ASSIGNMENT 1- CAPITAL MARKET AND MONEY MARKET

MEANING OF CAPITAL MARKET- Capital markets commonly referred to as the stock markets have been in existence for centuries. The British East India Company was the first company to invite the public to buy shares in the company. Since then, over the years, markets have gone through tremendous changes. The way the market works, the asset classes, the framework of the exchanges, and everything has been evolving over time.

TYPES OF CAPITAL MARKET

a) Primary Capital Market- The primary capital market is the marketplace where the companies create and issue bonds, stocks, and other liquid assets to the public. One of the most important roles of primary market is to issue publish share or conduct Initial Public Offering for companies. The person who purchases becomes an investor. So, it can imply that the primary market is the market of common or public investors and businesses.

b) Secondary Capital Market- The market where previously issued/bought/sold liquid assets are traded among the investors is called the secondary market. The secondary consists of treasury bills, bonds, shares, debentures, preference shares, etc. these assets are products of the secondary market. It is also known as the stock market. The rates and prices in the secondary capital market are fairly controlled by the demand and supply of liquid assets in the business industry. There are in total 4 secondary markets. They are auctions and dealer markets, the other two are OTC (Over the Counter) and exchange markets. It allows the investors to raise a better portion of funds in the least period.

INSTRUMENTS OF CAPITAL MARKET

1. Equities- Equity securities refer to the part of ownership that is held by shareholders in a company. The main difference between equity holders and debt holders is that the former does not get regular payment, but they can profit from capital gains by selling the stocks. The equity holders get ownership rights and they become one of the owners of the company. When the company faces bankruptcy, then the equity holders can only share the residual interest that remains after debt holders have been paid. Companies also regularly give dividends to their shareholders as a part of earned profits coming from their core business operations. 

2. Debt Securities- Debt Securities can be classified into bonds and debentures:

     a. Bonds are fixed-income instruments that are primarily issued by the centre and state governments, municipalities, and even companies for financing infrastructural development or other types of projects.

     b. Debentures- Debentures are unsecured investment options unlike bonds and they are not backed by any collateral. The lending is based on mutual trust and, herein, investors act as potential creditors of an issuing institution or company.

3. Derivatives- Derivative instruments are capital market financial instruments whose values are determined from the underlying assets, such as currency, bonds, stocks, and stock indexes. The four most common types of derivative instruments are forwards, futures, options and interest rate swaps:

§  Forward: A forward is a contract between two parties in which the exchange occurs at the end of the contract at a particular price.

§  Future: A future is a derivative transaction that involves the exchange of derivatives on a determined future date at a predetermined price.

§  Options: An option is an agreement between two parties in which the buyer has the right to purchase or sell a particular number of derivatives at a particular price for a particular period of time.

§  Interest Rate Swap: An interest rate swap is an agreement between two parties which involves the swapping of interest rates where both parties agree to pay each other interest rates on their loans in different currencies, options, and swaps.

4. Exchange-Traded Funds- Exchange-traded funds are a pool of the financial resources of many investors which are used to buy different capital market instruments such as shares, debt securities such as bonds and derivatives. Most ETFs are registered with the Securities and Exchange Board of India (SEBI) which makes it an appealing option for investors with a limited expert having limited knowledge of the stock market. ETFs having features of both shares as well as mutual funds are generally traded in the stock market in the form of shares produced through blocks.

5. Foreign Exchange Instruments- Foreign exchange instruments are financial instruments represented on the foreign market. It mainly consists of currency agreements and derivatives. Based on currency agreements, they can be broken into three categories i.e. spot, outright forwards and currency swap. Participants of the capital market may be discussed in groups because of their similar activities. Examples: Loan Providers, Loan takers, financial intermediaries

MEANING OF MONEY MARKET- The money market is a financial market wherein short-term assets and open-ended funds are traded between institutions and traders. The market offers very high liquidity as the assets can easily convert into cash. Thus, it helps businesses and the government in meeting their working capital requirements. Money Market refers to the financial segment for the trade of liquid and short-term assets that can be easily converted into cash. Businesses and governments particularly benefit from this market as it helps in meeting their working capital requirements.

INSTRUMENTS OF MONEY MARKET

1)   Call Money- Call money is one of the most liquid instruments. The validity is generally one working day. Banks can face shortfalls that can be solved by borrowing through call money. In contrast, those with surplus cash can invest in other banks through call money. Call money work as statutory reserves, the minimum cash balance which banks must hold as part of the central bank’s mandate to ensure enough liquid cash for daily operations. The investment is available to other financial institutions as well. Borrowing and lending take place at the call rate.

2)  Treasury Bills- T-bills are issued by a country’s central bank on behalf of its government. The government often raises funds through Treasury Bills that provide quick money. In the money market, it is considered one of the safest investments due to the government backing. They don’t offer an interest income. T-bills are issued at a discount and redeemed at par, with the investor pocketing the difference as profit. The tenure of T-bills is generally from 14 days to 364 days.

