Unit 2 Notes

What is Money Market?

 Money Market refers to that part of the broader Financial Market in

which highly liquid and short-term financial assets with maturity
upto 1 year are traded.

o Thus, it caters to the short-term borrowing needs of

working capital.

 Because of the short maturity period, it offers high liquidity of

securities, and hence money market investments are also called
cash investments.

– Financial Market is a broad term, referring to any center or arrangement

where buyers and sellers participate in the trade of financial claims such as
equities, bonds, currencies, and derivatives.
– The Financial Market is classified into two categories.
a. Money Market– Market for trading short-term financial assets with a
maturity of upto 1 year
b. Capital Market – Market for borrowing and lending of medium and long-
term funds, above 1 year.

Structure of Indian Money Market

Broadly speaking, the money market in India comprises two sectors.

Organized Money Market

  This sector of the money market in India is characterized
by registration, approval, and license from market regulators.

 It is called organized because it is systematically coordinated by the

RBI and other market regulators.

 Major participants in the Organized Money Market in India include –

the RBI, Banks, NBFCs, Mutual Funds, Insurance
Companies, etc.

Unorganized Money Market

 This sector of the money market in India refers to the one that is not
registered and not regulated.

 It is called unorganized because it is not systematically coordinated by

the RBI or any other market regulator.

 Major participants in the Unorganized Money Market in India include

– Local Moneylenders, Chit Funds, etc.

Major Instruments of Money Market

Various types of Money Market Instruments are used in India, each catering
to specific needs and participants. Some of the major instruments of Money
Market in India are discussed in detail in the sections that follow.

Call Money or Money at Call

 Call Money refers to inter-bank borrowing and lending for a very

short period, typically overnight to upto 14 days.

 The Call Money or Money at Call enables banks and financial

institutions to manage their short-term liquidity requirements.

 The rate at which money is borrowed in these markets is called

the Call Money Rate.

o The Call Money Rate keeps changing on an hourly

basis, depending on the demand and supply.

 Call Money Market has 2 segments:

Call Market or Overnight Market

It refers to the market for borrowing and lending of money between

banks for 1 day.
Short Notice Market

It refers to the market for borrowing and lending of money between

banks for upto 14 days.

Treasury Bills (T-Bills)

 Treasury Bills or T-Bills refer to short-term securities issued by the

RBI on behalf of the Central Government.

 They act as short-term fundraising tools for the government.

 Treasury Bills (T-Bills) are one of the two types of Government

Securities (G-Secs).

o One other type of Government Securities (G-

Secs) is Government Bonds, which have a maturity period
of more than 1 year and hence are Capital Market
instruments.

Features of Treasury Bills (T-Bills)

 Treasury bills are issued at a discount to the original value and

the buyer gets the original value upon maturity.

o For example, a Rs 100 treasury bill can be availed of at Rs 95,

but the buyer is paid Rs 100 on the maturity date. This is
called redemption at par or face value.

o Thus, they are non-interest bearing i.e. 0 coupon or 0 interest,

and hence are also called 0 coupon bonds.

 Being backed by the Government, these bills are considered risk-free

and are highly liquid.

 These bills are issued only by the Central Government (through

the RBI).

o The State Governments do not issue T-Bills.

 Instead of direct selling, T-Bills are auctioned in the

market, wherein each buyers submit their bids and the bill is sold to
the buyer willing to pay the highest price.

o The option of bidding ensures the highest revenue for the

government as well as transparency in the issuing process.
  T-Bills are available for a minimum amount of ₹ 25,000 or in
multiples of ₹ 25,000.

 As of now, there are 3 types of T-Bills auctioned by the RBI:

o 91-day T-Bills – Have a maturity period of 91 days.

o 182-day T-Bills – Have a maturity period of 182 days.

o 364-day T-Bills – Have a maturity period of 364 days.

 T-Bills can be used by the Banks for:

o Keeping as part of their SLR requirements.

o Providing as collateral to the RBI for getting loans under Repo.

Cash Management Bills (CMBs)

 Similar to T-Bills, CMBs are also short-term securities sold by the RBI
on behalf of the Central Government, but with a maturity period of
less than 91 days.

 It is also aimed at meeting the short-term cash flow mismatches of the

Government of India.

 Similar to T-Bills, CMBs are also issued at a discount to the face

value through auctions by the RBI.

 Banks are allowed to keep CMBs to meet their SLR requirements.

Ways and Means Advances (WMAs)

 Way and Means Advances (WMAs) are temporary loans or overdraft

facilities extended by the RBI to the Governments.

 This facility is available to both Central Government as well

as State Governments.

 WMA was introduced as per an agreement between the RBI and the
Government of India under Section 17(5) of the RBI Act.

 They replaced the Ad-hoc T-Bills, which were earlier used by the
Government to meet short-term expenditure for a particular purpose.

 WMAs are not considered as a source of finance for the government.

Rather, they are aimed to bridge the time interval of mismatch
between the government’s expenditures and expected receipts.
  If the government avails immediate cash from the RBI under normal
WMA, it has to return the amount within 90 days. In case the
WMA repayment surpasses 90 days, it is treated as an
overdraft.

 For the normal WMA, the rate of interest charged by the RBI is the
Repo Rate. For the overdraft, the rate of interest is (Repo Rate +
2%).

Certificate of Deposit (CD)

 Certificate of Deposit (CD) is a security issued by the Scheduled

Commercial Banks (SCBs) and some other Financial Institutions
(FIs) that have been permitted by the RBI to raise short-term
funds.

o Note: Cooperative Banks and Regional Rural Banks

(RRBs) are not allowed to issue Certificates of Deposit
(CDs).

 Certificates of Deposit (CDs) should be issued in multiples of ₹1

lakh, with a minimum amount of ₹1 lakh.

 They are issued at a discount on face value and are redeemed

at par or face value.

 Their maturity period is, usually, more than 7 days and less than
1 year.

 Withdrawal of a CD before the maturity date results in a penalty.

