Bill / sale
Document

9.Pay off
10.Reimbursement
5. pay
off/Discountin
g

3. Acceptance

8
.
C
o
n
f
i
r
m

I
n
v
o
i
c
e
/
B
i
l
l

/

s
a
l
e

D
o
c
u
m
e
n
t

Discounting
(DFHI)
Commercial Bills
Process Flow of Bill of Exchange
A is the seller.B is BuyerA may need money immediately however B can make
payment only after reselling the goods.at a future date
Therefore, A draws a Bill on BA is known as Drawer of the BillB is known as
Drawee of the Bill
A sends the Bill to B who acknowledges the Bill by writing on the Bill his
Acceptance
B confirms the Bill to its Bank XYZ

A can now take the bill to his bank MNO for exchange of Ready moneyA is the
customer of the Bank
Bank will purchase/accept the Bill against fee charged to customer
Bank MNO sends the bill to XYZ for reimbursement of the Bill. Immediately if it
is demand Bill Reimbursed
Then XYZ collects the amount(face value) from Buyer B and will charge fee
If it is Time Bill
Bank MNO sends the bill to XYZ for reimbursement after the maturity of the Bill
( no. of days for credit),
If the seller needs money before maturity, Bank MNO will discount the bill

Commercial Bills
The pricing of acceptance fee by bank MNO would depend
upon the rating of clientsseller

Also XYZ charges fee from Buyer B for issuing and confirming
the Billacceptance commission.may charge ROI if buyers
does not pay on time
The characteristic of easy transferability of the Bill was the
key feature of the instrument

Commercial Bills
Acceptance is very crucial to impart liquidity to the CB Market..once it is accepted by
the drawee (Buyer) then only drawer (seller) can get the ready money
If Bill is accepted, when a Bank writes on the draft its agreement to pay it on maturity
It is used for financing both International and Internal trade transaction.
Secondary Market
If Bank MNO who has purchased the bill needs funds before the maturitythen it can
further discount the bill with Discount Houses .Rediscounting of Billwith Discount
Houses/Bigger Banks
Rediscounting happens before maturity of the Billin Case of Time Bill
Bankers Acceptance, being a tradable money market instrument, its liquidity and pricing in
the secondary market would largely hinge upon the rating of the bank that grants the
acceptance

It is highly liquid money market instrument as the ownership can be changed very
conveniently.it is a shift able asset
Rediscounting of Bill& Secondary market.Before the Bill maturity
The no of times the Bill gets rediscountedchanges hands before the maturity.its
velocity.indicates a well developed secondary market.high liquidity

Discount Market
Need: Short term liquidity management is fundamental to the health of any financial system
Discounting & Rediscounting facility
NABARD, EXIM Bank, SIDBI, NHB play a role in discounting and rediscounting
Known as Bankers Acceptance in the US &
In the UK, it is Acceptance Houses

Institutionalized Discounting in several countries, such as Discount Houses in
the UK
- Commercial organisation, owned and operated independently

- Operate both in the primary and secondary market
- Operate in all short term markets: T Bills, Commercial Bills, CP, CD etc
- A similar set up is set up in India with the establishment of DFHIin
1998It is a specialised money market intermediary
It manages the imbalances in short term liquidity
It discounts money market instruments.hence develop a secondary market
Short Term Surplus and Deficit of funds are equilibrated at market rates.

DFHI & STCIDiscount Finance House of India & Securities
Trading Corporation Of India

A very significant step in evolution of the Indian money market has been setting up of the
DHFI and the STCI.
As a sequel to the recommendations of the Working Group of the money market, the
Discount and Finance House of India was set up by the RBI jointly with the Public Sector
Banks and all-India financial institutions to deal in money market instruments. DHFI was
incorporated on March 8, 1988 under the Companies Act, 1956 with an autorised share
capital of Rs. 100 crores subscribed by the RBI (Rs. 33crores) and all-India financial
institutions (Rs 16 crores).
DHFI quotes regular bid and offer rates for treasury bills and commercial bills
rediscounting.develops secondary market
However only bid prices for CDs and CPs are normally quoted.provides liquidity
DHFI is also authorized to undertake REPO transaction against treasury bills and it provides
daily buy back and sell back rates for treasury bills to suit their requirements of commercial
banks.
The STCI is of recent origin. Basically, set-up for dealing in government securities market to
broaden and deepen this market, the STCI also has been allowed to deal in call money
market and the treasury bills market.

Bond Market
150
Definition..Bonds

A contractual obligation of a borrower to make periodic cash interest
payments to a lender for a fixed number of years. Upon maturity, the
lender is paid the original sum borrowedPrinicipal

The periodic interest is called the coupon.Coupon rate is coupon
payment as a percentage of the face value ( c = C/F )

The number of years for maturity is called Term-to-Maturity.

Face value is the principal amount of the loan.Redemption Price
Issue Price : Buying Price

Bond Features and Bond Markets

A conventional or Plain Vanilla Bond : .What is it ?
A debt instrument ,usually paying a fixed rate of interest over its
maturity period. It is a collection of cash flows as shown in the
figure below.
In this example the bond is a six yr issue that pays fixed interest
payments of r% of the nominal value ( par value or face value-) of
the bond on annual basis
152
Proceeds of
the issue
$r $r $r $r $r
$f + $r
Maturity payment
Time
yrs
1 2 3 4 5 6
Issuer

Four principal types of issuers are there :
A. Sovereign Governments and their agencies
B. Local Government Authorities
C. Corporate
International Agency
Banks
Bonds issued by Sovereign Governments :

Largest issuer among these is definitely the Government.

The core of any domestic bond market is usually the govt. bond market
.In US the Government bonds are called Treasury Bonds or simply
Treasuries, while those of UK are called the Gilts. In India they are called
the G Secs.

153
Issuercontd..
Bonds issued by Local Governments or
Municipalities :
Municipalities issue debt securities regularly.
Broadly such issues may be grouped into the
following categories :
a. General Obligation Bonds ( GO s) : which are backed
by the full faith, credit and taxing power of the
municipality.
b. Revenue bonds : Which derive their cash flows from
specific project revenues.

