In this post, we are providing notes on money market and capital market pdf – money market and capital market instruments – similarities between money market and capital market – difference between capital market and money market.
The money market and capital market are two important segments of the financial market in India. The money market deals with short-term debt instruments and borrowing and lending of funds with a maturity period of up to one year. Some of the instruments traded in the money market include treasury bills, commercial paper, certificates of deposit, call money, and commercial bills. On the other hand, the capital market deals with long-term securities such as stocks, bonds, and debentures. The capital market provides a platform for companies to raise long-term capital through the issuance of securities, and investors to buy and sell such securities for investment purposes. The capital market is further divided into primary and secondary markets.
The money market is a segment of the financial market where short-term borrowing and lending of funds occur, typically with a maturity period of one year or less. The money market deals with various instruments such as treasury bills, commercial papers, certificates of deposit, and repurchase agreements. The primary objective of the money market is to facilitate short-term liquidity management and enable banks and other financial institutions to meet their short-term funding requirements. The Reserve Bank of India plays a crucial role in regulating and managing the money market in India.
Money market instruments
Money market instruments refer to short-term debt securities that are traded in the money market. These instruments have a maturity period of one year or less and are typically issued by governments, financial institutions, and large corporations to meet their short-term funding requirements. Some common money market instruments include treasury bills, commercial papers, certificates of deposit, and repurchase agreements. Treasury bills are short-term government securities that are issued to raise funds from the market, while commercial papers are unsecured promissory notes issued by corporations to raise short-term funds. Certificates of deposit are issued by banks and other financial institutions to raise funds from the public, and repurchase agreements involve the sale and repurchase of securities at a predetermined price.
Money market instruments are popular among investors who seek low-risk and low-return investments. These instruments offer a relatively high degree of safety and liquidity, making them attractive to investors who need to park their funds for a short period of time. The interest rates on money market instruments are generally lower than long-term interest rates, reflecting the shorter maturity and lower risk involved.
Call money is a type of short-term borrowing and lending in the money market, where funds are borrowed or lent on a day-to-day basis. It is also known as “overnight money” as the borrowing and lending transactions are settled on the same day. Call money is typically used by banks and financial institutions to meet their temporary liquidity requirements or to invest their excess funds for a short period of time. The interest rates on call money transactions are determined by market forces of demand and supply and are generally lower than other money market instruments due to their short-term nature. The Reserve Bank of India (RBI) regulates the call money market in India and sets the minimum and maximum interest rates that can be charged for call money transactions.
The bill market, also known as the discount market, is a segment of the money market where short-term debt instruments called bills of exchange are traded. These bills are essentially promissory notes issued by companies, banks, or governments, guaranteeing payment of a specified amount on a specific date in the future. The bill market in India is regulated by the Reserve Bank of India (RBI) and includes both the treasury bill market and the commercial bill market. The treasury bill market deals with short-term government securities issued by the RBI on behalf of the government, while the commercial bill market deals with bills of exchange issued by companies to finance their short-term working capital needs. Investors in the bill market typically purchase bills at a discount to their face value, which represents the interest earned on the instrument.
T-Bills: A Money Market Instrument
Treasury Bills, also known as T-Bills, is a popular money market instrument issued by the central government to raise short-term funds. These are short-term debt instruments with a maturity period of up to one year, usually ranging from 14 days to 364 days. T-Bills are sold at a discount to their face value, which means that investors can buy them for less than their face value and earn a return when the bill matures. The difference between the purchase price and the face value is the investor’s return on investment. T-Bills are considered to be one of the safest investments since they are issued by the central government and have no default risk. They are also highly liquid, meaning that investors can easily buy or sell them in the secondary market.
Cash Management Bills (CMBs)
Cash Management Bills (CMBs) are short-term debt instruments issued by the Reserve Bank of India (RBI) on behalf of the Central Government to meet temporary mismatches in the cash flows of the government. They have a maturity period of up to 90 days and are issued at a discount to face value. CMBs are used by the government to manage its cash balances and meet any unexpected expenditures without having to resort to higher borrowing from the market. They are considered safe and liquid investments for investors, as they are backed by the creditworthiness of the government. CMBs can be bought and sold in the secondary market, providing investors with an avenue for short-term investment and trading opportunities.
