Here is an essay on the ‘Financial Markets of India’ for class 11 and 12. Find paragraphs, long and short essays on ‘Financial Markets of India’ especially written for school and college students.
Financial Markets of India
Essay Contents:
- Essay on the Credit Market
- Essay on Non-Banking Financial Institutions
- Essay on Money Market
- Essay on the Foreign Exchange Market
- Essay on the Debt Market
- Essay on Capital Market
- Essay on Derivatives Market
Essay # 1. Credit Market:
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The major institutional suppliers of credit in India are banks and non-banking financial institutions, i.e., development financial institutions (DFIs) and other financial institutions (FIs) and non-banking financial companies (NBFCs) including housing finance companies (HFCs). However, presently DFIs are getting merged with banks – recent examples are merger of the ICICI with the ICICI Bank and the IFCI with the Punjab National Bank. The non-institutional or unorganised sources of credit include money-lenders, indigenous bankers and sellers for trade credit which play an important role till today despite of the expansion of the organized credit market. However, information about unorganised sector is limited and not readily available.
The credit market is the predominant source of finance. A company can raise money from the domestic credit market which is classified in terms of maturity as – (i) short-term credit, (ii) medium-term credit, and (iii) long-term credit. While banks and NBFCs predominantly cater to short- term needs, FIs provide mostly medium and long-term funds. Of course, the role of various institutions are changing very fast and no longer remains linked with the term structure. Credit market reforms in India helped to introduce new instruments of credit, changes in the credit delivery system and integration of functional roles of different players, such as, banks, financial institutions and non-banking financial companies (NBFCs).
Essay # 2. Non-Banking Financial Institutions:
Non-banking financial companies (NBFCs) are financial intermediaries engaged primarily in the business of accepting deposits and making loans and advances, investments, leasing, hire purchase, etc. NBFCs are a heterogeneous lot. NBFC sector is characterised by a large number of privately owned, decentralised and relatively small-sized financial intermediaries.
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NBFCs are of various types, such as, loan companies (LCs), investment companies (ICs), hire purchase finance companies (HPFCs), equipment leasing companies (ELCs), mutual benefit financial companies (MBFCs) also known as Nidhis, miscellaneous non-banking companies (MNBCs) also known as Chit Funds and residuary non-banking companies (RNBCs). Loan companies, investment companies, hire purchase finance companies and equipment leasing companies are defined on the basis of the principal activity of their business.
For a latest list of NBFCs visit www(dot)rbi(dot)org(dot)in
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Essay # 3. Money Market:
Money market performs the crucial role of providing a conduit for equilibrating short-term demand for and supply of funds, thereby facilitating the conduct of monetary policy.
The money market instruments mainly comprise:
(i) Call money,
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(ii) Certificates of deposit,
(iii) Treasury bills,
(iv) Other short-term government securities transactions, such as, repos,
(v) Bankers’ acceptances/commercial bills,
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(vi) Commercial paper, and
(vii) Inter-corporate funds.
While inter-bank money markets and central bank lending via repo operations or discounting provide liquidity for banks, private non-bank money market instruments, such as, commercial bills and commercial paper provide liquidity to the commercial sector.
Important money market instruments are – auctions of Treasury Bills (beginning with the introduction of 182-day Treasury Bills effective November 1986), certificates of deposit (June 1989), commercial paper (January 1990) and RBI repos (December 1992).
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The overnight inter-bank call money market, in which banks trade positions to maintain cash reserves, is the key segment of the money market in India. It is basically an ‘over the counter’ (OTC) market without the intermediation of brokers.
Participation has been gradually widened to include other financial institutions, primary/satellite dealers, mutual funds and other participants in the bills rediscounting market and corporates (through primary dealers) besides banks, LIC and UTI. While banks and primary dealers are allowed two-way operations, other non-bank entities can only participate as lenders.
As per the announced policies, once the repo market develops, the call money market would be made into a pure inter-bank market, including primary dealers.
The call money market is influenced by liquidity conditions (mainly governed by deposit mobilisation, capital flows and the Reserve Bank’s operations affecting banks’ reserve requirements on the supply side and tax outflows, government borrowing programme, non-food credit off take and seasonal fluctuations, such as, large currency drawals during the festival season on the demand side).