154
Issuercontd..
Bonds issued by Multilateral Development Banks (MDB) : viz
World Bank( IBRD) :

The International Bank for Reconstruction and Development (IBRD),
generally referred to as the World Bank, is
one of the largest international borrowers

one of the most frequent international bond issuers with hundreds of
transactions per year.
.
155
Bonds issued by Corporate..Debt Financing
Corporate borrowers wishing to finance long term investments can
raise capital in various ways. The principal methods are :

a. Retained earnings : not always available particularly if required
to pay dividends
b. raising additional equity capital : expensive, plus dividends are
not tax deductible.
c. Bank loan : interest rate may be high plus interest rate may
fluctuateIndirect Finance
Bonds : (Direct Finance)
Comparatively a cheaper way
fixes the rate of interest for a long term period,
their tradability(shiftable) in secondary markets makes investors more willing to
lend funds to the company.

156
Issuercontd..
Bonds Issued by Banks
To Finance borrowers.Loan
Tier I & Tier II BondTo main Capital

Both Fixed and Floating Bond
Discount Bond

Key Features of a Bond

Original and Residual Time to maturity :
Number of years after which the issuer will repay the
obligation and pay back the principal.
The provision under which a bond is issued may allow either
the issuer or the investor of a bond to change its maturity.(
callable bond or put bond).

Principal /Par Value: The principal is the amount that the
issuer agrees to repay the bondholder on the maturity date.
This is also referred to as the redemption value, maturity
value, par value, or face value or simply par. It is normally
$1000 in US and Rs100 or Rs1000 in India

158
Key Features of a Bond...contd..
The coupon rate

It is the interest rate that the issuer agrees to pay each
year.annual..semiannualquarterly The annual amount of interest payment
(calculated on the face value).

In US, UK , Japan, and in India also the practice is to make coupon
payments in two semi annual basis. For bonds in European markets(
except UK) and Eurobond markets the practice is to make coupon
payments annually.

All bonds make periodic interest payments in the form of coupons except
for the zero coupon bonds or zeros. These bonds allow the holder to
realize interest by being sold substantially below their principal value. The
bonds are redeemed at par, with the interest amount then being the
difference between the principal value and the price at which the bond
was soldIssue Price

159
Key Features Concept.Yield
Coupon yield(Rate): refers to nominal interest payable on a fixed income
security .Bond
Illustration: Face Value: Rs.100 ,Market Value: Rs.103.00 , makes coupon
payment of Rs.8.24 in each year..Coupon yield = 8.24/100 = 8.24%...w.r.t face
value
If coupon payments is Rs. 3.50 in every six month..semi annual basis..coupon rate
(2*3.50)/100 = 7%
The coupon yield is simply the coupon payment as a percentage of the face value
W.R.T face value

Current Yield: Current yield = (Annual Coupon rate / Purchase price)*100
Illustration: The current yield for a 10 year 8.24% coupon bond selling for Rs.103.00 per
Rs.100 par value is calculated below:
Annual coupon interest = 8.24% x Rs.100 = Rs.8.24 Current yield = (8.24/Rs.103)*100 = 8.00%

W.R.T. Market Value
If the Bond is selling at Rs. 98CY is 8.24/98 = 8.4%

Key Features.. Concept.Yield

Yield to Maturity : the expected rate of return on a bond if it is held
until its maturity.
Thus YTM is the discount rate which equates the present value of the future cash
flows from a bond to its current market price. In other words, it is the internal
rate of return (IRR) on the bond.

Illustration: Taking the example of a two a year Bond bearing a coupon yield of
8% and a price of say Rs. 102 per face value of Rs. 100(Current
Yield8/102=7.84%). Semi annual Coupon

102 = 4/(1+r/2)
2*(0.5)
+ 4/(1+r/2)
2*1
+ 4/(1+r/2)
2*(1.5)
+ 104/(1+r/2)
2*2
r is the YTM

Pricing a Plain vanilla Bond

The principles in pricing a bond are exactly the same as those of other
financial securities, which states that : the price of any financial
instrument is equal to the present value of all the future cash flows
expected from the instrument.

So for determining the price of a bond we first need to know the cash
flows expected from the bond, and the appropriate interest rate at which
to discount the bonds cash flows.

Present value of the Bond.Inputs requiredExpected stream of
future Cash flows & Discount Rate

Discount Rate.Inputs requiredExpected stream of future Cash flows
& Present value of the Bond

162
Bond Pricing contd..
The price of a bond that pays regular (annual) coupons is
given bymaturity n years :

P= Sum {C/(1+r)
t
+ M/(1+r)
n
}
N
N
i
i
i
N N
r
M
r
c
r
M
r
c
r
c
r
c
r
c
P
) 1 ( ) 1 (
) 1 ( ) 1 (
..........
) 1 ( ) 1 ( ) 1 (
1
3 2
+
+
+
=
+
+
+
+ +
+
+
+
+
+
=
=
N N
r
M
r r
c
P
) 1 (
]
) 1 (
1
1 [
+
+
+
=
Bond pricing contd..
The price of a bond that pays semi annual coupon payments is given by (
N= number of yrs to maturity)

164
N N
N
T
i
i
N N
r
M
r
r
c
r
M
r
c
r
M
r
c
r
c
r
c
r
c
P
2 2
2
2
1
2 2 3 2
)
2
1 ( )
2
1 (
1
1
)
2
1 ( )
2
1 (
2
)
2
1 ( )
2
1 (
2
.... ..........
)
2
1 (
2
)
2
1 (
2
)
2
1 (
2
+
+
(
(
(
(
+
=
+
+
+
=
+
+
+
+ +
+
+
+
+
+
=
Pricing Example

When the market price of the bond is equal to its face value, i.e., the bond sells at par, YTM =
current yield = coupon yield.

Proof

Suppose a bond is issued with 10 yrs to maturity. The bond has an annual coupon
payment of $80 and the face value is $1000. The coupon rate is thus 8%.Similar
bonds ( with similar risk characteristic) have YTM of 8%.What would this bond sell
for in the market ?

1 2 3 4 5 6 7 8 9 10
$80 $80 $80 $80 $80 $80 $80 $80 $80 $80
$1000

Example Contd..

Solution :

The bonds cash flows have 2 principal components--- coupon payment and the face
value paid at maturity. The market value of the bond is found by calculating the
present value of the two components separately and adding the results together.

Present value of the redemption amount ($1000) at the going rate of 8% =
$1000/1.08
10
= $463.19

Present value of the coupon payments= $80 x (1-1/1.08
10
)/0.08 = $ 536.81

The total bond value (price at this point of time)will therefore be = $463.19 + $
536.81= $1000 i.e the bond sells exactly for its face value.