Interbank Term Money
Interbank term money refers to funds borrowed or lent by banks or financial institutions to each other for a fixed period, usually ranging from 1 day to 1 year. It is a type of money market instrument that allows banks to manage their short-term funding needs by borrowing or lending money to other banks. Interbank term money rates are determined by market demand and supply, as well as the prevailing interest rate environment. These rates are used as benchmarks for other short-term borrowing and lending rates in the financial system. The interbank term money market is an important component of the overall money market in many countries, including India.
Certificates of Deposit
Certificates of Deposit (CDs) are a type of money market instrument that allows individuals and institutions to earn a fixed rate of interest on their savings over a specified period of time. CDs are issued by banks and financial institutions and have a fixed maturity date, ranging from a few weeks to several years. When an investor purchases a CD, they agree to deposit a specific amount of money with the issuing bank or financial institution for a set period of time. In return, the investor earns a fixed rate of interest on their deposit, which is typically higher than the interest rates offered on savings accounts. The longer the maturity period of the CD, the higher the rate of interest paid. CDs are considered a safe investment option as they are typically insured by the government up to a certain amount, usually up to Rs. 5 lahks in India.
Inter Corporate Deposits Market
Inter-corporate deposits (ICDs) refer to short-term borrowings and lendings between corporates. The inter-corporate deposits market provides a platform for corporates to invest their surplus funds or borrow funds for a short duration from other corporates. The duration of these deposits can range from a few days to a few months, and the interest rates are typically higher than those in the money market due to the higher risk involved. The inter-corporate deposits market is not as regulated as the money market, and therefore, carries a higher level of credit risk.
Commercial Paper (CP)
Commercial Paper (CP) is a short-term debt instrument issued by companies to meet their short-term funding requirements. It is an unsecured promissory note issued in a discounted form with a fixed maturity date, usually ranging from 7 days to 1 year. CPs are typically issued by companies with a high credit rating, and the interest rates are determined by market forces and credit ratings of the issuing company. The minimum investment in CPs is usually Rs. 5 lakh, and they are mainly held by banks, financial institutions, and corporate treasuries. CPs are a popular source of short-term funding for companies as they are relatively easy to issue and offer flexibility in terms of timing and size. They also provide investors with a short-term investment option with a relatively higher yield than traditional bank deposits.
Commercial bills, also known as trade bills or trade acceptances, are short-term negotiable debt instruments used to finance the purchase of goods and services by businesses. They are essentially IOUs issued by a buyer of goods or services to the seller, who can then sell them to investors for cash before they mature. Commercial bills are usually issued for periods of up to 180 days and are typically backed by a letter of credit from a bank or financial institution, which provides assurance that the bill will be paid on maturity. They are an important source of short-term funding for businesses and are traded in the money market.
Discount and Finance House of India (DFHI)
Discount and Finance House of India (DFHI) is a subsidiary of the Reserve Bank of India (RBI) that operates in the money market. It was established in 1988 to provide an additional market for government securities and to regulate the interbank money market in India. DFHI facilitates the issuance and trading of Treasury Bills and other money market instruments and also provides short-term funds to banks and other financial institutions. DFHI plays an important role in managing the liquidity of the banking system by providing funds to banks during periods of stress and by acting as a lender of last resort.
Working of DFHI
Discount and Finance House of India (DFHI) is a financial institution in India that was established in 1988 to provide a discounting facility for short-term money market instruments. DFHI is owned by the Reserve Bank of India (RBI) and is regulated by the RBI.
The working of DFHI involves the following steps:
- Discounting of Money Market Instruments: DFHI provides a discounting facility to banks and financial institutions for money market instruments like commercial bills, treasury bills, and certificates of deposit. The banks and financial institutions sell these instruments to DFHI at a discounted rate and receive the funds immediately.
- Investment in Government Securities: DFHI also invests in government securities like treasury bills and bonds to earn income on its surplus funds.