3)  Commercial Papers (CPs)- Companies generally use commercial papers to fund their short-term working capital needs, such as payment of accounts receivables, inventory purchases, etc. However, these are unsecured in nature. As such, in case of liquidation of the company, they will not have priority against other secured financial short-term instruments. CPs come with an average maturity of two odd months. However, just like the Treasury Bills, these are also issued at a discount, and therefore, they don’t come with separate interests.

4)     Certificate of Deposits (CDs)- A certificate of deposit is a type of time deposit with the bank. Only a bank can issue a CD. Like all other time deposits, CDs also have a fixed maturity date and cannot be withdrawn before maturity. This acts as a major disadvantage for the instrument.

5)   Repos- Repo is a repurchase agreement with repo as its abbreviation. These are very short-term in nature. Tenure ranges from overnight to a month, while the securities can be directly transferred without the credit risk.

PARTICIPANTS OF MONEY MARKET

1. Central Government: The Central Government is an issuer of Government of India Securities (G-Secs) and Treasury Bills (T-bills). These instruments are issued to finance the government as well as for managing the Government’s cash flow. G-Secs are dated (dated securities are those which have specific maturity and coupon payment dates embedded into the terms of issue) debt obligations of the Central Government. T-bills are short-term debt obligations of the Central Government. These are discounted instruments. These may form part of the budgetary borrowing or be issued for managing the Government’s cash flow. T-bills allow the government to manage its cash position since revenue collections are bunched whereas revenue expenditures are dispersed.

2. State Government: The State Governments issue securities termed as State Development Loans (SDLs), which are medium to long-term maturity bonds floated to enable State Governments to fund their budget deficits.

3. Public Sector Undertakings: Public Sector Undertakings (PSUs) issue bonds which are medium to long-term coupon bearing debt securities. PSU Bonds can be of two types: taxable and tax-free bonds. These bonds are issued to finance the working capital requirements and long-term projects of public sector undertakings. PSUs can also issue Commercial Paper to finance their working capital requirements. Like, any other business organization, PSUs generate large cash surpluses. Such PSUs are active investors in instruments like Fixed Deposits, Certificates of Deposits and Treasury Bills. Some of the PSUs with long-term cash surpluses are also active investors in G-Secs and bonds.

4. Scheduled Commercial Banks (SCBs): Banks issue Certificate of Deposit (CDs) which are unsecured, negotiable instruments. These are usually issued at a discount to face value. They are issued in periods when bank deposits volumes are low, and banks perceive that they can get funds at low interest rates. Their period of issue ranges from 7 days to 1 year. SCBs also participate in the overnight (call) and term markets. They can participate both as lenders and borrowers in the call and term markets. These banks use these funds in their day-to-day and short-term liquidity management. Call money is an important tool to manage CRR commitments.

5. Private Sector Companies: Private Sector Companies issue commercial papers (CPs) and corporate debentures. CPs are short-term, negotiable, discounted debt instruments. They are issued in the form of unsecured promissory notes. They are issued when corporations want to raise their short-term capital directly from the market instead of borrowing from banks.

6. Provident Funds: Provident funds have short term and long-term surplus funds. They invest their funds in debt instruments according to their internal guidelines as to how much they can invest in each instrument category.

7. General Insurance Companies: General insurance companies (GICs) have to maintain certain funds which have to be invested in approved investments. They participate in the G-Sec, Bond and short-term money market as lenders. It is seen that generally they do not access funds from these markets.

8. Life Insurance Companies: Life Insurance Companies (LICs) invest their funds in G-Sec, Bond or short-term money markets. They have certain pre-determined thresholds as to how much they can invest in each category of instruments.

9. Mutual Funds: Mutual funds invest their funds in money market and debt instruments. The proportion of the funds which they can invest in any one instrument vary according to the approved investment pattern declared in each scheme.

10. Non-banking Finance Companies: Non-banking Finance Companies (NBFCs) invest their funds in debt instruments to fulfil certain regulatory mandates as well as to park their surplus funds. NBFCs are required to invest 15% of their net worth in bonds which fulfil the SLR requirement.

11. Primary Dealers (PDs): The organization of Primary Dealers was conceived and permitted by the Reserve Bank of India (RBI) in 1995. These are institutional entities registered with the RBI.

ANALYSIS AND INTERPRETATION:

Mostly trade takes place over the counter. The basic function of money market is to provide efficient facilities for adjusting liquidity positions of commercial banks, non-financial institutions, business firms and other investors. It meets short-term fund requirements of borrowers and provides liquidity to lenders. The main participants in money market include banks, primarily dealers, development finance institutions, finance companies. Mostly, banks and primary dealers can operate as borrowers and lenders. Money market help in high securities like cash, cash equivalents and high-rated debt-based securities. Money market funds offer high degree of safety. They offer investors higher yields, then traditional savings account. They help to finance trade, industry, invest profitability, enhance commercial bank’s self-sufficiency and lubricate central bank policies. We need to know capital market because it provides a platform for mobilising funds. Capital markets is also referred to as stock markets. It helps to accelerate the process of economic growth. It helps in proper allocation of resources from the people who have surplus capital, to the people who are in need of capital. So, we can say it helps in the expansion of industry and trade, in both public and private sectors leading to balanced economic growth in the country.