---------------.Why.-----------

Because the bond pays exactly the same as the markets expectationPV of future
cash flows = face value for similar instruments, therefore there is no premium or
discount attached to the bonds face value to arrive at its price.

166
Pricing of Bonds contd..

When YTM > current yield > coupon yield. then the market price of the instrument is less than
the face value, i.e., the instrument sells at a discount,
Proof

Suppose residual maturity of the bond is now 9 yrs. If suppose the interest rate for
other similar instruments in the market has risen to 10%, what will the bond be
worth?

Present value of the $1000 redemption value will be = $1000/1.10
9
=$424.10
Present value of the coupon stream of $ 80 per year for nine years = $80 x ( 1-
1/1.10
9
)/0.10 = $460.72
Total bond value now comes out to be = $424.10 + $ 460.72 = $884.82
The bond now sells at a discount to its face value -----
---------------.Why.-----------
Because the Bond Pays less than the markets expectation
Because the bond pays less than at the market rate of 10%...PV of Expected Future
Cash Flows < face valueit is sold at a discount.
167
Pricing of Bonds contd..

When YTM < Current yield < Coupon yield. then the market price of the instrument is more
than the face value, i.e., the instrument sells at a Preium,
Proof

If the interest rate dropped to say 6%?..Residual Maturity is 9 Years

Calculate the PV of Future Cash flows.. $1136.03

The bond would then sell for more than $1000 we say the bond sells at a
premium( $1136.03 )--- i.e at a premium over its face value.
---------------.Why.-----------

Because the bond pays more than than at the market expectation.PV of
Expected Future Cash Flows > face valueit is sold at a Premium

168
Key Features.. Concept..Price & Yield
The yield of a bond is inversely related to its price.
The relationship between yield to maturity and coupon rate may be stated as
follows:

When the market price of the instrument is less than the face value, i.e., the
instrument sells at a discount, YTM > current yield > coupon yield.

When the market price of the instrument is more than its face value, i.e., the
instrument sells at a premium, YTM < current yield < coupon yield.
..in the above cases the Bond is marked to the Market
When the market price of the bond is equal to its face value, i.e., the bond sells at
par, YTM = current yield = coupon yield.

Price Yield relation : Interest rate risk
From the expression of price vs yield it can be seen that as the yield
increases there is a downward movement in price and vice versa.

So other things remaining unaltered it can be seen that only fluctuation in the
market determined interest rate( which in turn determines the YTM) gives rise to a
lot of uncertainty in the bond prices and hence the return from the bond called
interest rate risk.

170
Price
Yield
171
Concept..Accrued interest, Dirty price, Clean price of Bonds
Assume that t1 and t2 represent two consecutive coupon dates in the life
of a bond..annual coupon

Say t^ is the sale date of the bond, such that t1<t^<t2.

On t* the seller will be parting with the right to the entire next coupon,
which is due on day t2,although he would have held the bond for a
fraction of the current coupon period.

The portion of the next coupon that rightfully belongs to the seller is
called the accrued interest and is computed as follows :
AI =C *(t^-t1)/(t2-t1)will be discussed in detail
Had it been semiannual coupon.with coupon C and t^ is the sale
date of the bond, such that t1<t^<t2..AI = ????????

172
Concept..Accrued interest, Dirty price, Clean price of
Bonds
Paid to a Bond seller..Portion of next coupon Interest payment already
earned by the seller
The reason why we need to consider accrued interest is the fact that the
quoted prices of bonds are reported net of accrued interest and are called
Clean prices.
AI = (Days since last coupon/ days between coupons) * Coupon Payment

Clean Price + Accrued Interest = Dirty Price Since the convention (Clean
Price) is to quote prices net of accrued interest, the buyer obviously needs to
compute and factor in the accrued interest in order to determine the total
amount payable by him the Dirty Price.
173
PROPERTIES OF A BOND
1.Bond price & Market interest rates are inversely related

2.The proportionate increase in bond price when rates fall exceeds the
proportionate decrease in bond price when rates rise Convexity
3.Price volatility of a long term bond is greater than that of a short term
bond
4.Price volatility of a low coupon bond is greater than that of a high
coupon bond

Bond Property - 2
Int. rate Bond price Change %Change
15% 1000.00 - -
10% 1368.31 +368.31 +36.83%
20% 769.49 - 230.51 - 23.05%
Time to Maturity (TTM) 14 years
Coupon 15%
For a specific change in interest rate, the proportionate
increase in bond price when rates fall exceeds the
proportionate decrease in bond price
when rates rise
Convexity i.e, the price always falls at a slower rate as the yield
increase.
Types of Bonds

1) Govt. Bonds : Issued by Govts. Treasury Notes and Bonds ( 2 yrs to
30 yrs or even more)

2) Municipal Bonds : or munis issued by state and local governments.

3) Corporate Bonds : issued by Public and Private corporations for
funding their operations

4) Zero coupon bonds : A bond that pays no coupon at all. It is issued at a
discount to the maturity value. Also called zeros.issue price< face
Value

5) Floating rate bonds / Floaters : The coupon payments are functions of
some prefixed interest rate benchmark which itself may vary ..eg LIBOR
+ 0.5% or MIBOR + 0.5% etc.

Types of Bondscontd..

6) Junk Bonds : Junk bonds are high yield bonds issued by companies and have
high risk of default. The credit rating of these bonds are usually below
investment grade. The yields asked from these bonds are naturally much
higher .
7) Euro bonds Example : dollar denominated bonds issued in Europe or Asia
will be an Eurobond.

8) Foreign Bonds : are long term bonds issued by the firms and governments
outside the issuers home country and are usually denominated in the
currency of the country in which they are issued, rather than the domestic
currency. Countries sometimes name their foreign bonds to denote the
country of origin example

foreign bonds issued in US are called Yankee bonds,
those issued in Japan are called Samurai bonds,
those issued in UK --- bulldog bonds.