- Repurchase Agreements: DFHI enters into repurchase agreements with banks and financial institutions to provide them with short-term liquidity. Under a repurchase agreement, DFHI buys government securities from banks and financial institutions with an agreement to sell them back at a predetermined price on a future date.
- Money Market Development: DFHI also plays a role in developing the money market in India by promoting the use of money market instruments and providing a platform for banks and financial institutions to trade in these instruments.
London Interbank Offered Rate (LIBOR)
The London Interbank Offered Rate (LIBOR) is the interest rate at which major global banks lend to one another in the international interbank market for short-term loans. LIBOR serves as a benchmark rate for various financial products, such as adjustable-rate mortgages, business loans, and derivatives contracts. It is calculated and published daily in five currencies (USD, EUR, GBP, CHF, and JPY) and multiple tenors (overnight, 1-week, 1-month, 3-month, 6-month, and 1-year). LIBOR is scheduled to be phased out by the end of 2021 due to concerns over its reliability and potential for manipulation and will be replaced by alternative benchmark rates such as the Secured Overnight Financing Rate (SOFR) in the US and the Sterling Overnight Index Average (SONIA) in the UK.
Mumbai Interbank Offered Rate (MIBOR)
Mumbai Interbank Offered Rate (MIBOR) is a benchmark interest rate at which banks in Mumbai lend to one another on an unsecured basis. It is calculated on a daily basis by the National Stock Exchange of India (NSE) and represents an average of the rates at which a panel of banks are willing to lend or borrow funds from each other in the Mumbai interbank market. MIBOR serves as a benchmark for short-term interest rates in India and is used as a reference rate for a variety of financial products, including loans, bonds, and derivatives. The Reserve Bank of India (RBI) uses MIBOR as a key indicator of the monetary policy stance and takes it into consideration while setting the repo rate, which is the rate at which the RBI lends money to banks.
Reforms of Money Market
Money market reforms refer to the changes and initiatives undertaken by the Reserve Bank of India (RBI) to improve the functioning and efficiency of the money market in India. These reforms aim to enhance transparency, deepen liquidity, and promote the development of new instruments in the money market. Some of the key reforms introduced by the RBI include the creation of a tri-party repo market, the introduction of a new liquidity framework based on the Marginal Standing Facility (MSF) and the Standing Deposit Facility (SDF), and the establishment of the Clearing Corporation of India (CCIL) to provide central counterparty clearing and settlement services for money market transactions. Other measures taken to strengthen the money market in India include the introduction of a credit rating system for money market instruments, the adoption of international accounting and disclosure standards, and the promotion of electronic trading platforms to improve price discovery and enhance market efficiency.
The capital market refers to a segment of the financial market where long-term securities are traded, such as stocks, bonds, and other instruments with a maturity period exceeding one year. The primary function of the capital market is to facilitate the allocation of long-term capital to corporations, governments, and other entities to finance their investment needs. In the capital market, companies issue securities to raise funds from investors, who purchase them in exchange for a share in the ownership or interest payments. The capital market plays a crucial role in the economy by channeling savings into productive investments, promoting economic growth and development. It also provides an avenue for investors to earn returns on their investments and diversify their portfolios. The capital market is regulated by securities market regulators such as the Securities and Exchange Board of India (SEBI) to ensure fair and transparent trading practices and protect the interests of investors.
Capital market instruments
Capital market instruments are financial products that are used to raise capital from investors in the capital markets. These instruments can be divided into two main categories: equity securities and debt securities.
Equity securities, also known as stocks or shares, represent ownership in a company. When you purchase a stock, you become a part-owner of the company and share in its profits and losses. Equity securities can be traded on stock exchanges or over-the-counter markets.
Debt securities, such as bonds, represent a loan made by an investor to a borrower, typically a corporation or government entity. The borrower agrees to pay back the loan at a specified interest rate and maturity date. Debt securities can also be traded on the secondary market.
Similarities between money market and capital market
Money market and capital market are both parts of the financial market that serve different purposes but are interconnected. Here are some similarities between the two:
- Both markets provide a platform for buying and selling financial instruments. Money market and capital market both provide a platform for buying and selling financial instruments such as bonds, stocks, and securities.