 Banks are not allowed to provide loans against the CDs.

Commercial Paper (CP)

 Commercial Paper (CP) is a type of unsecured, short-term debt

instrument issued by large Corporations, Primary Dealers, and
Financial Institutions (FIs).

 The eligible institutions may issue Commercial Papers (CPs) to finance

their short-term needs, such as inventory management, meeting
payroll expenses, funding new projects, etc.

 A Commercial Paper is issued as an unsecured promissory

note and is placed privately.
  They should be issued in multiples of ₹5 lakh, with a minimum
amount of ₹5 lakh.

 Their maturity period is a minimum of 7 days and a maximum of

upto 1 year.

Commercial Bill (CB) or Trade Bill

 Commercial Bill (CB) is a negotiable instrument drawn by the

seller or buyer of goods/services for the value of goods/services
delivered.

 Commercial Bills (CBs) act as a way for a seller (drawer) to extend

credit to a buyer (drawee) for goods or services purchased.

 When a Commercial Bill gets accepted by a Commercial Bank, it is

called as Trade Bill.

o Note: A Commercial Bill or Trade Bill is discounted by the

Commercial Bank first. The Bank, then, gets it re-
discounted by the RBI.

Importance of Money Market

 It provides a mechanism for managing liquidity. Banks and other

financial institutions use various instruments of money market to
balance their short-term surplus and deficits, ensuring cash availability
is aligned with their operational needs.

 It enables the growth of businesses and industries by allowing them to

finance their short-term capital requirements and expenses without
dipping into long-term funding resources, which may be costlier and
less flexible.

 It plays a crucial role in financing both internal as well as international

trade.

 It reflects short-term interest rates, offering insights into the broader

economy’s health.

 Interest rates in the money market serve as benchmark rates for the
economy. The rates for various instruments in this market form the
basis for pricing loans, mortgages, and other types of credit in broader
financial markets.
In conclusion, the Money Market plays a pivotal role, serving as a mechanism
for the efficient management of liquidity and short-term funding needs for
individuals, businesses, and governments. Its critical role in ensuring
financial stability means that it is crucial for the smooth functioning of the
financial system.

Related Concepts

Promissory Note

A Promissory Note is a legal document that serves as a written promise

by the issuer to repay a certain sum of money to another party (the
payee) under specific terms and conditions.

Government Securities (G-Secs)

 A Government Security or G-Sec refers to a tradable instrument

issued by the Central Government or the State Government.

 Being backed by the government, these securities are considered risk-

free.

 G-Secs are, mainly, of 2 types.

Treasure Bills (T-Bills)

 These are short-term Government Securities (G-Secs), with

a maturity period of less than 1 year.

o Thus, they are a Money Market instrument and not a Capital

Market instrument.

 In India, only the Central Government can issue Treasury Bills (T-
Bills).

o State Governments are not empowered to issue Treasury Bills (T-

Bills).

Government Bonds or Dated Government Securities or Gilt-Edged

Securities

 These are long-term Government Securities (G-Secs), with

a maturity of more than 1 year.

o Thus, they are a Capital Market instrument and not a Money

Market instrument.
  In India, both the Central Government and the State
Governments can issue Government Bonds.

What is Capital Market?

 Capital Market refers to that part of the broader financial market which
provides a market for borrowing and lending of medium and long-
term funds, above 1 year.

o Thus, it caters to the borrowing needs for medium to long

term projects and investments.

 Because of the long maturity period, the Capital Market facilitates the
mobilization and allocation of long-term funds.

– Financial Market is a broad term, referring to any center or arrangement

where buyers and sellers participate in the trade of financial claims such as
equities, bonds, currencies, and derivatives.
– The Financial Market is classified into two categories.
A. Money Market – Market for trading short-term financial assets with a
maturity of upto 1 year
B. Capital Market – Market for borrowing and lending of medium and long-
term funds, above 1 year.

Components and Structure of Capital Market

The capital market is a complex system, formed by various components.

Various components and structure of capital market can be classified into the
following 3 categories.

Capital Market Participants

Capital Market participants include the individuals and institutions that

interact within the market. These participants can be, broadly, categorized
into 2 groups:

 Investors or Suppliers of Capital: These are entities with surplus

funds and are looking to invest. They include individuals, pension
funds, insurance companies, and commercial banks.

 Borrowers or Issuers of Securities: These are entities that raise

funds by issuing various types of securities. They include businesses
looking to expand, governments financing projects, and individuals
seeking loans.

Capital Market Instruments

Capital Market Instruments or the Instruments of Capital Market refer to
various types of financial tools used within the market. They include financial
securities and derivatives that serve as mediums and facilitate the flow of
money among the participants of the capital market.

Various capital market instruments can be, broadly, classified into

the following types:

 Share or Stock

 Debt Instruments

 Derivatives

 Mutual Funds

 Exchange Traded Funds (ETFs)

 Instruments of Foreign Investments

Each type of capital market instrument has been discussed in detail in our
article Instruments of Capital Market.

Capital Market Infrastructure

Capital Market Infrastructure refers to the institutions that facilitate the

smooth operation of the market. These institutions play a crucial role in
connecting various participants and ensuring their regulated interactions for
trading through instruments available in the market.

Major types of institutions forming part of the capital market

infrastructure are as follows:

 Stock Exchanges: Stock exchanges are essentially marketplaces for

buying and selling financial instruments. They act as a central platform
where investors and companies connect.

o Various concepts regarding Stock Exchanges have been dealt

with in detail below.

 Regulatory Bodies: These organizations ensure fair and transparent

practices within the market. Major regulators involved in regulation of
Capital Market in India are:

o Securities and Exchange Board of India (SEBI)

o Reserve Bank of India (RBI)

 o Union Ministry of Corporate Affairs, and

o Department of Economic Affairs, Union Ministry of Finance.

 Financial Intermediaries: These institutions connect investors with

those seeking capital.

o Brokers, investment banks, and underwriters are some

examples.