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Given below in the Table 1.4 indicative volumes and interest in the call money market:
At times of easy liquidity, call rates tend to hover around the Reserve Bank’s repo rate, which provides a ready avenue for parking short-term surplus funds. During periods of tight liquidity, call rate L. tend to move up towards the Bank Rate and more recently the Reserve Bank’s reverse repo rate (and sometimes beyond) as the Reserve Bank modulates liquidity in pursuit of monetary stability.
Besides, there are other influences, such as:
(i) The reserve requirement prescriptions (and stipulations regarding average reserve maintenance),
(ii) The investment policy of non-bank participants in the call market which are among the large suppliers of funds in the call market, and
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(iii) The asymmetries of the call money market, with few lenders and chronic borrowers.
Repo is a money market instrument, which enables collateralised short-term borrowing and lending through sale/purchase operations in debt instruments. Under a repo transaction, a holder of securities sells them to an investor with an agreement to repurchase at a pre-determined date and rate. In the case of a repo, the forward clean price of the bonds is set in advance at a level which is different from the spot clean price by adjusting the difference between repo interest and coupon earned on the security.
Repo is also called a ready forward transaction as it is a means of funding by selling a security held on a spot (ready) basis and repurchasing the same on a forward basis. Reverse repo is a mirror image of repo as in the case of former, securities are acquired with a simultaneous commitment to resell.
Subsequent to the irregularities in securities transactions, repos were initially allowed in the Central Government Treasury bills and dated securities created by converting some of the Treasury bills. In order to activate the repos market essentially to be an equilibrating force between the money market and the Government securities market, the Reserve Bank gradually extended repos facility to all Central Government dated securities and Treasury bills of all maturities.
Recently, while the State Government securities were made eligible for repos, the Reserve Bank also allowed all non-banking entities, maintaining SGL and current account with its Mumbai office, to undertake repos (including reverse repos). Furthermore, it has been decided to make PSU bonds and private corporate securities eligible for repos to broaden the repos market.
The Reserve Bank also undertakes repo/reverse repo operations with Primary Dealers and scheduled commercial banks, as part of its open market operations. It also provides liquidity support to SDs and 100 per cent gilt mutual funds through reverse repos. There is no limit on the tenor of repos. The Reserve Bank initially conducted repo operations for a period of 14 days. Since November, 1996, the Reserve Bank has been conducting 3-4 days repo auctions, synchronizing with working day and weekend liquidity conditions, in order to modulate short-term liquidity.
With the introduction of Liquidity Adjustment Facility (LAF) from June 5, 2000, the Reserve Bank has been injecting liquidity into the system through reverse repos and absorbing liquidity from the system through repos on a daily basis. These operations are conducted on all working days except on Saturdays, through uniform price auctions and are restricted to scheduled commercial banks and PDs. This is apart from the liquidity support extended by the Reserve Bank to PDs through refinance/reverse repo facility at a fixed price.
The DFHI was originally set up in April 1988 for developing the money market. It was also allowed to participate in Treasury bills and dated securities. Further, for developing an efficient institutional infrastructure for an active secondary market in Government securities and public sector bonds, the Securities Trading Corporation of India (STCI) was set up in May 1994. Both DFHI and STCI later transformed themselves into PDs.
Essay # 4. Foreign Exchange Market:
The foreign exchange market in India comprises customers, authorised dealers (ADs) and the Reserve Bank. With the transition to a market determined exchange rate system in March 1993 and the subsequent gradual but significant liberalisation of restrictions on various external transactions, the forex market in India has acquired more depth.
Since the unification of the exchange rate in March 1993, several measures have been introduced to widen and deepen the forex market.
First, banks have been given the freedom to:
(i) Fix net overnight position limits and gap limits (with the Reserve Bank formally approving the limits),
(ii) Initiate trading position in the overseas markets, and
(iii) Determine the interest rates of NRI deposits [Linked to LIBOR in the case of FCNR(B) deposits] and maturity period [minimum maturity of one year in the case of FCNR(B) deposits].