- Both markets involve the trading of financial assets. Money market and capital market both involve the trading of financial assets, but the nature of the assets traded in each market is different.
- Both markets provide opportunities for investors to earn returns. Money market and capital market both provide opportunities for investors to earn returns on their investments. Money market investments typically offer lower returns but also lower risks, while capital market investments offer higher returns but also higher risks.
- Both markets are regulated by the government and other regulatory bodies. Money market and capital market are both regulated by the government and other regulatory bodies to ensure that investors are protected and the markets operate in a fair and transparent manner.
Difference between capital market and money market
Capital market and money market are two important components of the financial market, but they differ in many ways. Here are some of the key differences:
- Purpose: Capital market is used to raise long-term capital by companies and governments through the issuance and trading of securities such as stocks and bonds. Money market, on the other hand, is used to provide short-term funds to businesses, banks, and governments through the trading of short-term securities such as treasury bills and commercial paper.
- Risk and return: Capital market investments are generally riskier than money market investments but offer the potential for higher returns over the long term. Money market investments, on the other hand, are generally considered low-risk investments but offer lower returns compared to the capital market.
- Maturity: Capital market instruments have a longer maturity period, usually more than one year, while money market instruments have a shorter maturity period, usually less than one year.
- Trading volume: Capital market transactions involve large sums of money and take place less frequently than money market transactions, which involve smaller sums of money and occur more frequently.
- Participants: Capital market participants include corporations, governments, institutional investors, and retail investors, while money market participants include banks, financial institutions, and other large corporations.
Components of the capital market in India
The capital market in India comprises two main components:
- Primary market: It is the market where companies issue new securities to raise capital from the public. These securities may include equity shares, preference shares, and debentures. The primary market is regulated by the Securities and Exchange Board of India (SEBI).
- Secondary market: It is the market where existing securities are traded among investors. The securities traded in the secondary market include equity shares, bonds, debentures, and other financial instruments. The secondary market is regulated by SEBI and the stock exchanges in India, such as the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE).
The primary market, also known as the new issue market, is where newly issued securities are bought and sold for the first time. In the primary market, companies raise funds by issuing securities such as equity shares, preference shares, debentures, and bonds. These securities are sold to the public through initial public offerings (IPOs), rights issues, or private placements. The secondary market, also known as the stock market or the stock exchange, is where securities that have already been issued in the primary market are bought and sold by investors. The secondary market provides liquidity to investors by allowing them to sell their securities to other investors, enabling them to exit their investments and realize their gains or losses. In India, the major stock exchanges include the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE), which provide a platform for trading in equity shares, preference shares, bonds, and other securities.
The capital market also includes other intermediaries such as investment banks, brokerages, mutual funds, and insurance companies, which play an important role in facilitating the buying and selling of securities, providing research and advisory services to investors, and managing their investments. The capital market is an important component of the Indian financial system, providing a crucial source of long-term funding for companies and enabling investors to participate in the growth of the economy.
Government securities or bonds are debt instruments issued by the government to finance its budget deficits or meet other financing needs. These securities are considered to be safe investments because they are backed by the full faith and credit of the government. In India, government securities are issued by the Reserve Bank of India on behalf of the Government of India. They come in various tenures ranging from 1 year to 40 years and carry a fixed rate of interest. The interest is paid semi-annually, and the principal is repaid on the maturity date. Government securities are traded in the capital market through a process called auction. The auction is conducted by the Reserve Bank of India on a weekly basis. Market participants, such as banks, primary dealers, and institutional investors, can bid for these securities at the auction. The bidding process determines the cut-off yield, which is the minimum yield accepted by the RBI for the auction. The cut-off yield is determined by the demand and supply of the securities in the market.
Dated Government Securities
Dated Government Securities (or Dated G-Secs) are long-term debt instruments issued by the government of India to fund its fiscal deficit and other expenditure requirements. They are called ‘dated’ because they have a specific maturity date, which can range from 5 to 40 years. Dated G-Secs are one of the safest investment options in India and are considered virtually risk-free as they are backed by the government’s sovereign guarantee. They are issued at face value and pay a fixed coupon rate to investors, which is generally paid twice a year. The coupon rate is determined by the prevailing market conditions at the time of issuance. Dated G-Secs are actively traded on the capital market, and their prices and yields are determined by market demand and supply dynamics. They are an important benchmark for interest rates in the Indian economy, and their yields are closely watched by investors and policymakers alike.