Types of Capital Market

Based on the type of securities traded, the Capital Market is of 2 types:

Primary Market or New Issue Market

 The Primary Market is the type of Capital Market where new

securities are issued for the first time.

o Thus, it is also called the New Issue Market.

 The primary market provides the channel for the sale of new securities.
The issuer of securities sells the securities in the primary market to
raise funds for investment and/or to discharge.

o In other words, the market wherein resources are mobilized by

companies through the issue of new securities is called the
primary market.

Secondary Market or Old Issue Market

 The Secondary Market refers to a market where those types of

securities are traded, which have already been issued and offered
to the public in the Primary Market and/or listed on the Stock
Exchange.

o Thus, it is also called the Old Issue Market.

 The secondary market enables securities holders to adjust their

holdings in response to changes in their assessment of risk and return
or to buy/sell their securities as per their liquidity needs.

Difference between Primary Market and Secondary Market

Primary Market Secondary Market

New market securities are sold. Only existing securities are traded.
Primary Market Secondary Market

Investors have the option of only buying Investors can both buy and sell
the securities. securities.

The price of securities is

The price of securities is mostly decided by
determined by the demand and
the management of the issuing company.
supply of the market.

Secondary Markets are located at

Primary Markets have no fixed
specified places, known as Stock
geographical location.
Exchange.

Major intermediaries – Merchant Banks,

Major intermediaries – Brokers,
Underwriters, Debenture Trustees, Portfolio
Jobbers, etc.
Managers, etc.

The functioning dynamics of both types of markets are discussed in detail in

the sections that follow.

Primary Market or New Issue Market: Concepts

Types of Issues in Primary Market

The issue of new securities in the Primary Market occurs through various
methods as discussed below.

Public Issue or Public Offering

 Public Issue or Public Offering refers to the process of a

company offering its securities (usually stocks or bonds) for sale to
the general public for the first time or subsequently.

 It is the usual way through which companies raise capital from a broad
range of investors.

 There are 2 main types of public issues:

Initial Public Offering (IPO)

 Initial Public Offering (IPO) refers to the process when a private or

unlisted company sells its shares to the public for the very first
time.

 This process transforms the company from being privately owned to a

public company.
 o This is why an IPO is also referred to as “going public”.

 It is generally used by new and medium-sized firms that are looking for
funds to grow and expand their business.

 After IPO, the company’s shares are traded in an open market.

o Those shares can be further sold by investors through secondary

market trading.

Follow on Public Offering (FPO)

 Follow on Public Offering (FPO) refers to the process when a company,

that has already issued shares and is listed on a stock
exchange, issues shares again to raise additional fund.

 Public companies have to sell at least 25% of their shares to the public
to be traded on a stock exchange. Usually, it is this requirement that
makes companies go for FPOs.

Offer For Sale

 Under this method, securities are not issued directly to the public but
are offered for sale through intermediaries like issuing houses or stock
brokers.

 In this case, a company sells securities enbloc at an agreed price to

brokers who, in turn, resell them to the investing public.

Bonus Issue or Scrip Issue or Capitalization Issue

 It refers to offer of share to the existing shareholders against their

distributable profit.

 Thus, under this, shareholders’ share in profit is converted as shares.

Rights Issue

 Rights Issue is an invitation to existing shareholders to purchase

additional new shares in the company.

 This type of issue gives existing shareholders rights to purchase

new shares at a discount to the market price on a stated future date.

o That’s why it is called Rights Issue.

Private Placement
When an issuer makes an issue of securities to a limited group of pre-
selected investors, and which is neither a rights issue nor a public issue, it is
called a private placement.

Private placement can be of 2 types:

Preferential Allotment

When a listed issuer issues shares or convertible securities to a select

group of persons, it is called a Preferential Allotment.

Qualified Institutional Placement (QIP)

When a listed issuer issues shares or convertible securities to a select

group of Qualified Institutional Buyers (QIBs), it is called a Qualified
Institutional Placement (QIP).

Key Terminologies Related to Primary Market

Declared Price Issue

Its a method of pricing new issues wherein the issuer offers securities at a
pre-fixed price.

Book Building Issue

Its is another method of pricing new issues wherein the price is not
announced beforehand. Rather, the issuer, first, offers the shares and gets
application from public and then based on the demand fixes the price.

Authorized Capital

It is the maximum amount authorized by Memorandum of Association of a

company that can be raised by the company. The issuer can issue securities
upto worth this amount only.

Issued Capital

It is the actual amount issued by the issuer. It may be equal to or lesser than
the Authorized Capital.

Subscribed Capital

After the company issues shares, the public starts subscribing to those
shares. The subscription can be oversubscribed (demand of shares more
than the issued number of shares) or undersubscribed (demand of shares
less than the issued number of shares). The actual amount subscribed is
called Subscribed Capital.
Merchant Bankers

A “merchant banker” means any person who is engaged in the business of

issue management either by making arrangements regarding selling, buying
or subscribing to securities or acting as manager, consultant, adviser or
rendering corporate advisory service in relation to such issue management.

Underwriting

Underwriting means an agreement with or without conditions to subscribe to

the securities of a body corporate when the existing shareholders of such
body corporate or the public do not subscribe to the securities offered to
them.

Underwriter

The financial intermediary which agrees to purchase the undersubscribed

portion of issued capital is called Underwriter.

Called Up Capital

The company usually collects the subscribed capital in installments. The

portion of money demanded from subscriber is known as Called Up Capital.

Paid Up Capital

The amount actually paid by subscribers, when the money is demanded by

the issuer, is known as Paid Up Capital.

Reserve Capital

Usually, the issuer does not demand the whole amount from the subscriber.
A small portion of money is left un-demanded, which is called Reserve
Capital.

Secondary Market or Old Issue Market: Concepts

Components of Secondary Market

Based on the type of trading, the secondary market has 2 components:

Over-The-Counter (OTC) Market

 Over-The-Counter Markets or OTC Markets are essentially informal

markets for trading securities.