Secondly, inter-bank borrowings have been exempted from statutory pre-emptions. Thirdly, banks have been permitted the use of derivative products for asset-liability management. Fourthly, in order to facilitate integration of domestic and overseas money markets, ADs have been allowed to borrow abroad. However, as a prudential measure, their external borrowings have been linked to their capital base.
As means of liberalization of forex market, the companies have been provided significant freedom in managing their foreign exchange exposures. They are permitted to hedge anticipated exposures, though this facility has also been temporarily suspended after the Asian crisis. Exchange Earners’ Foreign Currency (EEFC) account entitlement has also been rationalised.
Risk management strategies like freedom to cancel and rebook forward contracts have been allowed to corporates, although currently due to Asian crisis, freedom to rebook cancelled contracts was suspended. However, corporates are allowed to roll over the contracts. Other risk management tools like cross-currency options on back-to-back basis, lower cost option strategies like range forwards and ratio range forwards and hedging of external commercial borrowing (ECB) exposures have been allowed subject to prudential requirements.
Essay # 5. Debt Market:
The domestic debt market comprises of two main segments, viz., the Government securities and other (mainly corporate) securities comprising of private corporate debt, PSU bonds and DFIs bonds. The Government securities market is pre-dominant, while the other segment is not very deep and liquid.
The main investors in the Government securities market in India are commercial banks, co-operative banks, insurance companies, provident funds, financial institutions (including term-lending institutions), mutual funds especially the gilt funds, primary dealers, satellite dealers, non-bank finance companies and corporate entities.
The RBI also absorbs primary issuance of Government securities, either through private placement or devolvement. In order to promote the retail market segment and provide greater liquidity to retail investors, the Reserve Bank allowed banks to freely buy and sell Government securities on an outright basis at prevailing market prices, removing restriction on the period between sale and purchase.
The corporate debt market still constitutes a small segment of the debt market despite policy initiatives taken during the ‘nineties. The interest rate ceiling on corporate debentures was abolished in 1991 paving the way for market based pricing of corporate debt issues. In order to improve the quality of debt issues, all publicly issued debt instruments, irrespective of their maturity, are presently required to be rated. The role of trustees in case of bond and debenture issues has also been strengthened over the years.
The secondary market activity in the debt-segment, in general, however, remains low and subdued both at BSE and the Wholesale Debt Market Segment of the NSE, partly due to of lack of sufficient number of securities and partly due to lack of interest by retail investors.
Essay # 6. Capital Market:
After the abolition of the office of the Controller of Capital issues 1992, capital market reform was expedited to keep in place an efficient fund raising platform. For this purpose the Securities and Exchange Board of India (SEBI) was formed which carried out the capital market reform taking a strong note of investors’ protection, facilitating on line trading system and settlement system and curbing insider trading.
Pricing corporate equity remained a controversial area as it mostly depends on the future projection of performance rather than past performance. Therefore, a strong book building mechanism has been developed by which the prospective investors can offer their own price. Book building mechanism is a method through which an offer price of an Initial Public Offering (IPO) is based on investors’ demand.
The book building mechanism which was introduced in 1995 gave the issuer choice to raise resources either through this or the fixed price mechanism. Although the book building guidelines were prescribed in 1995, no issue was floated due to certain restrictive guidelines, which were changed in 1999.
The efficiency of automated vis-a-vis floor-based trading system in the secondary segment of the market is widely debated, although the evidence around the world suggests that markets are moving away from the floor-based trading system.
Till recently, trading on the Indian stock exchanges took place through open outcry system barring NSE and OTCEI, which adopted screen-based trading system from the beginning (Le., 1994 and 1992, respectively). At present all other stock exchanges have adopted on-line screen-based electronic trading, replacing the open outcry system. Of the two large stock exchanges, the BSE provides a combination of order and quote driven trading system, while NSE has only an order driven system. With the introduction of computerised trading, members could enter their orders/quotes on work stations installed in their offices instead of assembling in the trading ring.
Average movement in the stock price is reflected by the market index. S&P CNX Nifty is index of fifty stock released by the National Stock Exchange.
