Pariksha SaathiLesson 9 of 10 · Banking and Financial Awareness
Money Market and Capital Market: Instruments, IPOs, Exchanges and Mutual Funds
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Two markets for funds
The financial market is divided by the length of the funds traded. The money market deals in short-term funds, from overnight up to one year, and lets banks, companies and the government manage day-to-day cash; the RBI regulates it and uses it to pass on monetary policy. The capital market deals in long-term funds, more than one year, such as shares and bonds; SEBI regulates it, while government securities come under the RBI. The Vaghul Working Group (1987) set out the plan for developing India's money market.
Call money and repo
In the call money market banks and primary dealers lend to each other without collateral: call money is for one day, notice money for 2 to 14 days and term money for 15 days up to one year. In a market repo one party sells securities and agrees to buy them back; in a tri-party repo a third agent manages the collateral. The Clearing Corporation of India (CCIL, 2001) settles trades in government securities, money market and foreign exchange, and its tri-party repo (TREPS) replaced the older CBLO in 2018.
Treasury bills, CPs and CDs
Treasury bills are short-term borrowings of the central government, issued by the RBI through auctions in three tenors: 91, 182 and 364 days. They are zero-coupon instruments, issued at a discount and repaid at face value, the difference being the return. Commercial paper (CP), introduced in 1990, is an unsecured promissory note issued at a discount by highly rated companies, primary dealers and all-India financial institutions. A certificate of deposit (CD), introduced in 1989, is a negotiable deposit receipt issued at a discount by banks and some financial institutions; unlike an ordinary fixed deposit it can be sold before maturity.
Shares and debt instruments
An equity share is a unit of ownership in a company; its holder gets voting rights and dividends but is paid last if the company is wound up. A preference share gets a fixed dividend and is repaid before equity but usually carries no vote. A debenture or bond is a loan to the issuer: the holder is a creditor who gets fixed interest (the coupon) and repayment at maturity. Debentures may be secured or unsecured, convertible into shares or non-convertible. Government securities are issued through the RBI by the central government (dated securities) and state governments (state development loans); they carry practically no default risk and are called gilt-edged. Other forms include zero-coupon bonds, sovereign gold bonds (first issued in 2015), green bonds and masala bonds, which are rupee-denominated bonds sold outside India.
Primary market and IPOs
The primary market is where securities are issued for the first time. An initial public offer (IPO) is a company's first sale of shares to the public, after which the shares are listed on a stock exchange; a follow-on public offer (FPO) is a later public issue by a listed company. A rights issue offers new shares to existing shareholders in proportion to their holding, while a bonus issue gives them free shares out of reserves. The price is set either as a fixed price or by book building, where investors bid within a price band. In a book-built issue the company first files a draft red herring prospectus with SEBI. Investors apply through ASBA (Application Supported by Blocked Amount), under which the money stays blocked in their own account until shares are allotted.
Stock exchanges and depositories
The secondary market is where existing securities are traded, on stock exchanges recognised under the Securities Contracts (Regulation) Act 1956. The Bombay Stock Exchange, founded in 1875 as the Native Share and Stock Brokers' Association, is Asia's oldest stock exchange; its index SENSEX tracks 30 companies with 1978-79 as the base year. The National Stock Exchange, incorporated in 1992 and trading from 1994, brought nationwide screen-based trading; its index NIFTY 50 tracks 50 companies. Shares are now held in electronic (dematerialised) form with depositories set up under the Depositories Act 1996: National Securities Depository Limited (NSDL, 1996) and Central Depository Services (India) Limited (CDSL, 1999). Investors open a demat account through a depository participant such as a bank or broker.
Mutual funds
A mutual fund pools money from many investors and invests it in shares, bonds or money-market instruments under professional managers. Investors get units, valued at the net asset value (NAV) per unit. In India a mutual fund is set up as a trust, with a sponsor, trustees, an asset management company that manages the money and a custodian that holds the securities, and it is regulated by SEBI under the Mutual Funds Regulations of 1996. The Unit Trust of India, created by an Act of 1963 and working from 1964, was the first mutual fund; public sector banks and insurers could start funds from 1987 and private companies from 1993. Open-ended schemes can be bought and sold on any working day; close-ended schemes have a fixed term. Systematic investment plans let investors put in a fixed sum regularly, and equity-linked savings schemes give tax benefits with a three-year lock-in.
Key facts
- Money market: funds up to one year, regulated by the RBI; capital market: funds for more than one year, regulated by SEBI (government securities by the RBI).
- Call money: 1 day; notice money: 2 to 14 days; term money: 15 days to 1 year; all without collateral.
- Treasury bills: 91, 182 and 364 days; zero-coupon, issued at a discount by the RBI for the central government.
- Commercial paper (1990): unsecured, issued by companies; certificate of deposit (1989): negotiable, issued by banks.
- CBLO was replaced by tri-party repo (TREPS) in 2018; CCIL (2001) settles government securities, money market and forex trades.
- Masala bonds are rupee-denominated bonds issued outside India, so the foreign investor bears the currency risk.
- BSE (1875) is Asia's oldest stock exchange; SENSEX has 30 stocks with base year 1978-79; NSE (1992) runs NIFTY 50 with 50 stocks.
- Depositories Act 1996: NSDL (1996) and CDSL (1999) hold shares in demat form through depository participants.
- IPO = first public issue; FPO = later issue by a listed company; ASBA keeps the application money blocked in the investor's account.
- UTI (working from 1964) was India's first mutual fund; SEBI (Mutual Funds) Regulations 1996; ELSS has a three-year lock-in.
Quick revision
Money market up to 1 year (RBI), capital market over 1 year (SEBI); Vaghul Group 1987; call 1 day, notice 2-14 days, term 15 days-1 year; T-bills 91/182/364 days at discount; CP 1990, CD 1989; CCIL 2001, TREPS replaced CBLO 2018; equity vs preference shares, debentures, G-secs (gilt-edged), masala bonds; IPO, FPO, rights, bonus, ASBA; BSE 1875 (SENSEX 30), NSE 1992 (NIFTY 50); Depositories Act 1996, NSDL 1996, CDSL 1999; UTI first mutual fund, SEBI MF Regulations 1996.