 It is a decentralized marketplace where securities are traded directly

between two parties, bypassing a central exchange.
  OTC markets are generally subject to less stringent regulations than
exchanges.

Stock Exchange Market

It refers to markets for trading of securities through a centralized exchange,

usually called Stock Exchange.

Key Terminologies Related to Secondary Market

Listed Securities

Listed Securities refer to those securities that are accepted to be traded in

stock exchanges.

Cash Trading

Its a type of trading in the Secondary Market wherein the sale and purchase
of securities takes place at the prevailing price on the day of trading.

Forward Trading

Its another type of trading in the Secondary Market wherein both buyer and
seller agree to buy and sell respectively at a future date at a pre-agreed
price, irrespective of the price that prevails on the day of trade.

Third Market

 Third Market refers to the trading of exchange-listed securities in the

over-the-counter (OTC) market.

 It allows institutional investors to trade blocks of securities directly,

rather than through an exchange, providing liquidity and anonymity to
buyers.

Fourth Market

Fourth Market refers to institution-to-institution trading directly, without

using the service of broker-dealers, thus avoiding both commissions, and the
bid–ask spread.

Stock Exchange

 A Stock Exchange is a regulated marketplace where investors can buy

and sell shares of publicly traded companies.

o It acts as a central hub for facilitating stock trading in a secure

and efficient manner.
  In India, a Stock Exchange can operate only if it is recognized by the
Government under the Securities Contracts (Regulation) Act, 1956.

Stock Exchanges of India

Bombay Stock Exchange (BSE)

 The Bombay Stock Exchange (BSE) is India’s largest and earliest

securities market.

 It is also Asia’s first stock exchange.

 BSE On-Line Trading (BOLT) is a screen-based automated trading

platform of BSE.

 The BSE also offers depository services through one of its arms called
the Central Depository Services Limited (CDSL)

National Stock Exchange of India Ltd. (NSE)

 The National Stock Exchange of India Ltd. (NSE) is India’s largest

financial market.

 It ranks fourth in the world by equity trading volume.

 NSE is the first exchange in India to provide modern, fully automated

electronic trading.

Stock Market Index

 A Stock Market Index is a statistical measure that reflects the overall

performance of a specific segment of the stock market, or the entire
market itself.

 Each index is composed of a weighted values of specific group of

stocks chosen based on certain criteria such as Market Capitalization,
Representation of various sectors, etc.

 From each sector, top companies are selected on the basis of total
value of all shares that are traded in the stock exchange.

o These companies are called Blue Chip Companies.

 It acts as an indicator of rise or fall in the prices of shares or other

securities.

 Investors use Stock Market Indices as a benchmark to track market

movements and compare the performance of their investments.
Important Stock Market Indices in India

BSE Sensex or Sensitive Index

It is an index of BSE, which measures the price movement of top 30

companies’ shares.

Nifty or National Index for Fifty

It is an index of NSE, which measures price movement of top 50 companies.

Nifty Junior

It is an index of NSE, which measures the price movement of the next top 50
companies.

Roles and Importance of Capital Market

The Capital Market, as the major channel for mobilization of funds, plays very
crucial role in an economy. Some of the its major roles and importance can
be seen as follows:

 Mobilization of Savings: It mobilizes idle savings or funds from

people for further investments in the productive channels of an
economy.

 Capital Formation: Through mobilization of ideal resources it helps in

formation of capital.

 Investment Avenues: It enables to raise resources for longer periods

of time. Thus it provides an investment avenue for people who wish to
park their resources for a long period of time and earn reasonable
return.

 Economic Growth and Development: As it makes funds available

for long period of time, the financial requirements of business houses
are met by the capital market. This, in turn, helps them grow.

 Optimal Allocation of Fund: By enabling price discovery as per the

demand and supply, it helps in optimal allocation of financial
resources.

 Service Provision: As an important financial set up, capital market

provides various types of services. It includes long term and medium
term liquidity to industry, underwriting services, consultancy services,
export finance, investor education by widening ownership base.
  Barometer of Economic Health: The performance of the Secondary
Market acts as the barometer of economic health. The investors use
the level of stock exchange indices as a benchmark to track market
movements and compare the performance of their investments.

Regulation of Capital Market in India

 Securities Contracts (Regulations) Act, 1956: It gives Central

Government regulatory jurisdiction over

o stock exchanges – through a process of recognition and

continued supervision.

o contracts in securities, and

o listing of securities on stock exchanges.

 Companies Act, 2013: It regulates incorporation of a company, lays

down responsibilities of a company, directors, dissolution of a
company.

o The Companies Act is mainly administered by the Union

Ministry of Corporate Affairs.

 SEBI Act, 1992: It has established the Securities and Exchange Board
of India (SEBI) as the primary regulator of securities markets in India.

 Depositories Act, 1996: It provides a legal framework for

establishment of depositories to facilitates holding of securities in
physical/dematerialised form and to effect the transfer of securities
through book entry only.

 RBI’s Provisions for NBFCs: Of late, the RBI has proposed a

significant shift in its regulatory approach towards the NBFCs.

The Capital Market serves as a vital channel for mobilizing savings into
investments, and hence driving economic growth and prosperity. As India
aims to grow faster in the time times to come, the role of the Capital Market
is going to become even more important. Efforts should be taken to ensure
its efficient functioning by focusing on transparency, fairness, and regulatory
oversight to maintain investor confidence and market integrity.

Related Concepts

Qualified Institutional Buyers (QIBs)

  Qualified Institutional Buyers (QIBs) are those institutional investors
who are generally perceived to possess expertise and the financial
muscle to evaluate and invest in the capital markets.

 Some prominent examples of QIBs are – Insurance companies,

provident funds, pension funds.

Commodity Exchange

 A commodity exchange is an exchange where various commodities,

derivative products, agricultural products and other raw materials are
traded.

 The commodity exchanges in India includes – National Spot Exchange

Limited (NSEL), Indian Commodity Exchange Limited (ICEX), Multi
Commodity Exchange (MCX), etc.

