Amity School of Business MODULE 3 Financial environment

Amity School of Business MODULE – 3 Financial environment 1

Amity School of Business Objective of the session: 1. To discuss the meaning of financial market or financial system; 2. To explain the meaning, functions and constituents of: a) Money market; & b) Capital market. 2

Amity School of Business Financial market (or a financial system) A market mechanism that facilitates the transfer of funds (both short-term and long-term) from providers of funds (lenders / investors) to borrowers or users (business units) is known as a financial market or financial system. Therefore, financial market may be defined as ‘a transmission mechanism for flow of funds between investors (or lenders) and the borrowers (or users). 3

Amity School of Business Any financial market (or system) consists of: 1. Players (be it fund providers and the borrowers of funds). They may be individuals, companies, financial institutions, government and intermediaries (brokers, banks etc. ); 2. Certain set of rules & regulations (laws), which all players have to follow (or abide); 3. Financial assets (instruments), e. g. shares, bonds etc. 4. Communication link (or network) –which connects various players in the market. 4

Amity School of Business Types of financial markets There are two major types financial markets: • Money markets – It is a market for short term funds. i. e. it deals in financial assets whose maturity is upto one year. This market deals in money or ‘near money’ instruments (those which can be converted into money with least transaction cost, e. g. bills of exchange, treasury bills, commercial paper, call money etc. ). • Capital market – It is a market for medium and long term funds. It is an institutional arrangement for investing and borrowing in various financial assets having maturity period of more than one year. 5

Amity School of Business Money Markets in India (Meaning, functions, and constituents) 6

Amity School of Business Refer: • • • Francis Cherunilam: Business Environment, “Money and Capital Markets; ” Chapter 23. Ruddar Datt, K. P. M. Sundharam (2010): Indian Economy, “Indian Financial System: money and capital markets in India; ” Chapter 49. Suresh Bedi: Business Environment, “Money Market in India; ” Chapter 24. 7

Amity School of Business Money market and capital markets the two important components of financial markets. Money market - meaning • Money market is the market for money and short-term financial assets, which are close substitutes of money and are highly liquid. It is distinct from capital market which deals in long-term funds. • It is a market where short-term surplus investible funds of banks and other financial institutions are demanded by borrowers comprising individuals, banks, financial institutions, companies and the government. 8

Amity School of Business • It generally does not have a formal place of transactions like a stock exchange. Most of the transactions take place through communication between various players. • Money market in India is broadly divided into organised and unorganised markets. The unorganised money market comprises of indigenous moneylenders, and is outside the control of RBI. The organised money market comprises of the RBI, commercial banks, and financial institutions. RBI plays a key role in functioning of the organised money market; • The organised money market has a number of sub-markets such as treasury bills market, the commercial bills market, and inter-bank call money market. 9

Amity School of Business Functions of Money Market 1. It augments supply of funds and makes it available to borrowers; 2. It helps in controlling volatility (ups and downs) in money market; 3. It helps in making funds available at cheaper rates; 4. Through quick transfer of funds from one place to another, an organised money market helps in avoiding regional deficiency or over-supply of funds; 10

Amity School of Business Continued - 5. By enhancing liquidity, the money market plays a catalytic role in economic growth of the country; 6. By providing profitable avenues for parking short-term surplus funds, the money market enhances profits of banks, financial institutions, and corporates. 11

Amity School of Business Instruments / Constituents of Money Market The Indian money market comprises of several sub-markets. Each one of which deals in a particular type of short-term credit. • Call money market; • Term money market; • Repos • Commercial paper; • Certificates of deposits; • Commercial bills markets • Treasury bills 12

Amity School of Business 1. Call money market • • • One of the important sub-market of Indian money market; It is the market for very short-term (one to 14 days) funds; Such funds are called money at call and short notice; Interest rates in such market are market determined; Commercial banks are predominant players in it, therefore it is also called inter bank call money market; • The call money market is influenced by: a) liquidity conditions (supply & demand of money) in the economy; b) the reserve requirement prescriptions of the RBI; c) The investment policies of participants. 13

Amity School of Business 2. Term money market • • Not much developed in India; Select financial institutions (IDBI, ICICI, IFCI, SIDBI, EXIM Bank, NABARD, IDFC, and NHB) are permitted to borrow term money (for 3 to 6 months maturity), within stipulated limits for each institution. 14

Amity School of Business 3. Repos: • • • A contract between seller and a buyer under which the seller sells a security with a commitment to repurchase (or buy-back) the same at an agreed price and date. The agreement binds the buyer to sell the security to the same party from whom he had bought it earlier. Reverse repo is opposite of repos, i. e. in it securities are purchased with a simultaneous commitment to sell at a future date and price. Repo instruments include treasury (government) bills, PSU and private corporate bonds. 15

Amity School of Business 4. Commercial Paper (CP): • • • Are unsecured promissory notes of short-term maturity of highly rated companies, issued to meet working capital requirements. Are tradable in stock market, thus are regarded liquid; Are rated by a recognised credit rating agency in India; Are privately placed with investors through banks; Banks usually park their idle short-term funds in CPs; Have a maturity period of 3 months or less; 16

Amity School of Business 5. Certificates of deposits (CDs): • • • Were introduced in June 1989 in Indian money markets; Are short-term deposits issued by banks during periods of tight liquidity, at relatively high interest rates; Transaction costs of CDs is often lower as compared to retail deposits. 17

Amity School of Business 6. Commercial Bills (Bills of Exchange): • • • Are drawn by sellers on buyers for the value of products transacted. These have maturity period up to 3 months; Are important instruments used to facilitate credit sales; These bills are tradable and can be resold in money market. These can also be discounted with banks; These bills can be categorized into demand (sight) and time (usance) bills; Commercial Bills market in India is very limited; The success of this market is contingent upon financial discipline on part of the borrowers. 18

Amity School of Business 7. Treasury Bills (T-Bills): • • • Are issued by Central Government to raise short-term funds; RBI issues T-Bills on behalf of the government; These have a maturity period of 91 – 182 days; These are important fiscal and monetary instruments of the government; T-bills combine liquidity and safety features in them, and are called gilt-edged securities; These are tradable in money market. 19

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