Commentary:
The S&P CNX Nifty closed at 1796.10 points on April 30, 2004 representing a rise of 24.20 points (1.37%), as compared to 1771.90 points on March 31, 2004. During the month of April 2004, S&P CNX Nifty touched a high of 1912.35 points on April 23,2004 before closing at 1796.10 points on April 30,2004. The market capitalisation of S&P CNX Nifty increased from Rs.638,599 crores on March 31,2004 to Rs.771,153 crores ie an increase of Rs.132,554 crores (20.76%).
Indian stock market is very unstable and cannot absorb the event risk. During the recent political uncertainty when the FIIs were the net seller the stock market became highly volatile.
Given below is the net investments of FIIs in the market during 3 May, 2004 to 21 May, 2004:
See Figure below:
Indian capital market was in a prolonged bull phase as you may observe from the first Figure which got wild because political uncertainty in May 2004 leading to heavy selling of equity in the stock market.
Understanding secondary market mechanism is an important aspect of finance. To more about Indian secondary capital market visit www.bseindia.com or www.nseindia.com. The regulator of the Indian capital market is the Securities and Exchange Board of India which can be visited at www(dot)sebi(dot)gov(dot)in.
Essay # 7. Derivatives Market:
Financial derivatives in the Indian financial markets are of recent origin barring trade related forward contracts in the forex market. Recently, over-the-counter (OTC) as well as exchange traded derivatives have been introduced, marking an important development in the structure of financial markets in India. Forward contracts in the forex market have also been liberalised.
Exchange traded derivatives tend to be more standardised and offer greater liquidity than OTC contracts, which are negotiated between counterparties and tailored to meet the needs of the parties to the contract. Exchange traded derivatives also offer centralised limits on individual positions and have formal rules for risk and burden sharing.
A beginning with equity derivatives has been made with the introduction of stock index futures by BSE and NSE. Stock Index Futures contract allows for the buying and selling of the particular stock index for a specified price at a specified future date. While the BSE introduced stock index futures for BSE Sensex comprising of 30 scrips, the NSE introduced Stock Index Futures for S&P CNX Nifty comprising 50 scrips. Stock Index Futures in India are available with one month and two month maturities. This has been widely used as risk management tools by the big fund investors. Subsequently, BSE and NSE were allowed to trade in futures and options in individual securities.
Futures at NSE:
NSE commenced trading in futures on individual securities on November 9,2001. The futures contracts are available on 53 securities stipulated by the Securities & Exchange Board of India (SEBI).
Security descriptor:
The security descriptor for the futures contracts is:
Market type: N
Instrument Type: FUTSTK
Underlying: Symbol of underlying security
Expiry date: Date of contract expiry
Underlying Instrument:
Futures contracts are available on 53 securities stipulated by the Securities & Exchange Board of India (SEBI). These securities are traded in the Capital Market segment of the Exchange.
Trading cycle:
Futures contracts have a maximum of 3-month trading cycle – the near month (one), the next month (two) and the far month (three). New contracts are introduced on the trading day following the expiry of the near month contracts. The new contracts are introduced for a three month duration. This way, at any point in time, there will be 3 contracts available for trading in the market (for each security) i.e., one near month, one mid-month and one far month duration respectively.
Expiry day:
Futures contracts expire on the last Thursday of the expiry month. If the last Thursday is a trading holiday, the contracts expire on the previous trading day.
In addition to trading individual stocks NSE has also started trading Index futures.
Futures on Nifty:
NSE commenced trading in index futures on June 12, 2000. The index futures contracts are based on the popular market benchmark S&P CNX Nifty index.
Security descriptor:
The security descriptor for the S&P CNX Nifty futures contracts is:
Market type: N
Instrument Type: FUTIDX
Underlying: NIFTY
Expiry date: Date of contract expiry
Underlying Instrument
The underlying index is S&P CNX NIFTY
Trading cycle:
S&P CNX Nifty futures contracts have a maximum of 3-month trading cycle the near month (one), the next month (two) and the far month (three). A new contract is introduced on the trading day following the expiry of the near month contract. The new contract will be introduced for a three month duration. This way, at any point in time, there will be 3 contracts available for trading in the market ie., one near month, one mid-month and one far month duration respectively.