 Commodity Exchanges in India are regulated by the Securities and

Exchange Board of India (SEBI).

o Earlier, they were regulated by the Forward Markets Commission

(FMC), which got merged with the SEBI on September 28, 2015.

FAQs on Capital Market

What is Indian Capital Market?

Indian Capital Market is a component of Indian Financial Market which

provides a market for borrowing and lending of medium and long-term
funds, above 1 year.

Who controls the Capital Market in India?

The Indian capital market isn’t controlled by a single entity, but rather
overseen by a number of regulatory bodies, including Securities and
Exchange Board of India (SEBI), Union Ministry of Corporate Affairs, Reserve
Bank of India (RBI), etc.

Who regulates the Capital Market in India?

There are several bodies involved in regulation of Capital Market in India.

They include – Securities and Exchange Board of India (SEBI), Union Ministry
of Corporate Affairs, Reserve Bank of India (RBI), etc.

Why do we need Capital Market?

The Capital Market is the major channel for mobilization of funds from
investors to borrowers.

Types of Capital Market Instruments

Various instruments used in the capital market for making and raising
investments can be, broadly, classified into the following types:

 Share or Stock

 Debt Instruments

 Derivatives

 Mutual Funds

 Exchange Traded Funds (ETFs)

 Instruments of Foreign Investments

Each types of capital market instruments has been discussed in detail in the
sections that follow.

Share or Stock

 Share or Stock refers to securities issued by a company

that represents a portion of the ownership of a company.

o The capital of a company is divided into shares. Each share forms

a unit of ownership of the company and is offered for sale in
order to raise capital for the company.

 When an investor purchases a share or stock, it, essentially, means

acquiring a stake in the company’s assets and earnings.

 The company pays a dividend to the shareholders as a return on their

investment.

o Thus, the shareholders receive dividends, and not

interest, as a return from the company.

 There are, primarily, 2 types of Shares.

Equity Shares or Common Shares

 Equity Shares give their holders a share in the earnings/profits of

the company as well as voting rights.
  The dividends paid to the holders of equity shares are not
fixed but depend on the company’s performance.

o Thus, they receive dividends if the company earns

profit, but have to bear the loss if the company incurs a
loss.

 Equity shareholders are considered the real owners of the

company.

Preference Shares

 Preference Shares give their holders only a share in the

earnings/profits of the company, but no voting rights.

 The dividends paid to the holders of preference shares are fixed.

o Thus, they have an entitlement to a fixed amount of dividend like

that of interest on a loan given.

 Preference Shares are named so because in case the company is

winding up, these shares have the preferential right to get back
the capital paid, before Equity Shareholders.

 Preference shares are further classified into 2 types:

Cumulative Preference Shares

Cumulative Preference Shares are those Preference Shares whose dividend, if

not paid in a particular year by the company due to loss or any other
reasons, gets accumulated and is paid in the next year or after.

Non-Cumulative Preference Shares

Non-Cumulative Preference Shares are those Preference Shares whose

dividend, if not paid in a particular year by the company due to loss or any
other reasons, does not get accumulated and is foregone.

Debt Instruments

 Debt Instruments are tools through which issuers borrow money

from investors.

 Unlike equity securities, holders of debt instruments do not have

ownership rights.

o Thus, debt instruments are like a loan from the investor to

the issuer. The issuer agrees to pay a specified rate of interest
 during the life of the bond and to repay the principal amount on
a specified date.

 The issuer of a debt instrument is liable to pay interest on the

capital borrowed through the instruments, regardless of profit or
loss.

Difference between Debt Instruments and Shares

Basis of
Debt Instruments Shares
Difference

Securities issued to borrow money Securities issued by a company

Meaning from investors, without offering that represents a portion of the
any share in ownership rights. ownership of a company.

Type Debt is the borrowed fund Equity is an owned fund.

Debt can be kept for a limited

Equity can be kept for a long
Term period and should be repaid after
period.
the expiry of that term.

Risk involved here is higher

Risk Risk is lower than Equity
than in the Debt

Can be in the form of loans, Equity can be in the form of

Forms
debentures, and bonds shares and stock.

Security Debt can be secured or unsecured. Equity is always unsecured.

Types of Debt Instruments

Based on their risk profiles, and other characteristics, there are various types
of debt instruments. The main types of debt securities used in the Capital
Market are discussed in the sections that follow.

Bonds

 Bond is a type of debt instrument that represents a loan from an

investor (lender) to an issuer (borrower).

o Thus, when an investor purchases a bond, it, essentially, means

giving a loan to the issuer of the bond

 Just as in the case of a loan, the issuer of the Bond pays the
bondholder
 o Interest at regular intervals (also called the Coupon
Payment), and

o Principal Amount (also called the Face Value) on the

bond’s maturity date.

 The effective return paid by a bond is called the Yield of Bond or

the Bond Yield.

o For example, if someone buys a bond of Face Value 100 and gets
Coupon Interest of 10 for a year, then the Yield of Bond is 10%
((10/100)x100)

 They are generally considered a safer investment compared to

Shares or Stocks, primarily because they provide steady
income through fixed interest payments.

 Based on the issuers, there are various types of Bonds as discussed

below.

Government Bonds

 Government Bonds refer to bonds issued by national governments or

lower levels of government.

o At the national level, these government bonds are known as

“sovereign” debt and are backed by the ability of a nation to
repay through taxation of its citizens and to print currency.

 Government Bonds are one of the two types of Government

Securities (G-Secs).

o One other type of Government Securities (G-Secs) is

Treasury Bills, which have a maturity period of less than 1
year and hence are Money Market instruments.

Municipal Bonds

 Municipal Bonds are debt securities issued by a state,

municipality or county to finance civic projects.

 They are aimed to meet the financial needs of the Urban Local Bodies
(ULBs) or the Municipalities.

