Capital n Money Market

Bachelor of Business Administration-BBA Semester 5 BB0022 Capital and Money Market - 4 Credits
Assignment Set- 1 (60 Marks)

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 what are the different forms which an underwriting agreement may take?

"An agreement entered into before the shares are brought before the public that, in the event of public not taking up the whole of them or the number mentioned in the agreement, the underwriter will, for an agreed commission, take an allotment of such part of the shares as the public has not applied for".

An Underwriting may take any of the following forms: i) Standing behind the Issue: Under this method the underwriter guarantee the sale of a specified number of shares within a specified period. If the public does not take up the whole of the specified amount of the issue, the underwriters standing behind the issue come forward to purchase the balance. Outright Purchase: Underwriters purchase the issue outright and resell the securities to the investors. The purchase price is negotiated between the issuers and the underwriters or maybe determined by competitive bidding. The Consortium Method: Underwriting is jointly done by group of underwriters who forma syndicate for the purpose. The method is adapted to large issues. The method enables the spread of risk among the members of the syndicate. No single underwriter bears the entire risk.

II)

III)

Q.2

Explain the various functions performed by stock exchange.

The stock exchange performs the following functions: 1. The stock exchange provides a ready and continuous and permanent market for the purchase and sale of existing securities. Securities traded on the exchange are easily marketable and highly liquid, less risky than other types of investment. 2. Evaluation of Securities: It is an open ,market appraisal based on a compromise between the opinion of willing buyers and willing sellers. Because of continuous purchase and sale, the current value of securities is determined. 3. Safety in dealings: The motto of stock exchange is DICTUM MEUM PACTUM i.e.: “My word is my bond”. There is high degree of commercial honour among the members of stock exchange. To ensure honesty and integrity in trading on stock exchange, its members are selected very judiciously. The members are required to observe the rules and regulations of the stock exchange. The provision of securities contract (Regulation) Act provides an element of safety to investors. 4. Mobilisation of Savings: The task of mobilising savings and directing them into productive uses in an important function. It inculcates the habit of saving, investing and risk taking among the members of general public. 5. Canalisation of Capital: Through the price quotations, stock exchange helps in canalizing national savings from less profitable to most profitable sectors of economy. The investors tend to withdraw their investments from the companies with less prospects and invest in companies whose prospects who seem to be better and reflected in their share quotations. Thus society savings are allocated to the promising issues and invested for the maximum social advantage. 6. Price Stability: The presence of a large number of buyers and sellers of securities, demand for and supply of different securities tend to equalise, thus eliminating the chances of sudden fluctuations in prices. 7. Economic Barometer: Alfred Marshal puts it, “stock exchange is not merely chief theaters of business transactions, and they are also barometers which indicate the general conditions of business in a country”. It is the nerve centre of economic health of a nation. It is a very sensitive institution that even a small change in the political, social or economic environment get immediately reflected in the dealings in the stock exchange. 8. Facilities for speculation: The stock exchange provides opportunities to shrewed businessmen to speculate and reap profits from fluctuations in security prices. Due to speculation, the supply of securities at different places may be equalised with demand.

9. Stock exchanges facilitate the growth of joint stock form of business enterprises. Due to the above important economic functions performed by the stock exchanges, they have arned a variety of names. A stock exchange has been described as the “Mart of the World” because the security which represent the ownership property of companies all over the world are marketed there.

Since a stock exchange is the market for business in securities of business concerns, it has been referred to as the market where “business of businesses” is carried on.

Q4. What are the basic requisites necessary for the growth of undeveloped money market?
(a) Highly organised commercial banking system: The commercial banks constitute the “nuclear of the whole money market”. They supply short-term funds and, therefore, any policy they follow regarding loans and advances and investments will have repercussions on the entire money market. On account of their intimate relations with the Central Bank of the country, commercial banks serve as the connecting link between the various segments of the money market and the Central Bank. A fully developed money market is characterized by the presence of a highly organised commercial banking system, while in an underdeveloped market, the banking system is not fully developed. (b) Presence of Central Bank: The second essential requisite for the organization of a developed money market is the presence of a central bank, which should be both de jure and de facto monetary and banking authority in the country. Just as a State cannot exist and function properly without a head, so also a money market cannot function without a Central Bank. The Central Bank comes to the rescue of commercial banks. and the money market as a whole in times of shortage of funds by rediscounting eligible securities. In times of emergency and crisis, the Central Bank enables the money market to convert near-money assets into cash. Besides, it performs a valuable service through open-market operations when it absorbs surplus cash during of seasons and provides additional liquidity in times of financial stringency. Thus, the central bank is the leader of money market as well as its controller and guide. Without an official central bank, a developed money market cannot exist. In an undeveloped money market, either the central bank does not exist or is in its infancy without adequate capacity to influence and control the money market. Though the existence of a well-organised banking system and a bank are essential prerequisites for the development of well organised money market, these requisites alone are not sufficient. Professor Sen cites the example of Australia where the banking system, including the central bank, has mad remarkable progress and is very well developed but there is no organised money market in Australia. Besides a well organised banking system and an efficient central bank, other factors should also be present for the existence of a well-organized and well-developed money market. (c) Availability of paper credit instruments: An efficient money market will require a continuous and adequate supply of acceptable securities such as bills of exchange, treasury bills, short-term government bonds, etc. at same time, there should be a number of dealers in the money market who should buy and sell these securities. These dealers and brokers are responsible for borrowing funds from the banks and using them to buy and hold short-term assets. Without their presence, there cannot be any competition or “life” in the money market. Thus the availability of adequate short-term assets and the presence of dealers and brokers to deal in them are essential conditions for the evolution of organized or developed money market. An under developed money market, on the other hand, is characterized by the absence of efficient short term crdit instruments as well as dealers and brokers to deal in them.