179
G-SEC MARKET
Primary Dealers
The system of Primary Dealers (PDs) in the Government Securities Market was introduced by
Reserve Bank of India in 1995 to strengthen the market infrastructure of Government Securities in
secondary Market

Two Way Quotes.Basically Liquidity Provider

Primary Dealers can also be referred to as Merchant Bankers to Government of India as only they
are allowed to underwrite primary issues of government securities other than RBI
PDs are allowed the following activities as core activities:
1. Dealing and underwriting in Government securities.
2. Dealing and underwriting in Corporate / PSU / FI bonds/ debentures.
3. Lending in Call/ Notice/ Term/ Repo/ CBLO market.
4. Investment in Commercial Papers.
5. Investment in Certificates of Deposit.
6.Investment in debt mutual funds where entire corpus is invested in debt securities
7. Dealing in Interest Rate Derivatives.
8. Providing broking services in Government securities

Some of the major PDs are ----
Currently around 21 PDs are operating . Some of them are : DFHI,STCI, ICICI Securities and Finance
Co.ltd. ,PNB Gilts ltd. SBI Gilts ltd, JP Morgan Securities India Pvt. Ltd. etc.

http://www.rbi.org.in/scripts/AboutUsDisplay.aspx?pg=PrimaryDealer.htm

Concepts

Dated Govt. Securities Market
long term securities and carry a fixed or floating coupon (interest rate) which is
paid on the face value, payable at fixed time periods (usually half-yearly). The
tenor of dated securities can be up to 30 years.
The nomenclature of a typical dated fixed coupon Government security contains
the following features - coupon, name of the issuer, maturity and face value. For
example, 7.49% GS 2017 would mean:
Coupon : 7.49% paid on face value
Name of Issuer : Government of India
Date of Issue : April 16, 2007
Maturity : April 16, 2017
Coupon Payment Dates : Half-yearly (October 16 and April 16) every year
Minimum Amount of issue/ sale : Rs.10,000
If the coupon payment date falls on a Sunday or a holiday, the coupon payment is made on the
next working day. However, if the maturity date falls on a Sunday or a holiday, the
redemption proceeds are paid on the previous working day itself.

State Development Loans (SDLs)
State Governments also raise loans from the
market. SDLs are also dated securities issued through
an auction similar to the auctions conducted for dated
securities issued by the Central Government.

Approved Securities: Principal and coupon guaranteed
by the Govt.. Securities issued by institutions such as
State Electricity Boards, Public Sector Undertakings,
IDBI, NABARD, HUDCO, REC, SAIL etc.

Concepts Types of Dated Securities
Fixed Rate Bonds - These are bonds on which the coupon rate is fixed for the
entire life of the bond. Most Government bonds are issued as fixed rate bonds.

For example 8.24%GS2018 was issued on April 22, 2008 for a tenor of 10 years
maturing on April 22, 2018. Coupon on this security will be paid half-yearly at
4.12% (half yearly payment being the half of the annual coupon of 8.24%) of the
face value on October 22 and April 22 of each year.

Notification
http://rbidocs.rbi.org.in/rdocs/PressRelease/PDFs/I
EPR98GS0713.pdf
Government Stock - Full Auction Results
s/IEPR139GS0713.pdf
Underwriting
s/IEPR129GS0713.pdf

G - Sec
Floating Rate Bonds - Floating Rate Bonds are securities which do not
have a fixed coupon rate. The coupon is re-set at pre-announced intervals
(say, every six months or one year) by adding a spread over a base rate.
In the case of most floating rate bonds issued by the Government of India
so far, the base rate is the weighted average cut-off yield of the last three
364- day Treasury Bill auctions preceding the coupon re-set date and the
spread is decided through the auction.
Floating Rate Bonds were first issued in September 1995 in India.
For example, a Floating Rate Bond was issued on July 2, 2002 for a tenor of
15 years, thus maturing on July 2, 2017. The base rate on the bond for the
coupon payments was fixed at 6.50% being the weighted average rate of
implicit yield on 364-day Treasury Bills during the preceding six auctions.
In the bond auction, a cut-off spread (markup over the benchmark rate) of
34 basis points (0.34%) was decided. Hence the coupon for the first six
months was fixed at 6.84%.
http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=6862&Mode=0
Concepts
Zero Coupon Bonds - Zero coupon bonds are bonds with no coupon payments.
Like. They are issued at a discount to face value (Issue Price< face value). Such
securities were issued by the Government of India in the 1990s.
Capital Indexed Bonds - These are bonds, the principal of which is linked to an
accepted index of inflation with a view to protecting the holder from inflation.
A capital indexed bond, with the principal hedged against inflation, was issued in
December 1997. These bonds matured in 2002.
The government is currently working on a fresh issuance of Inflation Indexed
Bonds wherein payment of both, the coupon and the principal on the bonds, will
be linked to an Inflation Index (Wholesale Price Index). In the proposed structure,
the principal will be indexed and the coupon will be calculated on the indexed
principal.
In order to provide the holders protection against actual inflation, the final WPI
will be used for indexation.
https://www.ccilindia.com/RiskManagement/Documents/Paper%20on%20FRB%2
0Valuation/Topic-14-03-2005072208.pdf
https://www.ccilindia.com/RiskManagement/ForexForwards/Lists/listDefaultfund/
Attachments/229/Forex%20Forward%20Segment%20Default%20Fund%20Notifica
tion_02-July-2012.pdf

Option Clause
Bonds with Call/ Put Options - Bonds can also be issued with
features of optionality wherein
the issuer can have the option to buy-back (call option)
or the investor can have the option to sell the bond (put option) to the
issuer during the currency of the bond.
6.72%GS2012 was issued on July 18, 2002 for a maturity of 10 years
maturing on July 18, 2012.
The optionality on the bond could be exercised after completion of five
years tenure from the date of issuance on any coupon date falling
thereafter.
The Government has the right to buyback the bond (call option) at par
value (equal to the face value) while the investor has the right to sell the
bond (put option) to the Government at par value at the time of any of the
half-yearly coupon dates starting from July 18, 2007.
http://rbidocs.rbi.org.in/rdocs/notification/PDFs/30319.pdf

Concepts
Special Securities -In addition to Treasury Bills and dated securities issued by the
Government of India under the market borrowing programme,
the Government of India also issues, from time to time, special securities to
entities like Oil Marketing Companies, Fertilizer Companies, the Food Corporation
of India, etc. as compensation to these companies in lieu of cash subsidies.