 Municipal bonds were first issued in India in 1997, 5 years after the
74th Constitutional Amendment constitutionalized the Urban Local
Bodies (ULBs).
  The growth of the municipal bond market is critical for India’s large
cities and towns to upgrade their creaking infrastructure.

o However, as of now, the Municipal Bond market in India is not

much developed, primarily because of their non-tradability and
lack of regulatory clarity.

Corporate Bonds

 Corporate Bonds are issued by corporations to raise capital. As

compared to Government Bonds, Corporate Bonds are characterized by
higher yields because there is a higher risk of a company defaulting
than a government.

 Corporate Bonds are, primarily, of 2 types:

Convertible Bonds

 Convertible Bonds are those bonds that can be converted into a

predefined number of stocks as and when required by the investor.

 In other words, they are, essentially, a bond with a stock option hidden
inside.

Non-Convertible Bonds

Non-convertible bonds refer to those bonds which cannot be converted into

stocks.

Impact Bonds

 Impact Bonds are a form of contractual agreement between Investors

and an implementation agency wherein the investors pay money to the
implementation agency only if it is able to achieve the pre-determined
empirically verifiable social indicators.

 Of late, Impact bonds have become an innovative method of financing

social projects related to Education, Health, etc.

 Some popular examples of Impact Bonds include – USAID’s Utkrisht

Bond, World Bank’s Women’s Livelihood Bonds, etc.

Green Bonds

 Green Bonds are a type of debt securities, specifically designed to

finance projects that have a positive environmental impact.
  Green Bonds are similar to Corporate Bonds. However, the proceeds of
such Bonds are exclusively used for financing green projects such as
renewable energy projects, projects to mitigate the impact of climate
change, reducing the emission of fossil fuels, etc.

Masala Bond

 Masala Bond is a term used to refer to a financial instrument through

which Indian entities raise money from overseas markets in Indian
Rupees.

 In other words, Masala Bonds are essentially rupee-denominated bonds

issued by Indian entities outside India.

Zero-Coupon Bond

 Zero-Coupon Bond is also known as Discount Bond.

 It is a type of debt security that, unlike regular bonds, doesn’t pay

regular interest. Instead, it’s sold at a discount to its face
value (maturity value), and at its maturity, face value is paid to its
holder.

 Thus, the return of the Masala Bond holder comes from the difference
between the purchase price and the face value received at maturity.

Inflation Indexed Bond

 Inflation Indexed Bond is a special type of debt security, designed to

protect investors from the negative effects of inflation.

 Unlike regular bonds, it provides a constant return, irrespective of the

level of inflation.

Debentures

 Debentures are a type of debt instrument just like Bonds that

represents a loan from an investor (lender) to an issuer
(borrower). However, unlike bonds, which are usually secured by
specific assets of the issuer, debentures are typically unsecured.

 As they are not backed by any security, Debentures are

considered riskier than Bonds.

Difference between Bonds and Debentures

Parameters Bonds Debentures

A bond is a financial instrument A debt instrument used to

Meaning showing the indebtedness of the raise long-term finance is
issuing body towards its holders known as Debentures.

Debentures may be
Yes, Bonds are generally secured
Collateral Secured or Unsecured by a
by Collateral
collateral

Interest Ratio Low High

Government Agencies, financial

Issued By Companies
institutions, corporations, etc.

Payment Accrued Periodical

Owners Bond-Holders Debenture-Holders

Risk Factor Low High

Priority in
repayment at the First Second
time of liquidation

Derivatives

 Derivative is a financial contract between two parties (buyer and

seller) that derives its value/price from one or more underlying
assets and/or securities such as shares, bonds, commodities, etc.

 The buyer agrees to purchase the underlying asset(s) from the

seller on a pre-specific date at a pre-specific price.

 Derivates are named so because their values are derived from

fluctuations in the underlying assets.

 Since the underlying assets in derivative contracts are bought/sold at a

pre-agreed price, they reduce future price fluctuations and
uncertainties.

o Thus, they help in hedging the risks and hence are used as risk-
hedging instruments.

 Some common forms of derivatives used in the capital market are as

follows:
 o Forward Contracts

o Future Contracts

o Options

o Swaps

Forward Contracts

 A Forward Contract is an agreement between two parties – a buyer

and a seller – to buy or sell something at a future date at a price
agreed upon today.

o The pre-agreed price is called the Strike Price.

 Forward contracts are typically traded Over-The-Counter

(OTC), meaning they are negotiated directly between the two parties
involved, rather than on a centralized exchange.

o Thus, they are unregulated.

Future Contracts or Futures

 Future Contracts are also called Futures.

 Similar to Forward Contracts, a Future Contract is an agreement

between two parties – a buyer and a seller – to buy or
sell something at a future date at a price agreed upon today.

o The pre-agreed price is called the Strike Price.

 Unlike forward contracts, futures contracts are traded on organized

exchanges.

o Thus, they are regulated.

Difference between Forward Contracts and Future Contracts

Though similar in nature, Forward Contracts and Future Contracts (Futures)

differ in various respects as can be seen below.

Forward Contracts Future Contracts (Futures)

Traded Over-The-Counter (OTC), Traded on organized exchanges, thus are

thus are unregulated. regulated.
Forward Contracts Future Contracts (Futures)

Settled only once – at the end date Changes in the price of the underlying asset
of the contract. are settled on a daily basis.

Options

 An Option is a contract between two parties – a buyer and a seller –

that gives the holder of the contract the right, but not obligation,
to buy or sell something at a future date at a price agreed upon
today.

o Thus, unlike Forward Contracts and Future Contracts (Futures),

there is no obligation on the holder of the contract to perform the
contract.

 The pre-agreed price is called the Strike Price.

 The person who writes the option is the seller of the option and is
denoted as the “Option Writer”. The person who buys and
holds the option is called the “Option Holder”.

o A Premium Price is paid by the Option Holder to the

Option Writer to gain the right, but not obligation, to
perform the contract.

 Options are traded on organized exchanges.

o Thus, they are regulated.

 Based on the type of right available to the holder of the contract, there
are two types of Options – Call Option and Put Option.