(d) Existence of a number of sub-markets: The fourth condition for the evolution of a developed money market is the existence of a number of sub-markets, each specializing in particular type of short-term asset. For instance, in the London money market, which is probably the most developed in the world, they are the call money market, the commercial money market, the treasury bill market, the foreign exchange market, and so on. Each type of short-term asset – depending upon the nature of the asset and period of maturity involved – is dealt with in a separate market. Professor Sen states, “The larger the number of sub-markets, the broader and more developed will be the structure of the money market.” An undeveloped money market does not possess all the important and essential sub-markets, particularly the bill market. Besides, there is no co-ordination between the different sectors of the money market in an undeveloped money market, because the interconnection between them is often loose and uncoordinated. As a result of this, there are great differences in money rates in the different sub-markets in an undeveloped money market.

Tow important points should be emphasized as regards the existence of sub-market. First of all, each sub-market should consist of a good number of dealers “in reasonably high competition” and should possess adequate source of supply of funds for dealing in particular short-term assets. A second point is that the sub-market should not be independent or isolated but should form an integrated structure in which every part of the money is in intimate relationship with each other. This is essential for the free flow of funds from one sub-market to another, for the existence of a common rate of interest in all sub markets and for the effective control of the entire money market by the central bank. (e) Availability of ample resources: a developed money market assumes the existence of ample resources to finance the dealings in the various sub-markets. These resources come from generally within the country but it is also possible that foreign funds may also be attracted. Well, developed money markets like London and New York, attract funds form all over the world, undeveloped money markets do not attract foreign funds mainly because of political instability and absence of stable exchange rates. (f) Other contributory factors: Apart from these above important factors which are responsible for the evolution of a developed money market over a number of years, there are many other contributory factors also, bills of exchange, great industrial development leading to the emergence of a stock market, stable political conditions, absence of discrimination against foreign concerns, and so on. London money market is the best example of a fully developed money market, for all the characteristics of a developed money market are to be found there.

Q5. Describe various sectors of Money Market.
The money market is not a single homogenous market. It is composed of several sectors of submarkets. For each type of short term credit transactions, there is specialized sub-market. The important sectors or sub-markets are: (i) Call Money Market: Call money market is an important sector of the money market. It is the market where extremely short-term funds called call money or call loans are lent and borrowed. Call loans are given just for a night, a day or a maximum of 14 days. As these loans can be called back on demand or at a short notice of 1 day, they are called call loans. They are, generally, given without any collateral securities. Such types of market fulfill the financial requirements of Bill brokers and dealers in stock exchange. These loans are preferred by commercial banks for two reasons. First, as they are given for short periods, they satisfy the requirements of liquidity. In fact, they are liquid next only to cash. They are the second line of defence to the banks. Secondly, unlike cash, they are some what profitable. (ii) Collateral loan market: Collateral loan market is one of the important sectors of the money market. This market deals with collateral loans (i.e., loans against collateral or tangible securities). Collateral loans are given for a period of 3 months or 6 months against easily realizable collateral securities. When the borrowers repay the loans, the collateral securities will be returned to the borrowers. Incase the borrowers fail to repay the loans; the collateral securities will be taken over by the leaders. Collateral loans are mainly granted by the commercial banks. Commercial banks prefer to invest their money on collateral loans for many reasons. First, they are highly profitable, because they fetch the highest yield. Secondly, as they are given against collateral securities, they are safe. Thirdly, as they are given for short periods, they are liquid. The main borrowers for collateral loans are business and industrial concerns. Stock exchange dealers and private individuals also borrow collateral loans. (iii) Acceptance Market: Acceptance market was a very prominent section of the money market in the past. But, today, its importance has declined considerably.

Acceptance market is a sub-market, which is considered with the acceptance of commercial bills, inland as well as foreign, either by specialized institutions and acceptance houses as in England or by commercial banks, on behalf of their customers. Generally a trader who sells goods on credit to a buyer may agree to draw a bill of exchange on the buyer himself, if h knows the buyer. Incase he does not know the buyer, the seller may be reluctant to sell the goods on credit and draw the bill on the buyer. In such a case, the buyer approaches a acceptance house or a commercial bank and requests it to accept the bill on his behalf. The acceptance house or the bank accepts the bill on behalf of the buyer and enables him to buy the goods on credit. The bill of exchange, which is accepted by an acceptance house or a commercial bank, can be easily discounted in the money market either with a discount house or with a commercial bank. (iv) Bill Market or discount Market: the bill market or the or the discount market is a submarket where short-term commercial bills of exchange and Government treasury bills are discounted. In the past (i.e., before the First World War), most of the bills discounted in this market consisted of commercial bills. But, after the First World War, the number of commercial bills has declined and that of Government treasury bills has increased. But, both trade bills and treasury bills, are discounted either by specialized institutions called discount houses as in England or by commercial banks. Discounting of commercial bills is popular, especially in the London money market for many reasons. First, as the bills are short dated, they are sufficiently liquid. In respect of liquidity, they rank next only to cash and call loans. Secondly, they are profitable, as they fetch good discount. Thirdly, they are safe, as the commercial bills arise out of commercial transactions and also bear the acceptances or endorsements of acceptance houses or commercial banks. Discounting of treasury bills is very popular in all the money markets, as treasury bills are safe, highly liquid and also profitable.