These securities are usually long dated securities carrying coupon with a spread of
about 20-25 basis points over the yield of the dated securities of comparable
maturity.
The beneficiary oil marketing companies may divest these securities in the
secondary market to banks, insurance companies / Primary Dealers, etc., for
raising cash.

http://www.rbi.org.in/Scripts/FAQView.aspx?Id=79

G Sec Market Price Based Auction
System
Details of bids received in the decreasing order of bid price
Price Amt Implicit Cumulative
of Bid (in Rs.Cr) yield Amount
1 100.31 300 300
2 100.26 200 500
3 100.25 250 750
4 100.21 150 900
5 100.20 100 1000
6 100.20 100 1100
7 100.16 150 1250
8 100.15 100 1350

Since the bid number 6 also is at the same price, bid numbers 5 and 6 would get allotment in
proportion so that the notified amount is not exceeded.
In the above case each would get Rs. 50 crore. Bid numbers 7 and 8 are rejected as the price
quoted is less than the cut-off price.Rs.100.20
Bids which are below the cut-off price are rejected.

Yield Based Auction System
Details of bids received in the increasing order of Yield
Yield Amt Cumulative
(in Rs.Cr) Amount
1 8.18 300 300
2 8.19 200 500
3 8.20 250 750
4 8.21 150 900
5 8.22 100 1000
6 8.22 100 1100
7 8.23 150 1250
8 8.23 100 1350
Since the bid number 6 also is at the same yield, bid numbers 5 and 6 would get allotment in
proportion so that the notified amount is not exceeded.
In the above case each would get Rs. 50 crore. Bid numbers 7 and 8 are rejected as the price
quoted is less than the cut-off price.Rs.100.20
Bids which are above the cut-off yield are rejected.
The corresponding price of the respective yield will be accordingly calculated

Underwriting Auctions
http://rbi.org.in/scripts/BS_PressReleaseDispl
ay.aspx?prid=25683

ay.aspx?prid=26779
ay.aspx?prid=26755
http://www.rbi.org.in/scripts/BS_PressRelease
Display.aspx?prid=26755

Valuation of G sec
G sec is valuedthe secondary market prices
on the basis appropriate YTM as announced
by FIMMDA
State Govt. and other approved securities are
valued with YTM + 25 bpsanounced by
FIMMDA
Dated G-Sec
When Issued Market
'When Issued', a short term of "when, as and if issued", indicates a G-Sec whose
issue has been announced but not yet taken place.
Purpose
A bidder at a G-Sec auction can only second guess what the demand for a bond will be.
This uncertainty leads to a volatility whenever there is a large auction.
A when-issued market will enable bidders to get an idea of how many investors are
interested in buying. Reduced volatility will draw more investors and lead to further
development of the bond market.
When Issued market helps in price discovery of the securities being auctionedBook
Building Measure.
In a when-issued market trade can take place only from the date of notification of
an auction of government securities to the date of the actual auction.

Need for Investing in G-Sec ?

A Government security is a tradable security issued by the Central Government or the
State Governments.. Governments debt obligation
In India, Central Government issues both Treasury Bills and bonds or dated securities while
the State Governments issue only bonds or dated securities, which are called the
State Development Loans (SDLs).

Sovereigns commitment for payment of interest and repayment of principalGuaranteed
Instruments.Risk free Instruments

Government securities can be sold easily in the secondary marketLiquidity

Government securities are available in a wide range of maturities from 91 days to as long as
30 years..match investors choice

Government securities can also be used as collateral to borrow funds

Government security prices are readily available due to a liquid and active secondary market
and a transparent price dissemination mechanism.

NDS-OM

The Reserve Bank introduced the Negotiated Dealing System-Order
Matching system or NDS-OM as it is called, in August 2005.
The NDS-OM is an electronic, screen based, anonymous, order driven
trading system for dealing in Government securities.
The Reserve Bank owns NDS-OM and CCIL maintains it

The NDS-OM brings transparency in secondary market transactions in
Government securities. Members can place bids (buy orders) and offers
(sell orders) directly on the NDS-OM screen.
Being order driven, the system matches all bids and offers on price/time
priority, that is, within the orders of the same price, it matches the oldest
order first. The system ensures complete anonymity among the
participants as CCIL acts as the central counter party (CCP) for settlement
of all the trades.
The NDS-OM also facilitates straight-through-processing (STP), that is, all the
trades on the system are automatically sent to the CCIL for settlement. With the
efficiency and ease of its operations, the NDS-OM has today captured over 80 per
cent of the trading volume in Government securities.
The trade details of NDS-OM are disseminated through the CCILs website
http://www.ccilindia.com/OMHome.aspx. Only authorised users of the member
entities can log in to the system.
Why trade on NDS-OM?
NDS-OM ensures anonymity of participants and, therefore, ensures objective
pricing in the market.
Since players know each other in market, in OTC trade, players can face adverse
pricing.
The system provides information, both pre-trade (e.g., bids/offers) and post-trade
(e.g., last traded price and volume) on real time basis. This assures transparency
and better price discovery as against the OTC market where there could be a delay
of up to 30 minutes in information dissemination.
Trading happens in standardised lot size of Rs.5 crore and in multiples of Rs.5 crore
providing enough liquidity in the system.
To facilitate trading in small lot sizes of less than Rs.5 crore, a separate odd lot
segment (with the minimum trading lot size being only Rs.10,000) is also available.
Participants get to know the depth of the market as the system shows the order
depth in terms of number and total amount of sell/ buy orders for each security.
This is not possible in OTC market

Tenor-wise Volumes of G-Secs (Rs. Crore) Secondary
Market
Instrument-wise Trade Volumes
Participation in Secondary Market(%)
CPR = f(CDR)
Integration of Short Term Market

CPs = 0.024CMM + 0.489CDs + 0.700T-bills
LOOP
Market Liquidity Indicators
/Pages/MarketLiquidityIndicator.aspx

Security
(EQUITY/STOCK/CAPITAL) Market
Reasons for Issuing Equity
To expand its business, a company, at some point, needs to
raise money. To do this, it can either borrow by taking a loan
or raise funds by offering prospective investors a stake in the
company --- which is known as issuing stock. A company
usually borrows from banks and/or financial institutions. This
is called debt financing.
On the other hand, issuing stock is called equity financing.
While raising loans is used for temporary cash requirements
(such as borrowing to fund a project), issuing stock is used to
raise funds of a permanent nature. While a lender gets
interest for the loan given to the company, an equity
shareholder gets a share.