Call Option

A Call Option is a type of Option that gives the Option Holder the right to
‘buy’ the underlying asset at a certain pre-agreed price at a pre-agreed
date.

Put Option

A Put Option is a type of Option that gives the Option Holder the right to
‘sell’ the underlying asset at a certain pre-agreed price at a pre-agreed date.

Difference between Call Option and Put Option

Call Option Put Option

Gives the Option Holder the right, but Gives the Option Holder the right, but
not the obligation, to ‘buy’ the not the obligation, to ‘sell’ the
underlying asset. underlying asset.

Usually, it is preferred when the prices Usually, it is preferred when the prices
of the underlying assets are expected of the underlying assets are expected
to rise in the future. to fall in the future.

Swaps

 A Swap is a contract between two parties for exchange of pre-agreed

cash flows of two different financial instruments.

 Swaps are generally used to manage risks related to fluctuations in the

interest rates and market value of currencies. Thus, there are two
major types of swaps – Interest Rate Swaps and Currency Swaps.

Interest Rate Swaps

 An Interest Rate Swap (IRS) is a specific type of swap agreement that is

used to exchange cash flows based on interest rates.

 They involve swapping only the interest rates-related cash flows

between the parties in the same currency, which may be on account of
a fixed or floating rate of interest.

 They are generally used to manage the risks related to

fluctuations in interest rates.

Currency Swaps

 A Currency Swap is a type of swap agreement where two

parties exchange cash flows denominated in different
currencies.

 They entail swapping both principal and interest between the parties,
with the cash flows in one direction being in a different currency than
those in the opposite direction.

 They are generally used to manage the risks related to changes in

the market value of a currency.

Currency Derivatives
  A Currency Derivative is a contract between the seller and
buyer, whose value is derived from the currency value in the
market or the currency exchange rate.

 It entails that two currencies may be exchanged at a future date at a

stipulated exchange rate, irrespective of the exchange rate prevailing
on the day of exchange.

Mutual Funds

 A Mutual Fund collects money from investors and invests the money,
on their behalf, in stocks, bonds, and other securities.

 Thus, a Mutual Fund is, basically, a mediator that brings together a

group of people and invests their money.

 Each investor who gives his/her money to the Mutual Fund owns shares
in the Mutual Fund, which represent a portion of the holdings of the
fund.

 The managers of the Mutual Fund charge a small fee from the investors
for managing the fund on their behalf.

 Mutual funds can be broadly classified into three categories based on

the asset classes they invest in.

Equity Funds

Equity mutual funds invest primarily in stocks and equity-oriented

instruments, such as shares of the listed companies.

Debt Funds

Debt mutual funds invest in fixed-income instruments like government

securities, corporate bonds, treasury bills, money market instruments, etc.

Hybrid Funds

These are mutual funds that invest in more than one type of asset class,
including equity as well as debt.

Exchange Traded Funds (ETFs)

 An Exchange Traded Fund (ETF) is a basket of marketable

security that tracks an index, a commodity, bonds, or a basket of
assets like an index fund.
  Exchange Traded Funds (ETFs) combine the features of Mutual
Funds as well as Stocks.

o Similar to a mutual fund, an ETF holds a collection of underlying

investments, which can be stocks, bonds, commodities, or a
combination of these.

o Similar to Stocks and unlike Mutual Funds, ETFs are traded on an

exchange and experience price changes throughout the day as
they are bought and sold.

Difference between Mutual Funds and Exchange Traded Funds

(ETFs)

Exchange Traded Funds

Parameters Mutual Funds
(ETFs)

An investment fund where a

The index fund, which tracks
number of investors pool their
Meaning the index and is listed & traded
money together to invest in
in the financial market.
diversified securities.

Disclosure of Holdings are disclosed on a Holdings are disclosed on a

Holding quarterly basis. daily basis.

The average expense ratio of The average expense ratio of

Disclosure of
the mutual fund is higher than the ETFs is lower than Mutual
Expense Ratio
an ETF. Funds.

In a mutual fund, the buying Conversely, in ETF the trading

Trading Market and selling of shares proceed is done between two investors
from the fund house. in the secondary market.

The funds are traded on the Net ETF is traded on quoted price
Trade Price
Asset Value (NAV). rather than their NAV.

Exchange Traded Funds are

Mutual funds are considered considered more tax efficient
Tax Efficiency less tax-efficient than Exchange than mutual funds because due
Traded Funds to frequent trading their capital
gains tax is higher.

Requirement of In Mutual Funds, there is no As the ETF is traded in the

Share Trading requirement for a share trading stock market a share trading
 Exchange Traded Funds
Parameters Mutual Funds
(ETFs)

account is required to proceed

Account account to buy a mutual fund.
with the transaction.

Brokerage is not paid in Mutual

Brokerage Brokerage is paid in ETFs.
funds.

Fractional Mutual Funds can be issued in a ETFs cannot be sold in a

Shares fraction. fraction.

Mutual Funds are actively

managed by the fund The ETF funds have passive
Management managers, i.e. the assets are management as they tend to
continuously bought and sold in match a specific index.
order to outperform the market.

Gold ETF

 Gold ETF stands for Gold Exchange Traded Fund.

 Gold ETF is a commodity ETF that consists of only one principal asset
i.e. Gold.

 Generally, one unit of Gold ETF represents one gram of gold.

 Gold ETFs are traded in the stock exchange like usual stocks.

CPSE ETF

 CPSE ETF stands for Central Public Sector Enterprise Exchange

Traded Fund.

 CPSE ETF pools shares of various Central Public Sector

Enterprises (CPSEs) and offers them to investors in the form of a
diversified equity investment product.

 CPSE ETF was created to help the Indian government in its initiative to
disinvest some of its stake in various CPSEs.

Bharat-22 ETF

 Bharat 22 ETF comprises 22 stocks including Central Public Sector

Enterprises (CPSEs), Public Sector Banks (PSBs), and Specified
Undertakings of the Unit Trust of India (SUUTI).
  As compared to CPSE ETF, Bharat-22 ETF is more diversified, spanning
six sectors –

o Basic materials (4.4%),

o Energy (17.5%),

o Finance (20.3%),

o FMCG (15.2%),

o Industrials (22.6%),

o Utilities (20%).

