Financial Markets

Financial Markets
Money Market : for short-term funds (less than a year)
Organised (Banks) Unorganised (money lenders, chit funds, etc.)

Capital Market : for long-term funds

Primary Issues Market Stock Market Bond Market

What is Money Market?

It is a market for overnight to short term funds having maturity period of one year or less. It has no physical location

Money Markets
Money Market is diversified - It consists of diverse sub-markets, each dealing in a particular type of short-term credit Money Market has evolved through many stages

Purpose of the Money Market

Banks borrow in the money market to:
Fill the gaps or temporary mismatch of funds To meet the CRR and SLR mandatory requirements as stipulated by the central bank To meet sudden demand for funds arising out of large outflows (like advance tax payments)

Structure of Money Market

Money market consists of : unorganised sector organised sector

Characteristics of Money Market

A collection of markets for several short-term debt instruments
Wholesale market Need-based market

Money Market is Efficient

Prices show all available information Price can decline/rise quickly

Benefits of an Efficient Money Market

1.

Provides a stable source of funds to banks Facilitates government market borrowing Makes effective monetary policy actions Helps in pricing different floating-interest products

2. 3. 4.

Framework of Pricing Money Market Securities

International Economic Conditions Countrys Fiscal Policy Countrys Monetary Policy Countrys Economic Conditions Issuers Industry Conditions Issuers Unique Conditions

Short term Risk Free Interest Rate (T-Bill Rate)

Risk Premium of Issuer

Required return on Money Market

Price of the Money market Security

Role of the Reserve Bank in the Money Market

Money Market provides a mechanism for an effective implementation of the monetary policy.

Money Market Instruments

Treasury bills Commercial paper Call/Notice money market Certificates of deposit Commercial bills Collateralised borrowing and lending obligation (CBLO)

Compute T-bill Discount

Compute the T-bill discount.

par pp

360

YD = ------------------- x -----------------Par n

Commercial Paper
An unsecured short-term promissory note issued at a discount

Issuers
Creditworthy Corporates Primary dealers All India financial institutions Usually privately placed with investors Attracts stamp duty Underwriting not mandatory

Guidelines Relating to CPs

Corporates, primary dealers and all India financial

institutions eligible to issue a CP

Minimum credit rating P2 of CRISIL Maturity period of minimum of 7 days and maximum up to one year from the date of issue Minimum of Rs 5 lakh and multiples To be issued in DEMAT form

Commercial Bills
A short-term, negotiable and self liquidating instrument with low risk.

Negotiable Certificates of Deposit (NCDs)

United States was the first country to create NCDs in 1961. NCD is a fixed deposit receipt issued by a bank that is negotiable in the secondary market for financial assets.

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Certificates of Deposit
A short- term tradable time deposit issued by commercial banks and financial institutions. Issued at a discount to face value. Minimum amount Rs 1 lakh and in multiples thereof Maturity period 7 days to one year for banks 1 to 3 years for FIs No lock-in period Transferable by endorsement

Banks to maintain appropriate reserve requirement on issue

of CDs. Issued in DEMAT form

Key investors--Mutual Funds

Call / Notice Money Market

Call Money Market is an integral part of the Indian money market where day-to-day surplus funds (mostly of banks) are traded Banks borrow/lend money for a period ranging between 1 and 14 days. No collateral security required Highly liquid, risky, and volatile market Banks trade money to adhere to CRR requirement Average daily turnover in March 2005 Rs.15294 cr and in March 2006 Rs 18290 cr. Call Money Borrowing and Lending rate 5% to 5.9% The borrowing is exclusively limited to banks, who are temporarily short of funds

Call money market

Call loans are generally made on a clean basis- i.e. no collateral is required The main function of the call money market is to redistribute the pool of day-to-day surplus funds of banks among other banks in temporary deficit of funds The call market helps banks economize their cash and yet improve their liquidity It is a highly competitive and sensitive market It acts as a good indicator of the liquidity position

Call Money Market Participants

Those who can both borrow and lend in the market RBI (through LAF), banks and primary dealers

Developments in Call Money Market

The volatile nature of the call money market led to emergence of market repo and collateralised borrowing and lending obligation (CBLO) instruments Repo : Repurchase agreement is the sale of securities

together with an agreement for the seller to buy. It is form of short-term borrowing for dealers in government. Usually reserve bank and commercial banks involve in repo. CBLO : Clearing Corporation of India Ltd. (CCIL) launched a new money market instrument CBLO. It is a mechanism to borrow and lend funds against securities for maturities of 1 day to 1 year.

Bond
Risk :
IRR Default Risk Marketability Risk Callability Risk

Bond Market
It is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the Secondary market.

Bond Yields has Two Components

Coupon (interest) payments The difference between the par value and the price when bond was sold.

Bond Market
The primary goal of the bond market is to provide a mechanism for long term funding of public and private expenditures.

Bond market participants

1. 2. 3. 4. 5. 6. 7. Commercial banks Finance companies Mutual funds Brokerage firms Investment banking firms Insurance companies Pension funds

Bond indices
The most common American benchmarks are the Barclays Capital Aggregate Bond Index, Citigroup BIG and Merrill Lynch Domestic Master.

Bond Prices
Bond Prices are sensitive to
Interest Rate Movements Credit Risk Exchange Rate Fluctuations

Equity Capital Markets

Primary Secondary

Stock Prices
Investor Decisions Affect Stock Prices a. Investors buy when they believe market price is below the stocks valuation; sell when market price is above b. Investors rely on Information they respond to the release of new information that affects the firms future performance

Factors Affecting Stock Prices

International Economic Conditions Countrys Fiscal Policy Countrys Monetary Policy Countrys Economic Conditions Stock Market Conditions Market Risk Premium Risk Free Interest Rate (T-Bill Rate) Expected cash Flows to be generated by the firm Price of Firm Stock Firms Risk Premium of Issuer Industry Conditions Firm Specific Conditions

Firms Systematic Risk

Required return who invest

Stock Market Index

Stock Market Index is a method of measuring a section of the stock market. Financial services firms use it as benchmarks, to measure the performance of portfolios such as mutual funds.

Stock Valuation Methods

Price-Earnings (PE) Method Valuation = Expected x per share earnings Dividend Discount Model

Mean industry PE ratio

Dt P t 1 t 1 k
where t = period Dt=dividend in period t k = discount rate Capital Asset Pricing Model Arbitrage Pricing Model

Stock Market Efficiency

Forms of Efficiency
a. Weak-Form Efficiency b. Semistrong-Form Efficiency c. Strong-Form Efficiency

Note : Rates
Repo (Repurchase) rate is the rate at which the central bank lends short-term money to the banks against securities. The reverse repo rate is the rate at which the banks park surplus funds with reserve bank, while the repo rate is the rate at which the banks borrow from the central bank. It is mostly done when there is surplus liquidity in the market. Bank rate The interest rate that is charged by a countrys central or federal bank on loans and advances to control money supply in the economy and the banking sector Benchmark prime lending rate : rate at which a bank lends its money to its prime customers that is the minimum rate at which the bank gives loans to its prime customers

Ends..