Q6. Explain the various constituents of organized sector in Indian Money market.
The Indian Money market is constituted by variety of institutions. On the basis of nature and functions of various institutions it can be classified on the basis of the following: (a) On the basis of persons (b) On the basis of organizations, and (c) On the basis of sub-markets. (i) Classification on the basis of persons: The classification of money market on the basis of persons associated may be divided into two parts as creditors and debtors. The persons or institutions, which ask for credit, are called debtors. On the other hand persons or institutions that provide credit in the market are called creditors. Classification on the basis of organization: On this basis, Indian Money Market can be divided into the following two parts viz., (a) Organized, and (b) Unorganized

(ii)

Organized sector: the organized sector of the Indian Money Market is well organized. It consists of managed financial institutions. The following are the important constituents of organized sector. (1) Reserve Bank of India: The Reserve Bank of India was formed on 1st April, 1935. It is the Central Bank of the country. It occupies an important space in the Indian Money Market. It has direct and close contact with th various institutions in the organized sector of the money market. But, unfortunately, it has no connection with the unorganized sector or indigenous sector. As such, it has effective control only over the organized sector, and not over the indigenous sector. (2) State Bank of India: The state Bank of India was formed on 1 st July, 1955 after the nationalization of the Imperial Bank of India. It is the biggest Commercial Bank in the country. It occupies an important position in the Indian Money Market. It receives all types of deposits from the public and provides short-term loans to merchants and manufacturers. Of late, it has been laying emphasis on providing finance to co-operative institutions, farmers and small industries. It also undertakes foreign exchange business. (3) Subsidiaries of the State Bank of India: today, there are subsidiary banks of the State Bank of India. They are: (i) The State Bank of Bikaner and Jaipur (ii) The State Bank of Hyderabad (iii)The State Bank of Mysore (iv) The State Bank of Patiala

(v) The State Bank of Sourashtra (vi) (vii) The State Bank of Travancore The State Bank of Indore.

These banks are also Commercial Banks. They receive various typs of deposits and provide short-term loans to trade and industry. (4) Twenty Nationalized Banks: Fourteen major joint stock banks with deposits of Rs. 50 crores or more were nationalized on 19th July, 1969. They are: (i) (ii) (iii) (iv) (v) (vi) The Central Bank of India The Bank of India The Punjab National Bank The Bank of Baroda The Commercial Bank The United Bank of India

(vii) The Canara Bank (viii) The Dena Bank (ix) The Syndicate Bank

(x) (xi)

The Union Bank of India The Allahabad Bank

(xii) The Indian Overseas Bank (xiii) The Bank of Maharashtra and (xiv) The Indian Bank. Again on 15th April, 1980, six more joint stock banks nationalized. They are: (i) The Vijaya Bank Ltd (ii) The Corporation Bank Ltd (iii)The Andhra Bank Ltd (iv) The Bank of India Ltd

(v) The Oriental Bank of Commerce, and (vi) The Punjab and Sindh Bank Ltd.

They are Commercial Banks. They occupy an important position in the Indian Money Market. With more than 40,000 branches, they control about 60% of the total deposits of the country. They provide short-term funds to industries, traders, farmers, and others. Some of them do foreign exchange also.

(5) Foreign Exchange Banks: There are fourteen foreign exchange banks today, in the country. These are foreign banks undertaking India’s foreign exchange business through their braches in India. They also finance the internal trade of the country. They perform even ordinary commercial banking business, such as acceptance of deposits. (6) Co-operative Credit institutions: Co-operative credit institutions are institutions, which are concerned with the provision of agricultural finance. There are three types of co-operative credit institutions in the country. They are: (i) (ii) (iii) Primary Credit Societies at Village Level Central Co-operative Banks at District Level and State Co-operative Banks at State Level.

All these institutions provide short-term finance. The state co-operative finance provides short-term finance to the central co-operative banks. The central co-operative bank provides short-term funds to the primary credit societies. The primary credit societies provide short term funds to the farmers. The co-operative credit institutions also occupy an important position in the Indian Money Market. Today, they finance about 35% of the needs of agriculturists in India. (7) Other institutions: These segments of Indian Money Market can b classified into two categories viz., (a) Public Sector Institutions: These institutions mainly include the following: (i) All India Term Leading Institutions – These are the following:

(a) (b) (c) (d) (e) (f) (g) (h) (i)

Industrial Development Bank of India (IDBI) Industrial Credit and Investment Corporation of India (ICICI) Industrial Finance Corporation of India (IFCI) Industrial Reconstruction Bank of India (IRBI) National Bank for Agriculture and Rural Development (NABARD) Export-Import Bank of India (EXIM) National Housing Bank of India (NHB) Discount and Financial Bank of India (DFHI) Small Industries Development Bank of India (SIDBI)

(ii) State Level Institutions – These are the following: (a) State Finance Corporation (b) Small Industries Development Corporation. (iii)Investment Institution – These are the following: (a) Life Insurance corporation of India (b) General Insurance Corporation (c) Unit Trust of India.

(iv)

Other institutions – These are the following:

(a) Export Credit and Guarantee Corporation of India (ECGC) (b) Deposit Insurance and Credit Guarantee Corporation of India (DICGCI) (B) Other Institutions in Private Sector – These are the following: (a) Chit Fund Companies (b) Hire Purchas Companies (c) Investment Companies (d) Corporation and other Institutions. Unorganized Sector: The indigenous bankers and moneylenders are in the unorganized sector of the Indian Money Market. They are unorganized. They do not have any connection with the Reserve Bank of India. They do not have contact even with the commercial banks or other institutions in the organized sector of the money market. As such, they are not under the control of the Reserve Bank of India. Though they are not properly organized, they play a ver prominent role in rural finance. They meet more than50% of the financial requirements of the rural people. They provide short-term loans to farmers, artisans and other people in rural areas. There are nearly 2,500 indigenous bankers in the country. They are known as shroffs, multanis, chettiars, khatris, etc.