Expiry day:
S&P CNX Nifty futures contracts expire on the last Thursday of the expiry month. If the last Thursday is a trading holiday, the contracts expire on the previous trading day.
Contract size:
The permitted lot size of S&P CNX Nifty futures contracts is 200 and multiples thereof
Price steps:
The price step in respect of S&P CNX Nifty futures contracts is Re. 0.05.
Equity Options: In addition to equity and index futures, National Stock Exchange and Mumbai Stock Exchange deals in individual stock options.
Options are derivative instrument that gives right to the buyer to exercise it for buying or selling the underlying at an agreed price. Equity options are derivative that gives right to the buyer to exercise it to buy or sell the underlying equity at an agreed price.
NSE became the first exchange to launch trading in options on individual securities. Trading in options on individual securities commenced from July 2, 2001. Option contracts are American style and cash settled and are available on 53 securities stipulated by the Securities & Exchange Board of India (SEBI).
Option Contract Specifications in the NSE:
Security Descriptor:
The security descriptor for the options contracts is:
Market type: N
Instrument Type: OPTSTK
Underlying: Symbol of underlying security
Expiry date: Date of contract expiry
Option Type: CA/PA
Strike Price: Strike price for the contract
Option type identifies whether it is a call or a put option., CA – Call American, PA – Put American.
Underlying Instrument:
Option contracts are available on 53 securities stipulated by the Securities & Exchange Board of India (SEBI). These securities are traded in the Capital Market segment of the Exchange.
Trading cycle:
Options contracts have a maximum of 3-month trading cycle – the near month (one), the next month (two) and the far month (three). On expiry of the near month contract, new contracts are introduced at new strike prices for both call and put options, on the trading day following the expiry of the near month contract. The new contracts are introduced for three month duration.
Expiry day:
Options contracts expire on the last Thursday of the expiry month. If the last Thursday is a trading holiday, the contracts expire on the previous trading day.
To get a list of 53 securities visit www(dot)nseindia(dot)com.
In India, OTC derivatives, viz., Interest Rate Swaps (IRS) and Forward Rate Agreements (FRAs) were introduced in July 1999, while one exchange traded derivative, viz., Stock Index Futures was introduced by the two largest stock exchanges in June 2000.
The FRA is an off-balance sheet contract between two parties under which one party agrees on the start date (or trade date) that on a specified future date (the settlement date) that party, viz., the party that agrees, would lodge a notional deposit with the other for a specified sum of money for a specified period of time (the FRA period) at a specified rate of interest (the contract rate). The party that has agreed to make the notional deposit has, thus, sold the FRA to the other party who has bought it.
The IRS is a contract between two counter-parties for exchanging interest payment for a specified period based on a notional principal amount. The notional principal is used to calculate interest payments but is not exchanged. Only interest payments are exchanged. The IRS and FRA were introduced with a view to deepening the money market as also to enable banks, Primary Dealers and financial institutions to hedge interest rate risks.
Indian stock market also deals in innovative derivative products linked exchange traded fund (ETF). SPIcE is an Exchange Traded Fund (ETF) on SENSEX, being launched by Prudential ICICI Mutual Fund. An ETF is a hybrid product having features of both an open-ended mutual fund and an exchange listed security. The price of one SPIcE unit will be equal to approximately 1/100th of SENSEX value. For example, if the current SENSEX is at 5600, one SPIcE unit will trade at around Rs.56. The scheme is managed by Prudential ICICI Asset Management Company (AMC) Ltd. and listed on both the Stock Exchange, Mumbai (BSE) and the Delhi Stock Exchange (DSE).
Similarly, in the NSE four ETFs are launched:
(i) S&P CNX NIFTY UTI NOTIONAL DEPOSITORY RECIEPTS SCHEME (SUNDER)
(ii) Liquid Benchmark Exchange Traded Scheme (Liquid BeES),
(iii) Junior Nifty BeES and
(iv) Nifty BeEs.