Types of G-Secs
G-Secs, or Government Securities, are debt instruments issued by the Indian government to raise funds for its various activities. These securities are issued for different tenures and carry different coupon rates.
There are several types of G-Secs based on their tenure, coupon rate, and other features. The types of G-Secs include:
- Treasury Bills (T-Bills): These are short-term securities with a maturity of up to one year. They are issued at a discount to face value and do not pay any coupon or interest.
- Dated Securities: These are medium to long-term securities with a maturity of more than one year. They pay a fixed coupon rate and are issued at face value.
- Floating Rate Bonds (FRBs): These are bonds that pay a variable coupon rate linked to a benchmark rate such as the Mumbai Inter-Bank Offer Rate (MIBOR) or the Government of India’s 91-day Treasury Bill yield.
- Capital Indexed Bonds (CIBs): These are bonds where the principal amount is adjusted for inflation, thus providing a hedge against inflation.
- Sovereign Gold Bonds (SGBs): These are bonds issued by the government that allows investors to invest in gold without actually buying physical gold. These bonds carry a fixed interest rate and the principal amount is linked to the prevailing market price of gold.
- State Development Loans (SDLs): These are debt instruments issued by state governments to finance their development projects.
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State Development Loan (SDL)
State Development Loans (SDLs) are debt instruments issued by state governments in India to raise funds for financing their development projects and other expenditures. These securities are issued for various tenures ranging from 1 year to 30 years and carry a fixed or floating coupon rate. SDLs are similar to central government securities (G-Secs) but are issued by state governments instead of the central government. The interest rate on SDLs is generally higher than that on central government securities due to the higher credit risk associated with state governments. The Reserve Bank of India (RBI) acts as the regulator and facilitator for the issuance of SDLs. The RBI sets the guidelines for the issuance of SDLs and conducts auctions on behalf of the state governments. The auctions are conducted on a weekly basis, and the bids are submitted by various entities such as banks, primary dealers, and other institutional investors.
Development Finance Institutions (DFIs) or Development Banks
Development Finance Institutions (DFIs), also known as Development Banks, are specialized financial institutions that provide long-term financing to support economic development in emerging and developing countries. DFIs play a crucial role in promoting economic growth, reducing poverty, and addressing infrastructure gaps in low and middle-income countries. DFIs typically offer a range of financial products and services, including loans, equity investments, guarantees, and technical assistance. They work with public and private sector entities to finance a wide range of projects, including infrastructure, energy, agriculture, manufacturing, and small and medium-sized enterprises.
DFIs are usually established and owned by governments or international organizations, such as the World Bank, the African Development Bank, the Asian Development Bank, and the Inter-American Development Bank. They may also partner with commercial banks and other financial institutions to leverage additional funding and expertise. DFIs often have a dual mandate of financial sustainability and development impact and are expected to balance both objectives in their operations. They may also be subject to specific policies and regulations to ensure transparency,
Merchant Banks (Investment Banks)
Merchant banks (also known as investment banks) are financial institutions that provide a wide range of services to their clients, including corporate finance, underwriting, and financial advisory services. They specialize in helping companies raise capital by underwriting and selling securities, such as stocks and bonds, in the primary market. Merchant banks also provide a range of other financial services, such as mergers and acquisitions (M&A) advisory, restructuring, and asset management. They often work with large corporations, governments, and other financial institutions to provide advice and execute complex financial transactions. Merchant banks typically employ highly skilled professionals, such as investment bankers, financial analysts, and traders, who have expertise in a variety of financial fields. They often work in large teams to provide customized solutions to their clients and may have offices in multiple locations around the world to serve a global clientele.