Sub-Market: Money market can be classified on the basis of sub-markets as follows: (i) Call money Market: The market for extremely short term funds is called the Call Money Market. Bill brokers and dealers in stock exchange require loan for support periods to finance their customer in trading on margin and their own holding of securities and such funds are provided by the Commercial Banks. These funds are provided for only for upto 7 days but more often from day to day or overnight only, and do not require any collateral securities. These loans are commonly known as call loans, i.e. call money since the banks can call them at the shortest notice. Thus, call loans are highly liquid. (ii) Treasury bill Market: In this market purchase and sale of short-term government securities (generally 182 days treasury Bills) take place. They are very popular now days because of their safety. Recently they have come to prominence. (iii)Collateral Loan Market: Collateral loan market refers to collateral loans also known as broker’s loans or street loans. They are on call basis re-payable on demand or call on one day notice by the bank advancing it to brokers and dealers in securities or business houses by a pledge of stocks and bonds. It is subject to legal restrictions regarding amounts, margin to be kept, etc. They are not very popular now days. (iv) Bill Market: The market in which short-term papers of bills are bought and sold is known as the bill discount market. The most important types of short-term papers are the bills of exchange and the treasury bills.

Bachelor of Business Administration-BBA Semester 5 BB0022 Capital and Money Market - 4 Credits
(Book ID: B0101)

Assignment Set- 2 (60 Marks)

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 Why the buy back of shares should be permitted?
MEANING OF BUYBACK OF SHARES A corporation's repurchase of stock or bonds it has issued. In the case of stocks, this reduces the number of shares outstanding, giving each remaining shareholder a larger percentage ownership of the company. This is usually considered a sign that the company’s management is optimistic about the future and believes that the current share price is undervalued. Reasons for buybacks include putting unused cash to use, raising earnings per share, increasing internal control of the company, and obtaining stock for employee stock option plans or pension plans. When a company's

shareholders vote to authorize a buyback, they aren't obliged to actually undertake the buyback. Also called corporate repurchase.

Arguments For Buybacks
Buyback deception was supported by two main arguments. First, it was claimed that buybacks did not forced up stock prices, but rather that high prices were the result of improved corporate earnings, productivity, innovation, and good economic times.
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Second, it was said that even if buybacks pushed prices upwards, this benefited investors.
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Buybacks, it was claimed, were just a more tax-efficient form of dividends. In other essays, we show how the arguments regarding earnings, productivity were misleading. What remains to be seen is whether buybacks were beneficial for the long-term investors that made up most of the market. Those who deny that stock buybacks drive up prices point to specific cases in which stock prices fell, despite repurchases. Buybacks were not able to support prices in the Crash of 2000-2001, although repurchase programs were ratcheted up to record levels. Some even contend that SEC rules against manipulation are so strict that companies are not allowed to manipulate prices. With so much money involved, alternative explanations and rationalizations are to be expected. To be sure that we have not misjudged the motives of corporate executives, we must look into the counter-arguments supporting stock buybacks.

SEC Rule 10b-18
There is an argument that buybacks cannot influence stock prices, because to do so would be against the law. American securities law has prohibited stock manipulation since the 1930s. The market manipulation that went on in the 1920s, with tricks such as wash sales, round-robin trading, and pump-and-dump schemes, inspired these rules. SEC Rule 10b-18, however, provides corporations with a safe harbor from charges of manipulation when the issuer follows certain guidelines on timing, price, volume, and the method of repurchasing stock. This rule does not stop a company from forcing prices up, which is bound to happen when stocks are taken from the market. The SEC Rule 10b-18 restrictions focus on a small set of manipulative practices that might mislead investors.

For example, the SEC bars buybacks in the last thirty minutes of a trading session, because speculators often refer to closing prices when opening the market the next day. Issuers also may not buy their own stocks at prices higher than the previous trade, nor may they use more than one broker on any day, since such tactics might be used to fake transactions. Rule 10b-18 says that company purchases of company stock on the exchange may not exceed twenty-five percent of the average trading volume in the last month, but there is no limit to large block purchases. An issuer can privately purchase large blocks off the market and still buy twenty-five percent of the stock traded before the last half-hour of the session, as long as each trade is not higher than the last independent price. With excess supply removed, an independent investor trying to acquire stock will have to pay a higher price, and once a higher independent price is established, the issuer may move back into the market and force prices even higher. After September 11, 2001, the SEC loosened even these lax requirements, with the intent of encouraging issuers to manipulate prices upwards following

the terrorist attack on America. Obviously, if the SEC has bothered to issue a safe harbor rule on buybacks, the government must recognize that buybacks are indeed manipulative. The SEC seems to be saying, manipulation is OK, as long as it is orderly and brokers get their commissions.

Failed Buybacks
Another non sequitur argument is that buybacks do not always work. When news about a company is bad and when investors are motivated to sell, issuers are powerless to keep prices from falling. Equity prices are set by the small percentage of shareholders that come to the market. When there are few buyers, other than the issuer, sellers may swamp the market. However, if the news on the company is favorable and there is no selling panic, a strong buyback program can easily force prices upwards. Furthermore, in Capital Flow Analysis we do not focus on individual companies, but rather on result of what many companies do and that together moves the market. When the overall supply of stocks is reduced relative to demand, covariance between stock prices will result in an upward trend in average prices, although individual stock buyback programs may fail. Buybacks will also fail to jack up prices in bear markets. In a market crash, issuers acting in concert cannot stand against an army of determined sellers. In the Crash of 2000-2001, the value of stocks in circulation was thirty times corporate earnings. All the cash that corporations could scrape together was not enough to counter determined selling pressure by investors. Also, foreign issuers sold into the 2000-2001 bear market, neutralizing the effect of domestic buybacks. There is high covariance among stocks in the market. Buybacks inflate prices of issuers that engage in repurchase programs. When many issuers are engaged in buybacks, many stocks rise, and stocks of companies without buyback programs also rise.