Nifty BeES is introduced by BENCHMARK, an Asset Management Company on January 8, 2002.
Interest Rate Derivatives:
Likewise the global market, in India the SEBI has introduced futures to begin with in:
i. Notional T-Bills
ii. Notional 10 year bonds (coupon bearing and non-coupon bearing)
Interest Rate Futures Contracts are contracts based on the list of underlying as may be specified by the Exchange and approved by SEBI from time to time.
To begin with, interest rate futures contracts on the following underlying shall be available for trading on the F&O Segment of the Exchange:
i. Notional T-Bills
ii. Notional 10 year bonds (coupon bearing and non-coupon bearing)
The list of securities on which Futures Contracts would be available and their symbols for trading are as under:
S. No. Symbol Description
1 NSETB91D Futures contract on Notional 91 day T bill
2 NSE 10Y06 Futures contract on Notional 10 year coupon bearing bond
3 NSE10YZC Futures contract on Notional 10 year zero coupon bond.
Contract Specification:
Security descriptor
The security descriptor for the interest rate future contracts is: Market type: N Instrument Type: FUTINT
Underlying: Notional T-bills and Notional 10 year bond (coupon bearing and non- coupon bearing)
Expiry Date: Last Thursday of the Expiry month.
Instrument type represents the instrument i.e. Interest Rate Future Contract.
Underlying symbol denotes the underlying. Expiry date identifies the date of expiry of the contract Underlying Instrument
Interest rate futures contracts are available on Notional T-bills, Notional 10 year zero coupon bond and Notional 10 year coupon bearing bond stipulated by the Securities & Exchange Board of India (SEBI).
Trading cycle:
The interest rate future contract shall be for a period of maturity of one year with three months continuous contracts for the first three months and fixed quarterly contracts for the entire year. New contracts will be introduced on the trading day following the expiry of the near month contract.
The schedule of contracts for the next one year will be as follows:
Expiry day:
Interest rate future contracts shall expire on the last Thursday of the expiry month. If the last Thursday is a trading holiday, the contracts shall expire on the previous trading day.
Further, where the last Thursday falls on the annual or half-yearly closing dates of the bank, the expiry and last trading day in respect of these derivatives contracts would be pre-poned to the previous trading day.
Floating Rates:
In the line of global practices, FIMMDA-NSE MIBID MIBOR based floating rate bonds and loans have been introduced in Indian market. It is a reference rate is an accurate measure of the market price. In the fixed income market, it is an interest rate that the market respects and closely watches. It plays a useful role in a variety of situations.
In particular, a call money reference rate can find the following applications:
i. Traders can make many decisions as offsets compared with the prevailing reference rate.
ii. Derivatives require a clearly defined reference rate as a foundation, off which the pay-off from the derivative is defined.
iii. A variety of contracts can be structured as offsets from the future levels of a reference rate. The simplest example may be a floating rate bond that uses an interest rate which is a given ‘n’ offsets above a given reference rate.
FIMMDA-NSE MIBID MIBOR is based on rates polled by NSE from a representative panel of 29 banks/institutions/primary dealers. The Exchange ensures that every day the FIMMDA-NSE MIBID MIBOR along with the respective standard deviations are disseminated to the market at 0955 (1ST) for overnight rate and at 1215 (1ST) for 14 day, 1 month and 3 month rates.
The following products linked to FIMMDA-NSE MIBID/MIBOR:
Floating Rate Notes:
1. GE Capital
Corporate Debentures
1. L&T
2. GE Capital
Term Deposit
1. ICICI bank Interest Rate Swaps
1. Parties: Standard Chartered Bank & Multinational entity
2. Parties: HSBC & Corporate entity
3. Parties: HDFC Bank & KEC International
4. Parties: ABN AMRO N. V. & Multinational entity
5. Parties: ABN AMRO N. V. & Reliance Industries
6. Parties: ABN AMRO N. V. & Multinational entity
7. Parties: Deutsche Bank & ICICI Ltd.
8. Parties: Deutsche Bank & Multinational Entity Forward Rate Agreements
Bank: HSBC