Stocks
Stocks, also known as Equities, are shares in a
company. It is the certificate of ownership on
Equitable basis of a corporation. In simple terms,
when you invest in a company's stock or buy its
shares, you own part of a company. Thus, as a
stockholder, you share a portion of the profit on
equitable basis the company may make, as well as
a portion of the loss a company may take.
Dividend: A sum of money, determined by a
company's directors, paid to shareholders of a
corporation out of its earnings/Profitthis is
discretionary

Introduction to SEBI
Security and Exchange Board of India (SEBI) was
established in 1992 as an autonomous body under the
SEBI Act 1992 with the objective of protecting the
interests of investors in securities and to promote the
development of the securities market as well as
regulating them. Prior to SEBI, Controller of Capital
Issues was the regulatory authority and it derived
authority from the Capital Issues (Control) Act, 1947.
While the corporates and governments raise resources
from the securities market to meet their obligations or
to make investments, the households representing
investors invest their savings in securities.

The basic objectives of the SEBI
To protect the interests of investors in securities
To promote the development of Securities
Market (Primary & Secondary)
To regulate the Securities Market

WHAT IS A PRIMARY MARKET?
What are the different kinds of issues which
can be made by an Indian company in India?
Primarily, issues made by an Indian company can be classified as Public,
Rights, Bonus and Private Placement.
While right issues by a listed company and public issues involve a detailed
procedure, bonus issues and private placements are relatively simpler.
The classification of issues is as illustrated below:
(a) Public issue
(i) Initial Public offer (IPO).ICICI Bank 2005
(ii) Further public offer (FPO).ICICI Bank 2007
(b) Rights issue
(c) Bonus issue
(d) Private placement
(i) Preferential issue
(ii) Qualified institutional placement
IPO Grading: IPO grading is the grade assigned by a Credit
Rating Agency registered with SEBI, to the initial public
offering (IPO) of equity shares or other convertible securities.
The grade represents a relative assessment of the fundamentals of that issue in
relation to the other listed equity securities in India. Such grading is generally
assigned on a fivepoint point scale with a higher score indicating stronger
fundamentals and vice versa as below.
IPO grade 1 Poor fundamentals
IPO grade 2 BelowAverage fundamentals
IPO grade 3 Average fundamentals
IPO grade 4 Aboveaverage fundamentals
IPO grade 5 Strong fundamentals

IPO grading has been introduced as an endeavor to make additional information
available for the investors in order to facilitate their assessment of equity issues
offered through an IPO.

IPO Grading is intended to provide the investor with an
informed and objective opinion expressed by a professional
rating agency after analyzing factors like business and
financial prospects, management quality and corporate
governance practices etc.

However, irrespective of the grade obtained by the issuer,
the investor needs to make his/her own independent
decision regarding investing in any issue after studying the
contents of the prospectus including risk factors carefully.
Credit Analysis & Research Ltd (CARE)
ICRA Limited
CRISIL
FITCH Ratings
Brickwork Ratings India Private Limited
SME Rating Agency of India Ltd. (SMERA)
http://www.sebi.gov.in/investor/addcra.html

TYPE OF INVESTOR

Investors are broadly classified under following categories:
(i) Retail individual Investor (RIIs)
(ii) NonInstitutional Investors (NIIs)
(iii) Qualified Institutional Buyers (QIBs)

Retail individual investor means an investor who applies or bids for securities
for a value of not more than Rs. 2,00,000.

Qualified Institutional Buyer shall mean:
(a) Public financial institution as defined in section 4A of the
Companies Act, 1956;
(b) Scheduled commercial banks;
(c) Mutual funds;
(d) Foreign institutional investor registered with SEBI;
(e) Multilateral and bilateral development financial institutions;
(f) Venture capital funds registered with SEBI;
(g) Foreign venture capital investors registered with SEBI;
(h) State Industrial Development Corporations;
(i) Insurance companies registered with the Insurance Regulatory and
Development
Authority (IRDA);
(j) Provident funds with minimum corpus of Rs. 25 crores;
(k) Pension funds with minimum corpus of Rs. 25 crores;
(l) National Investment Fund set up by resolution F. No. 2/3/2005DDII
dated November 23, 2005 of Government of India published in the
Gazette of India.

NIIs
Investors who do not fall within the definition of the above
two categories are categorized as NonInstitutional
Investors
High Net worth Individuals If retail investor applies more
then Rs 2,00,000 /- of shares in an IPO, they are considered as
HNI. /Non Institutional Buyers and Employees of the
company (NIIs), Corporate Sector
Individual investors, NRI's, companies, trusts etc who bid for
more then Rs 2 lakhs are known as Non-institutional bidders.

Which are the intermediaries involved in an issue?
1. Intermediaries which are registered with SEBI are Merchant
Bankers to the issue (known as Book Running Lead Managers
(BRLM) in case of book built public issues)..Merchant
Banker
2. Registrars to the issue
3. Bankers to the issue
4. Underwriters to the issue who are associated with the issue
for different activities. Their addresses, telephone/fax
numbers, registration number, and contact person and email
addresses are disclosed in the offer documents.
1. Book Running Lead Managers
(BRLM) p1,66.cil
Merchant Banker: Merchant banker does the due diligence
to prepare the offer document which contains all the details
about the company.
They are also responsible for ensuring compliance with the
legal formalities in the entire issue process and for marketing
of the issue.
1.Merchant Banker/Lead Manager
Mange the Public issue
Drafting Prospectus
Arrangement of Underwriting
Arrangement of Private placement
Arrangement of Banker to the issue
Selection of Brokers
Net worth not less than Rs.5 cr
Registered with SEBI

1. Book Running Lead Managers
(BRLM) p1,66.cil
Merchant Banker: Merchant banker does the due diligence
to prepare the offer document which contains all the details
about the company.
They are also responsible for ensuring compliance with the
legal formalities in the entire issue process and for marketing
of the issue.
1.Merchant Banker/Lead Manager
Mange the Public issue
Drafting Prospectus
Arrangement of Underwriting
Arrangement of Private placement
Arrangement of Banker to the issue
Selection of Brokers
Net worth not less than Rs.5 cr
Registered with SEBI

Pricing of an Issue
Book Building
Exhibit 3. Pricing of an IPO(No Green Shoe).
Book building .. Wants to raise 1,53,500 no. sharesprice band is 475-501

Order Book
Bid Price( per share) No of shares bid Cumulative no of shares
501 2500.2475 2500
499 3000.2970 5500
485 7,900.7820 13400
480 46,50046035 59,900
475 95,000.94050 154900 (153500) 1400
1.01 times
232
Pro rata 0.99
Exhibit 3

1. No Green Shoe: Price Band is Rs.475 501
2. Rs.475 total amount is taken care of and also,
oversubscribed by 1.01 times(154900/153500)
3. Pro rata allotment(1/1.01)0.99 times = ( 153500/154900)
4. 475 is cut off price.Uniform Price based auction
6. Bid at 472 is not considered as Rs.475 entire amount will be
mobilised

Mechanics of an IPOcontd..
GREENSHOES OPTIONS
An option that allows the underwriting of an IPO to sell
additional shares to the public if the demand is high.
many underwriting contracts contain a greenshoe option sometimes
also called the over allotment option, which gives the members of the
underwriting group the option to purchase additional shares from the
issuer at the agreed price and allocate ( in case of oversubscription).