Q.2

Explain the meaning of stock index futures with appropriate

examples.
Agreements to buy or sell a standardized value of a stock index, on a future date at a specified price, such as trading New York Stock Exchange composite index on the New York Futures Exchange (NYFE). As an investment instrument it combines features of securities trading based on stock indices with the features of commodity futures trading. It allows investors to speculate on the entire stock

market’s performance, short sell (see short sale) an index with a futures contract, or to hedge a long position against a decline in value. A stock index future can be defined as a futures contract where the underlying asset is a stock index. A futures contract is an agreement between two parties to purchase an asset at a fixed price and at a later date. Futures contracts are traded on a futures exchange and are subject to a daily settlement to guarantee to each party that the claims against the other party will be paid. Stock index futures are settled through cash. Structure 1. Stock index futures are based on the indices of common stock. The indices, such as S&P or the Dow Jones, are not traded
directly, but are traded only through futures contracts. The settlement of the contracts is based on cash and not the actual delivery of stock certificates.

Value
2. Stock index futures trade in terms of number of contracts. The dollar value of a stock index futures contract is calculated using the quoted futures price and multiple. The contract's multiple is a dollar amount fixed by the index.

Value Equation
3. A simple equation used to calculate the dollar value of a stock index futures contract using the quoted futures price and quoted multiple is as follows: dollar value of a stock index futures contract equals futures price times the multiple.

Daily Settlement
4. At the end of each trading day, the individual losses and gains on a stock index futures contract are credited or debited by the exchange to the trader's account. This is called the "daily settlement" procedure. The investor is required to have enough cash in the account to fund these daily variations.

Margin Requirements
5. The exchange requires cash margins to be maintained by the investor to fund the daily trade variations. This includes an upfront "initial margin" amount and a "maintenance margin," which is a minimum level of cash that the account should have until the contract is settled.

Q.3 Name the various players of the futures market who buy and sell futures contract.

A futures market, like any market, is a place where buyers and sellers meet in order to transact. For every buyer, there is a seller and for every seller, there is a buyer. Matching these two together so that a trade can be consummated requires the participation of a host of individuals and organizations, each having specific roles, which in the aggregate make the futures market the efficient mechanism that it is today. Throughout this section, reference is made solely to the futures market only for convenience and simplicity of presentation. The market for options on futures is structured in very much the same manner. The Futures and Options Exchange The central player of a futures market is a futures exchange. A futures exchange is a meeting place where futures contracts are bought and sold. Trading occurs against a background of regulatory surveillance and guidelines from the exchange itself and from the Commodity Futures Trading Commission (CFTC). Each exchange has its own list of products that it trades, and each product is traded in a designated futures trading pit. A trading pit is an area of floor, usually round with concentric steps leading down into the center. The trading pits are each divided into a number of sections designated for trading in particular contract months. No trading may occur outside a contract's assigned pit, nor is trading permitted at any time other than during those hours which have been designated by the exchange. (Some exchanges also use automated trading facilities or computer networks which serve as trading pits.) In addition to providing the market place for trading futures and regulating trading within its pits, futures exchanges also design and specify their futures contracts. Futures contracts are very specific in terms of the quality and quantity of goods underlying the contract. You may have wondered who determines these specifications. The answer is the futures exchange. Working with participants in the industry such as traders, fund managers and natural hedgers, a futures exchange designs a contract to meet the greatest need. If the exchange succeeds, it will have designed a futures product that many players can use or trade, and volume in the futures will grow. Contract specifications can sometimes be changed by the exchange, and is usually done to keep the contract viable. For this reason, it is a good idea to periodically check the specifications of the contracts that you trade or want to trade. The Futures Broker Buying or selling a futures contract or an option on a futures contract can only be done in one place: the trading pit on the floor of a futures exchange. To stand in a trading pit, you need to buy an exchange membership, pay annual dues, and register with various regulatory agencies. Naturally, few people would trade futures if it required that they stand in the trading pit. To solve this problem, in steps the futures broker. Your broker acts as a communication link between the trading pit and you, taking orders from you, the customer, and executing them in the futures pit. This is the traditional path that a futures order takes as it passes through the system (there are some exciting new developments in the world of trading, such as online trading where you place the order through an online broker or via specialized software): You, the customer, decide to buy or sell a futures contract. You phone your order to the futures order desk of our Futures Commission Merchant (FCM). The order desk relays by telephone your order to the phone clerk on the exchange floor. The clerk writes the futures order, time stamps it, and delivers it to the executing floor broker in the trading pit. If a market order, the order is executed. If any other kind of order, it is placed in a "deck" along with other orders ready to be executed if triggered by price movements. Once executed, the floor broker informs the clerk who informs the order desk who, in turn, informs you. You now have a futures position. The FCM prepares a trade confirmation report and mails it to you. The FCM marks-to-market your futures position against the margin in your trading account.