Instruments of Foreign Investments

There are various types of Capital Market Instruments that facilitate foreign
investments in India. Major instruments of foreign investment in the capital
market are discussed in the sections that follow.

Depository Receipts (DRs)

 A Depository Receipt (DR) is a financial instrument representing certain

securities such as shares, bonds, etc, issued by a company/entity in a
foreign jurisdiction.

 Securities of a firm are deposited with a domestic custodian in the

firm’s domestic jurisdiction, and a corresponding “depository receipt”
is issued abroad, which can be purchased by foreign investors.

 DRs constitute an important mechanism through which issuers can

raise funds outside their home jurisdiction.

o Thus, they enable tapping foreign investors who otherwise may

not be able to participate directly in the domestic market.

 Depending on the location of issue, Depository Receipts (DRs) are of

two types – American Depository Receipts (ADRs) and Global
Depository Receipts (GDRs).

American Depository Receipts (ADRs)

 ADRs are issued by an American Bank, acting as a custodian, that

represent shares of a non-American company.

 They provide a way of trading non-USA stocks on the USA Exchange.

  For example, if an Indian company wants to raise funds from the US
market, it gives its stocks to an American bank. In return for those
stocks, the American Bank provides receipts to the Indian company.
The company, then, raises funds by providing those ADR receipts in the
American share market.

Global Depository Receipts (GDRs)

 They are similar to ADRs, but issued by a depositary bank outside the
United States.

 They can be traded on stock exchanges around the world in various

currencies, depending on the location of the depositary bank.

 They can be denominated in the foreign company’s home currency,

USD, or the currency of the depositary bank’s location.

Foreign Currency Convertible Bond (FCCB)

 A Foreign Currency Convertible Bond (FCCB) is a type of convertible

bond issued in a currency different than the issuer’s domestic currency.

 The term ‘Foreign Currency’, here, means that the money being raised
by the issuing company is in the form of a foreign currency.

 The term ‘convertible’, here, they are, essentially, a bond, but offer the
holder the option to convert them into a predetermined number of the
issuer’s shares at specific times during the bond’s life.

Participatory Notes (P-Notes)

 Participatory Notes or P-Notes or PNs are financial instruments used

by foreign investors, that are not registered with the Securities
and Exchange Board of India (SEBI), to invest in Indian securities.

 Foreign Institutional Investors (FIIs) or Brokers, which

are registered with the SEBI, issue Participatory Notes (P-Notes) to
overseas investors willing to invest in the Indian stock market.

 P-Notes allow overseas investors who wish to invest in the Indian stock
markets, without requiring them to register themselves with the SEBI
and go through the hassles of scrutiny and KYC norms.

o Thus, P-Notes allow foreign investors to invest in the Indian

market, while remaining anonymous.

o This is what makes P-Notes very popular amongst the FIIs.

  The anonymous nature of P-Notes means that investors remain beyond
the reach of Indian regulators.

o This has led to concerns regarding these P-Notes being misused

for the purpose of money laundering.

In summary, the instruments of capital market are diverse, each serving

specific purposes for different types of investors and issuers. Understanding
these capital market instruments is crucial for grasping the dynamics of the
capital market as well as the financial system. As global financial markets
evolve, these instruments play a vital role in ensuring economic stability and
fostering growth.

Related Concepts

Dividends

 A dividend is a distribution of a portion of a company’s earnings,

decided by the board of directors, to a class of its shareholders.

 Dividends can be issued as cash payments, shares of stock, or other

property.

Scrip Share

 It is the share given to existing shareholders without any charge.

 It is also known as Bonus Share.

Sweat Equity Shares

 Sweat Equity Shares refer to equity shares given to the company’s

employees in recognition of their work.

 They allow the companies to reward their employees for their services.

Market Capitalization

Market capitalization is the aggregate valuation of the company based on its

current share price and the total number of outstanding stocks.

Government Securities (G-Secs)

 A Government Security or G-Sec refers to a tradable instrument issued

by the Central Government or the State Government.

 Being backed by the government, these securities are considered risk-

free.
  G-Secs are, mainly, of 2 types

Treasure Bills (T-Bills)

 These are short-term Government Securities (G-Secs), with a maturity

period of less than 1 year.

o Thus, they are Money Market instrument and not a Capital

Market instrument.

 In India, only the Central Government can issue Treasury Bills (T-
Bills).

o State Governments are not empowered to issue Treasury Bills (T-

Bills).

Government Bonds or Dated Government Securities or Gilt-Edged

Securities

 These are long-term Government Securities (G-Secs), with

a maturity of more than 1 year.

o Thus, they are a Capital Market instrument and not a Money

Market instrument.

 In India, both the Central Government and the State

Governments can issue Government Bonds.

Hedge Fund

 A Hedge Fund is a type of investment fund that pools capital from

accredited individuals or institutional investors and invests in a variety
of assets,

 Thus, Hedge Funds are similar to Mutual Funds. However, as opposed

to Mutual Funds, which collect funds from the public, in the case of the
Hedge Fund, a handful of investors join together, pool their funds, and
invest in different securities.

Alternate Investment Funds (AIFs)

 An Alternate Investment Fund (AIF) refers to any privately pooled

investment fund that invests in a variety of investment avenues other
than traditional stocks, bonds, and cash.
  These funds are typically pooled investment vehicles, similar to mutual
funds or hedge funds, but they focus on alternative asset classes and
investment strategies.

 AIFs are designed to provide investors with diversification options

beyond conventional investments, aiming to reduce risk and enhance
returns under different market conditions.

Venture Capital Funds (VCFs)

Venture Capital Funds (VCFs) are investment funds that manage money from
different investors seeking to provide capital in startups and small- and
medium-sized enterprises that have strong growth potential.