Name greenshoe is derived from the name of the Green Shoe
Manufacturing Company, which in 1963, was the first issuer that granted
such an option.

maximum of 15% of the issue size ( P 53..ICICI)
http://www.sebi.gov.in/dp/icicifollow.pdf

234
BOOK BUILDING
Quantum and price of the share to be decided on
the basis of the bids received from the
prospective shareholdersquantity demand
at various prices
It is a mechanism through which a offer price for IPOs based
on investors demand is determined.
It is basically an Uniform Price Based Auction of shares.

BSE is the 4th largest stock exchange in Asia and the
8th largest in the world by market capitalization .The
BSE has the largest number of listed companies in
the world.
SENSEX - The Barometer of Indian Capital Markets
SENSEX, first compiled in 1986
The stock market Index for NSE is S&P CNX Nifty
indexintroduced in 1995
It is the 9th largest stock exchange in the world by
market capitalization and largest in India by daily
turnover and number of trades.

Snapshot of NSE & BSE
Mcap( End May ,2012)
NSE: Rs. 56,95,547 cr
BSE: Rs.58,17,442 cr
Turn Over (Average Daily)
NSE: Rs.9852 cr
BSE: Rs.1894 cr
Listed Cos.
NSE: 1648
BSE: 9485

The 'liquidity ratio' is defined as trading volume over one
year divided by market capitalisation today.

MCAP/ GDP Ratio
The market capitalisation to GDP ratio of any
country represents the total listed wealth of a
country as a % of its GDP.
As more and more companies in a country get
listed on the capital market, this percentage
tends to move up.
Further, this ratio also helps as a measure of
relative valuation, in the sense whether a country
is undervalued or overvalued. The higher ratio
indicates there is a sense of high valuation in the
country.

During the financial year 2002-03, the market cap to
GDP ratio was as low as 23.28%, representing that
the total listed wealth in Indian capital markets was
as low as 23.28% of Indias GDP. This indicates that
the capital market penetration was very low in the
country.
From such modest levels in 2002-03, the market cap
to GDP ratio has substantially moved up to 109.47%
by 2007-08.
That is, for the first time in Indian capital market
history, the market cap of the country is more than
that of the country's GDP
However, the unprecedented financial crisis and
market meltdown during the financial year 2008-09,
has resulted in the market cap to GDP ratio crashing
to 55.36%. That is, the market cap of the country has
become just 55% of the countrys GDP.

The recovery of the capital markets during the financial year 2009-
10 has brought this market cap to GDP ratio back to 100.02%. That
is, once again, we are witnessing that the market cap of the
country is more than that of the countrys GDP.

Due to market sustainability during the financial year 2010-11 and
the mega public issues such as Coal India the market cap to GDP
ratio has reached record levels of 132.47%. That is, the market cap
of the country is 132% that of the countrys GDP.

The reason for such a substantial rise may be attributable to two
major factors. The first factor being the fact that more and more
Indian companies have started to access capital markets through
IPOs.
The second factor being the continuous rise in the valuations in the
capital market thanks to bull market during the period between
2002-03 and 2007-08.
Stock Market Index(NIFTY, SENSEX)
How to construct Index
A stock market index is created by selecting a group of stocks that are
representative of the whole market(NIFTY/SENSEX) or a specified sector /
segment of the market (Bank Index/PSE Index/Midcap Index, Small cap
Index.).
http://www.nseindia.com/index_nse.htm

An Index is calculated with reference to a base period and a base index
value.
An Index is used to give information about the price movements of
products in the financial, commodities or any other markets.
Financial(Price) indexes are constructed to measure price movements of
stocks, bonds, T-bills and other forms of investments.
Stock market indexes are meant to capture the overall behaviour of
equity markets

Stock market indexes are useful for a variety of reasons.
They provide a historical comparison of returns in the secondary market
on money invested in the stock market against other forms of
investments such as gold or debt.
They can be used as a standard against which to compare the
performance of an equity fund.
In It is a lead indicator of the performance of the overall economy or a
sector of the economy
Stock indexes reflect highly up to date information
Modern financial applications such as Index Funds, Index Futures, Index
Options play an important role in financial investments and risk
management

Stock Indices
Stock Indices: What are they and how are they calculated ?
A stock market index is like a portfolio of stocks, whose combined value ( mkt
cap) is tracked vis a vis a base year figure . The calculation of an index goes like
this:
An index base year is selected. The market cap for the constituent stocks is
considered. The sum total of the market cap is found . Say it comes out to 100
crores.
Then a value is assigned to this market cap, say 100 ( i.e 100 = 100 crores)
Now the next day the price of the shares will change and therefore the market
cap will also change. Say the new mkt cap becomes 112 crores. Then the new
index value will be given by

I
2
= I
1
x

=100 x (112/100)=112
Base date for SENSEX is April 1
st
1984.100
Base date for NIFTY is November 3
rd
, 1995..1000
day base for the cap mkt
day current for the cap mkt
Value Weighted Index ..example
Base date/year figures : 1
st
April, 2012

Total Market Capitalisaton = =2,206,800,000
Stock Price (P) (Rs) No of shares (Q) Market
Capitalisation
(Rs)
ACC 907 1,000,000 907,000,000
Bombay Dyeing 81 500,000 40,500,000
Colgate Palmolive 211 700,000 147,700,000
Cipla 68 200,000 13,600,000
Hindustan Lever 732 1,500,000 1098,000,000
245
5
1 i
i i
Q P
Value Weighted Index ..example
New date /year figures : 18
th
July, 2012