As you can see, there are several players, each having different roles, who are involved in the process. Despite the steps involved, the process has become very efficient - orders can often be executed within a minute or two while you wait on the phone. You may wonder why a futures broker requires an FCM to complete this process. By law, futures brokers do not have the authority to take customer funds and hold them in deposit. Only an FCM can do this. For this reason, a futures broker needs to team up with an FCM in order to provide order execution services to its customers. The Futures Commission Merchant The Futures Commission Merchant (FCM) is responsible for holding customer funds of the margin account, clearing the futures trade, and performing all back-office recording functions such as marking-to-market your futures account, sending trade confirmations and account summaries, and year-end tax forms. Customers who open a futures trading account deposit their margin funds at an FCM. The Clearing Corporation The clearing corporation guarantees the performance of every buyer and seller of a futures or options contract. In a literal sense, it stands as a buyer to every seller and a seller to every buyer. As a futures trader, that means that you don't have to worry about any default of a futures counterparty. For instance, say that you purchase several Swiss franc futures and the price goes up so that you have accrued a $4,500 profit. Whoever sold those futures contracts (and there is a seller for every buyer, and vice-versa) has incurred a loss of $4,500. What happens if that person can't pay? Do you sacrifice your profit? The answer is "NO". The clearing corporation guarantees the transaction. The clearing corporation's elimination of such counterparty credit risk provides a great benefit to the futures and options markets. You may wonder how the clearing corporation does this. The answer lies in the margin deposit that you and every other futures trader must make before trading any contract. This margin is available to the clearing corporation and, together with other reserve cash and various protection funds, are used to cover any customer default. A clearing corporation is composed of clearing members, most of which are large FCM's. It is a mark of distinction for an FCM to be a clearing member. Regulation of the Futures Market All futures industry-related operations, including exchanges, brokers and FCMs are regulated and licensed by the Commodity Futures Trading Commission (CFTC), a federal agency with jurisdiction over the United States commodities markets. The CFTC regulates in conjunction with the National Futures Association (NFA), the industry's only national association. The primary purpose of the NFA is to ensure, through self-regulation, high standards of professional conduct and financial responsibility on the part of the individuals and organizations that are its members: Futures Commission Merchants, Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators, and Associated Persons. In connection with its regulatory responsibilities, the NFA conducts periodic audits of its members' financial and other records, monitors sales practices and provides a mechanism for the arbitration of futures related disputes between NFA members and the investing public. Example: A silversmith must secure a certain amount of silver in six months time for earrings and bracelets that have already been advertised in an upcoming catalog with specific prices. But what if the price of silver goes up over the next six months? Because the prices of the earrings and bracelets are already set, the extra cost of the silver can't be passed on to the retail buyer, meaning it would be passed on to the silversmith. The silversmith needs to hedge, or minimize her risk against a possible price increase in silver. How? The silversmith would enter the futures market and purchase a silver contract for settlement in six

months time (let's say June) at a price of $5 per ounce. At the end of the six months, the price of silver in the cash market is actually $6 per ounce, so the silversmith benefits from the futures contract and escapes the higher price. Had the price of silver declined in the cash market, the silversmith would, in the end, have been better off without the futures contract. At the same time, however, because the silver market is very volatile, the silver maker was still sheltering himself from risk by entering into the futures contract. So that's basically what hedging is: the attempt to minimize risk as much as possible by locking in prices for future purchases and sales. Someone going long in a securities future contract now can hedge against rising equity prices in three months. If at the time of the contract's expiration the equity price has risen, the investor's contract can be closed out at the higher price. The opposite could happen as well: a hedger could go short in a contract today to hedge against declining stock prices in the future. A potato farmer would hedge against lower French fry prices, while a fast food chain would hedge against higher potato prices. A company in need of a loan in six months could hedge against rising interest rates in the future, while a coffee beanery could hedge against rising coffee bean prices next year.

Q.4 Describe the role played by dealers in the Money Market.
Primary dealers are large commercial banks which operate under the supervision of the U.S. Federal bank or broker-dealers registered with the SEC. They are required to have a capital base in accord with Tier 1 and Tier 2 capitalization, which covers both equity capitalization and core capitalization. Capitalization is a significant qualification for being a primary dealer because PDs keep the Federal Reserve trading desk operations running efficiently. Primary dealers buy securities from those issuing them and then sell them to smaller investors. The system of dealing through primary dealers gives the sellers an assurance that all the securities on issue will be sold. But at the same time it gives the primary dealers a lot of power and the ability to manipulate the process of buying and selling securities. For this reason strict laws have been enacted to prevent any collusion between dealers and to ensure that they cannot take undue advantage of their monetary power. Role of Government : To increase the stability of Financial Institutions and Markets, Government intervenes in the interest rates and money supply in the Money Markets. Government has several ways to control income and interest rates, which can be divided into two broad groups, fiscal policy and monetary policy. The government to adjust the exchange rate intervenes with the foreign exchange Markets; there may be an effect on the monetary base and the supply of money. When the currency is falling, foreign currencies must be sold and the currency must be bought to stabilize its price. The use of deposits of the national currency to do this suggest that the operational deposits of the banking sector must be reduced, causing the monetary base to fall, affecting the supply of money. Conversely, by selling the national currency to reduce its rate, the monetary base will rise. Securities may be sold on the open market in an attempt to dampen the effects of inflows of the national currency, but this would imply an increase in interest rates and cause the currency to rise further still. A number of institutions can affect the supply of money, but the greatest impact on the money supply is had by the central bank and the commercial banks. Role of Central Bank : • Firstly, the central bank could do this by setting a required reserve ratio, which would restrict the ability of the commercial banks to increase the money supply by loaning out money. If this requirement were above the ratio the commercial banks would have wished to have, then the banks will have to create fewer deposits and make fewer loans then they could otherwise have profitably done. If the central bank imposed this requirement in order to reduce the money supply, the commercial banks will probably be unable to borrow from the central bank in order to increase their cash reserves if they wished to make further loans. They might try to attract further deposits from customers by increasing their interest rates, but the central bank may retaliate by increasing the required reserve ratio. • The central bank can affect the supply of money through special deposits. These are deposits at the central bank, which the banking sector is required to lodge. These are then frozen, thus preventing the sector from accessing them, although interest is paid at the average treasury bill rate. Making these special deposits reduces the level of the commercial banks’ operational deposits, which forces them to cut back on lending. • The supply of money can also be controlled by the central bank by adjusting its interest rate, which it charges when the commercial banks wish to borrow money (the

discount rate). Banks usually have a ratio of cash to deposits, which they consider to be the minimum safe level. If demand for cash is such that their reserves fall below this level, they will able to borrow money from the central bank at its discount rate. If market rates were 8%, and the discount rate were also 8%, then the banks could reduce their cash reserves to their minimum ratio, knowing that if demand exceeds supply they will be able to borrow at 8%. The central bank, though, may raise its discount rate to a value above the market level, in order to encourage banks not to reduce their cash reserves to the minimum through excess loans. By raising the discount value to such a level, the commercial banks are given an incentive to hold more reserves, thus reducing the money multiplier and the money supply. • Another way the money supply can be affected by the central bank is through its manipulation of the interest rate. This is akin to the discount rate mentioned above. By raising or lowering interest rates, the demand for money is respectively reduced or increased. If it sets them at a certain level, it can clear the market at level by supplying enough money to match the demand. Alternatively, it could fix the money supply at a certain rate and let the market clear the interest rates at the equilibrium. Trying to fix the money supply is not easy, so central banks usually set the interest rate and provide the amount of money the market demands. • The central bank may also affect the money supply through operating on the open market. This allows it to manipulate the money supply through the monetary base. It may choose to either buy or sell securities in the marketplace, which will either inject or remove money respectively. Thus, the monetary base will be affected, causing the money supply to alter. To illustrate this, suppose the central bank sold gilts(Risk-free bonds) worth $10 million. $10 million would flow from the deposits of the purchasers to the central bank, taking the $10 million out of the monetary base. To inject money into the economy, the central bank would have to buy the gilts. As lenders and borrowers: Banks and institutions such as commercial banks, both Indian and foreign, State Bank of India, Cooperative Banks, Discount and Finance House of India ltd. (DFHL) and Securities Trading Corporation of India (STCI). As lenders: Life Insurance Corporation of India (LIC), Unit Trust of India (UTI), General Insurance Corporation (GIC), Industrial Development Bank of India (IDBI),National Bank for Agriculture and Rural Development (NABARD), specified institutions Already operating in bills rediscounting market, and entities/corporate/mutual funds. The participants in the call markets increased in the 1990s, with a gradual opening upof the call markets to non-bank entities. Initially DFHI was the only PD eligible to participate in the call market, with other PDs having to route their transactions through DFHI, and subsequently STCI. In 1996, PDs apart from DFHI and STCI were allowed to lend and borrow directly in the call markets. Presently there are 18 primary dealers participating in the call markets. Then from 1991 onwards, corporate were allowed to lending the call markets, initially through the DFHI, and later through any of the PDs. In order to be able to lend, corporate had to provide proof of bulk lendable resources to the RBI and were not suppose to have any outstanding borrowings with the banking system. The minimum amount corporate had to lend was reduced from Rs. 20 crore, in a phased manner to Rs. 3 crore in 1998.There were50 corporate eligible to lend in the call markets, through the primary dealers. The corporate which were allowed to route their transactions through PDs, were phased out by end June 2001.

Q.5 List the basic features of the Indian Money Market.
Every money is unique in nature. The money market in developed and developing countries differ markedly from each other in many senses. Indian money market is not an exception for this. Though it is not a developed money market, it is a leading money market among the developing countries. Indian Money Market has the following major characteristics :1. Dichotomy Structure: It is a significant aspect of the Indian money market. It has a simultaneous existence of both the organized money market as well as unorganized money markets. The organized money market consists of RBI, all scheduled commercial banks and other recognized financial institutions. However, the unorganized part of the money market comprises domestic money lenders, indigenous bankers, trader, etc. The organized money market is in full control of the RBI. However, unorganized money market remains outside the RBI control. Thus both the organized and unorganized money market exists simultaneously. 2. Seasonality : The demand for money in Indian money market is of a seasonal nature. India being an agriculture predominant economy, the demand for money is generated from the agricultural operations. During the busy season i.e. between October and April more agricultural activities takes place leading to a higher demand for money. 3. Multiplicity of Interest Rates : In Indian money market, we have many levels of interest rates. They differ from bank to bank from period to period and even from borrower to borrower. Again in both organized and unorganized segment the interest rates differs. Thus there is an existence of many rates of interest in the Indian money market. 4. Lack of Organized Bill Market : In the Indian money market, the organized bill market is not prevalent. Though the RBI tried to introduce the Bill Market Scheme (1952) and then New Bill Market Scheme in 1970, still there is no properly organized bill market in India. 5. Absence of Integration : This is a very important feature of the Indian money market. At the same time it is divided among several segments or sections which are loosely connected with each other. There is a lack of coordination among these different components of the money market. RBI

has full control over the components in the organized segment but it cannot control the components in the unorganized segment. 6. High Volatility in Call Money Market : The call money market is a market for very short term money. Here money is demanded at the call rate. Basically the demand for call money comes from the commercial banks. Institutions such as the GIC, LIC, etc suffer huge fluctuations and thus it has remained highly volatile. 7. Limited Instruments : It is in fact a defect of the Indian money market. In our money market the supply of various instruments such as the Treasury Bills, Commercial Bills, Certificate of Deposits, Commercial Papers, etc. is very limited. In order to meet the varied requirements of borrowers and lenders, It is necessary to develop numerous instruments.

Q.6 what are the various efforts made by the Government to make the government securities an attractive investment?
From a narrow ownership base, Government securities market has been increasingly becoming broadbased over the recent years. The main holders of government securities are banks, Primary/ Satellite Dealers, LIC, All India Financial Institutions, Provident Fund Trusts, Gilt Funds and lastly corporate entities and retail holders, mainly through Mutual Funds. Although Foreign Institutional Investors are allowed to invest in government securities such investments have not picked up. A large part of outstanding government securities are held by the Reserve Bank mainly as back up for its currency issue liabilities and for conducting Open Market Operations. Introduction of the system of Primary Dealers have ensured that underwriting of the primary issues is shouldered mainly by Primary Dealers and automatic devolvement on RBI does not happen. The main participants in the Government Securities market such as banks, Primary Dealers, Financial Institutions enter into transactions in government securities market mainly as a part of their investment and trading functions. RBI has issued detailed instructions to banks about the categorization and valuation of government securities. Further banks, which maintain "Trading Book", can do so, only subject to compliance with certain preconditions specified by the RBI from risk management angle. In order to develop the market on sound lines, RBI has initiated various reforms. Thus the prices at which different securities are bought/sold are made available to the market participants on a daily basis. National Stock Exchange also publishes the security prices in respect of transactions reported to them. As mentioned earlier system of DVP has been introduced to reduce counterparty risk in security transfers. In order to protect the interest of retail holders of government securities using the system of Constituents SGL Accounts, RBI have issued guidelines regarding maintenance of such accounts. A system of retail holding through Bond Ledger Form has also been introduced in respect of certain