Total Market capitalisaton = =2,267,500,000

Therefore index value =
Capitalisation (Rs)
ACC 925 1,000,000 925,000,000
Bombay Dyeing 90 500,000 45,000,000
Cipla 75 200,000 15,000,000
Hindustan Lever 750 1,500,000 1,125,000,000
246
5
1 i
i i
Q P
75 . 102 100
000 2,206,800,
000 2,267,500,
= x
Let us assign the index a value = 100
Index DivisorBase MCap
Change in Index Composition
Say on the same day as above, it was decided that Cipla with a price of 75 and
number of shares outstanding equal to 2,00,000 will be replaced by Ranbaxy
which has a price of Rs 120 and number of shares outstanding equal to
100,000. The market capitalisation of the component stocks after the change
will be as depicted below :

Capitalisation
(Rs)
ACC 925 1,000,000 925,000,000
Bombay Dyeing 90 500,000 45,000,000
Ranbaxy 120 100,000 12,000,000
Hindustan Lever 750 1,500,000 1,125,000,000
247 Total Market capitalisaton = 2,264,500,000

Change in Index Composition...contd..
Here as the index is 102.75 as per the original composition.
But the composition is changed. So it will have the same value(
index cannot have two values on the same date) at the end of the
day but in the process the base date market cap need to be
changed such that this is ensured.

That is,

Therefore, Modified base Mcap = 2,203,880,075 (
not 2,206,800,000)and this value will be used from this date
onwards for calculation of index.
248
75 . 102 100
cap mkt date base Modified
000 2,264,500,
= x
Base Date 2,206,800,000..100
Today 2,267,500,000..102.75
(2,267,500,000/ 2,206,800,000)*100
------------------------------------------------------
Composition is changed with New Scrip from TODAY
Mcap 2,264,500,000

Mcap is Base date will be changed to
(2,264,500,000 / M Cap Base Year)*100 = 102.75
--------------------------------------------------------------------------------------------------
Base Date New Mcap2,203,880,075derived from ..102.75

Index as on 18
th
Aug,2012

Stock Price (P) (Rs) No of shares (Q) Market Capitalisation
(Rs)
ACC 1050 1,000,000
10,500,00,000
Bombay Dyeing 95 500,000
475,00,000
Colgate Palmolive 190 700,000
1,330,00,000
Ranbaxy 150 100,000
150,00,000
Hindustan Lever 700 1,500,000
10,500,00,000
250
Total Market capitalisaton = 22,955,00,000.18
th
Aug
Total Market capitalisaton = 22,675,00,000 .18
th
July
Base Market capitalisaton = 22,03,880,075 .1
st
April

Growth(18
th
Aug..) ..wrt 1
st
April(Base) = 4.16%....increaseYTD Growth
Growth((18
th
Aug..) ..wrt .18
th
July = 1.23%...increaseMonthly Growth

Nifty
The S&P CNX Nifty CNX stands for CRISIL NSE Indices. The S&P prefix belongs to
the US-based Standard & Poors Financial Information Services. C- CRISIL N-NSE X-
Exchange

( Nifty 50 or simply Nifty) is a composite(basket) of the top 50 stocks(Cos)
listed on the National Stock Exchange (NSE), representing 24 different
sectors(Industry) of the economy. It is based upon solid financial research

It is a simplified tool that helps investors and ordinary people alike, to understand
what is happening in the stock market and by extension, the economy.

If the Nifty Index performs well, it is a signal that companies in India are
performing well and consequently that the country is doing well.
Nifty is the flagship index of NSE, the 3rd largest stock exchange in the world in
terms of number of transaction(buying & selling).turnover

The base is defined as 1000 at the price level of November 3, 1995
Free Float ( Shares & Mcap)
Shareholding of investors that would not, in the normal
course come into the open market for trading are treated
as 'Controlling/ Strategic Holdings' and hence not included
in free-float. Specifically, the following categories of holding
are generally excluded from the definition of Free-float:
Shares held by founders/directors/ acquirers which has control element
Shares held by persons/ bodies with 'Controlling Interest'
Shares held by Government as promoter/acquirer
Holdings through the FDI Route
Strategic stakes by private corporate bodies/ individuals
Equity held by associate/group companies (cross-holdings)
Equity held by Employee Welfare Trusts
Locked-in shares and shares which would not be sold in the open market
in normal course.

SENSEX
SENSEX is calculated using the "Free-float Market Capitalization"
methodology, wherein, the level of index at any point of time reflects the
free-float market value of 30 component stocks(20 Sectors) relative to a
base period.
The market capitalization of a company is determined by multiplying the
price of its stock by the number of shares issued by the company. This
market capitalization is further multiplied by the free-float factor to
determine the free-float market capitalization.
The base period of SENSEX is 1978-79 and the base value is 100 index
points. This is often indicated by the notation 1978-79=100. The
calculation of SENSEX involves dividing the free-float market capitalization
of 30 companies in the Index by a number called the Index Divisor.
The Divisor is the only link to the original base period value of the SENSEX.
It keeps the Index comparable over time
Good Stock Index
A stock market index should capture the behaviour
of the overall equity market.
They reflect the changing expectations of the stock
market about future dividends of India's corporate
sector. When the index goes up, it is because the
stock market thinks that the prospective dividends in
the future will be better than previously thought.
When prospects of dividends in the future become
pessimistic, the index drops.
The ideal index gives us instant-to-instant readings
about how the stock market perceives the future of
India's corporate sector.
Every stock price moves for two possible reasons: news about the
company (e.g. a product launch, financials, corporate governance etc.) or
news about the country (e.g. budget announcement, high growth rate
in GDP, inflation etc.).
The job of an index is to purely capture the second part, the movements
of the stock market as a whole (i.e. news about the country).
This is achieved by averaging.
Each stock contains a mixture of these two elements - company news
and economy news.

On any day, there would be good stock-specific news for a few
companies and bad stock-specific news for others. the individual stock
news tends to cancel out.well diversified
In a good index, these will cancel out, and the only thing left will be
news that is common to all stocks.

The news that is common to all stocks is news about India. That is what
the index will capture. .. leading Economic Indicator

Stock Market Capitalization To GDP Ratio'

A ratio used to determine whether an
overall market is undervalued or overvalued.
MCAP/GDP = Stock Market MCAP/GDP
The result of this calculation is the
percentage of GDP that represents stock
market value.
The Size of Stock Market

MCAP/ GDP

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