securities. Bond Ledger Accounts can be opened with branches of specified banks and this is expected to make it convenient for retail holders, although at present only Relief Bonds can be so held. RBI extends liquidity support to Mutual Funds Dedicated to Investments in Government Securities (GILT FUNDS) to encourage such Mutual Funds, which is a convenient way of indirect investments in government securities by individuals and other market participants. Primary Dealers play an important role in the government securities market. A brief account of their role is provided in the following paragraphs: Primary Dealers The Guidelines for Primary Dealers (PDs) in Government Securities were announced by the Bank in March 1995. The objectives of setting up the system of Primary Dealers are: i. ii. iii. iv. To strengthen the infrastructure in the government securities market in order to make it vibrant, liquid and broad based. To ensure development of underwriting and market making capabilities for government securities outside the RBI so that the latter will gradually shed these functions. To improve secondary market trading system, which would contribute to price discovery, enhance liquidity and turnover and encourage voluntary holding of government securities amongst a wider investor base. To make PDs an effective conduit for conducting open market operations.

Eligibility for being considered for Primary Dealership The following are the eligibility standards: i. The entity should be a subsidiary of a scheduled commercial bank/an All India Financial Institution dedicated predominantly to the securities business and in particular to the government securities market, or a company incorporated under the Companies Act, 1956 and engaged predominantly in the securities business and in particular the government securities market, and The applicant should have Net owned funds of a minimum of Rs.50 crore.

ii.

Three basic parameters would have to be necessarily fulfilled by an applicant for PD-ship, i.e., the company should have (a) net owned funds of Rs.50 crore (b) sizeable business in government securities and (c) should not be a loss making company. The relationship between the Bank and the entities in their capacity as PDs is not statutory, but contractual in nature. Primary Dealership is renewed every year on the basis of agreement to be entered into between the Bank and these entities. Legally they are non-banking financial companies and are subject to the registration requirements for NBFCs. However, if a PD does not accept public deposits it is exempt from the related regulations. On account of the special responsibilities assigned to them in the Government Securities Market, RBI has been monitoring their activities by undertaking off as well as on site surveillance through scrutiny of prescribed returns and also by on-site inspections to check compliance with the Guidelines and other terms of appointment. RBI has prescribed capital adequacy standards to be observed by Primary Dealers. The Primary Dealers' responsibilities are: i. A Primary Dealer will be required to commit to aggregative bid for Government of India dated securities and auction Treasury Bills on an annual basis of not less than a specified amount. The agreed minimum amount of bids would be separately indicated for dated securities and Treasury Bills. The Primary Dealer would have to achieve a minimum success ratio of 40 per cent for both dated securities and Treasury Bills (vis-à-vis bidding commitment). To maintain risk based capital adequacy as per RBI instructions

ii. iii.

iv. v.

The PD has to quote two-way at least in a few securities PDs have to underwrite primary auction of government securities.

Issues of Treasury Bills are not underwritten. Instead, PDs have to commit to submit minimum bids at each auction covering the entire issue amounts. The percentage of minimum bidding commitment so determined by the Reserve Bank will remain unchanged for the entire financial year. In determining the minimum bidding commitment, RBI will take into account the offer made by the PD, its net owned funds and its track record. Facilities extended to the PDs The following facilities have been extended to PDs: i. ii. iii. iv. v. Entitlement to open one Current Account and two Subsidiary General Ledger (SGL) Accounts for government securities (one for own operations and the second for operations on behalf of constituents), at all offices of the RBI. Permission to borrow and lend in the money market including call money market and to trade in all money market instruments. Liquidity Support through Repos operations/demand loans with RBI collateralized by Central Government dated securities and Auction Treasury Bills upto the limit fixed by RBI. Favored access to Open Market Operations. Permission to raise Commercial Paper as per the provisions contained in the "Primary Dealers (Acceptance of Deposits through Commercial Paper) Directions, 1996" issued in terms of Section 45 K and 45 L of the RBI Act, 1934. Facility of transfer of funds from one centre to another centre under RBIs Remittance Facility Scheme and also of clearing of cheques arising out of Government securities transactions, tendered at RBI counters.

vi.

Other Obligations of PDs The following important obligations are cast on them under the PD Guidelines: i. ii. iii. Obligation to offer a firm two-way quotes for government securities and take principal positions Achieving prescribed turn over ratios in government securities. Maintenance of physical infrastructure in terms of office, computing equipment, communication facilities like Telex/Fax, Telephone, etc., and skilled manpower for efficient participation in primary issues, trading in the secondary market, and to provide advice and education to investors. Putting in place efficient internal control system. Obligation to provide to RBI access to all records, books, information and documents as may be required. Adherence to all prudential and regulatory guidelines prescribed by RBI from time to time. Formation of self regulatory organization (SRO). Maintenance of a separate desk for government securities business and separate accounts and has an external audit of annual accounts. Maintenance separate accounts in respect of its own position and customer transactions. Responsibility to bring to RBIs attention any major complaint against him or action initiated/taken against him by authorities such as the Stock Exchanges, SEBI, CBI, Enforcement Directorate, Income Tax, etc. Setting up prudential ceilings, with the prior approval of the Board of Directors of the company, on borrowings from the money market including repos, as a multiple of net owned funds, subject to the guidelines, if any, issued by the Reserve Bank in this regard.

iv. v. vi. vii. viii. ix.

x.
xi.