Nidhi companies are a type of non-banking financial institution (NBFC) in India that operate on a mutual benefit principle. They are registered under Section 406 of the Companies Act, 2013, and are regulated by the Ministry of Corporate Affairs. Nidhi companies are essentially mutual benefit societies, where members pool their savings and lend to each other at low-interest rates. They are typically established as small-scale organizations and are often formed in rural areas to promote financial inclusion and encourage savings habits among low-income households. Nidhi companies are prohibited from engaging in the business of chit funds, hire-purchase finance, leasing finance, insurance, or any other business activity. In order to be registered as a Nidhi company, a minimum of 200 members is required, and the company must have a minimum net-owned fund of Rs. 10 lakhs. The company’s primary objective should be to cultivate the habit of thrift and savings among its members.
Collective Investment Scheme (CIS)
A Collective Investment Scheme (CIS) is a type of investment fund in which multiple investors pool their money together to invest in a diverse range of securities, such as stocks, bonds, and other financial instruments. The fund is managed by a professional fund manager who makes investment decisions on behalf of the investors. CIS is regulated and governed by the Securities and Exchange Board of India (SEBI) under the SEBI (Collective Investment Scheme) Regulations, 1999. CIS can be of various types, such as mutual funds, exchange-traded funds (ETFs), and real estate investment trusts (REITs). The primary objective of CIS is to provide small investors with an opportunity to invest in a diversified portfolio of securities, which they may not be able to do individually due to their limited financial resources and lack of investment expertise.
Alternative Investment Funds
Alternative Investment Funds (AIFs) are a type of investment fund that invests in non-traditional asset classes such as private equity, hedge funds, real estate, infrastructure, and commodities. AIFs are regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Alternative Investment Funds) Regulations, 2012. AIFs are set up as trusts, companies, or limited liability partnerships (LLPs) and are managed by professional fund managers. They are typically categorized into three types based on their investment strategies and the types of investors they cater to. AIFs offer several benefits to investors such as diversification, access to non-traditional asset classes, and professional management.
Real Estate Investment Trusts (REITs)
Real Estate Investment Trusts (REITs) are a type of investment vehicle that allows individuals to invest in a professionally managed portfolio of income-generating real estate properties. REITs are regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Real Estate Investment Trusts) Regulations, 2014. REITs generate income by investing in real estate assets such as office buildings, shopping malls, residential apartments, hotels, and warehouses. They distribute the rental income earned from these assets to investors in the form of dividends. REITs provide several benefits to investors, such as access to real estate investments with low investment amounts, liquidity, professional management, and diversification. Investors can buy and sell REITs on the stock exchange, similar to stocks.
Mutual funds are a type of investment vehicle that pools money from multiple investors to invest in a diversified portfolio of stocks, bonds, and other securities. Mutual funds are managed by professional fund managers and are regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Mutual Funds) Regulations, 1996. Mutual funds offer several benefits to investors, such as diversification, professional management, and access to a wide range of securities. They also provide liquidity, as investors can buy and sell mutual fund units on any business day. Mutual funds are classified based on their investment objectives and strategies, such as equity funds, debt funds, hybrid funds, and thematic funds. Investors should be aware of the risks involved in investing in mutual funds, such as market risk, interest rate risk, credit risk, and liquidity risk. Mutual funds are a popular investment choice for investors of all levels of experience, as they offer the potential for higher returns with lower risk and cost compared to direct investment in securities.
A hedge fund is a type of investment vehicle that pools money from a limited number of accredited investors and invests it in a wide range of securities using advanced investment strategies. Hedge funds are typically managed by professional fund managers and are not regulated by the Securities and Exchange Board of India (SEBI). Hedge funds use a variety of investment strategies, such as long-short equity, global macro, event-driven, and quantitative strategies. They may also use leverage and derivatives to enhance returns and manage risk. The goal of hedge funds is to generate high returns while managing risk, typically by hedging against potential losses. Hedge funds are known for their high fees, typically charging a management fee and a performance fee. They also have high minimum investment requirements and are generally only open to accredited investors with high net worth.
Venture capital is a type of private equity investment that provides funding to early-stage, high-growth companies with the potential for significant returns on investment. Venture capital firms raise money from institutional investors and high-net-worth individuals and use this capital to make investments in startups and other emerging companies. Venture capitalists provide funding to these companies in exchange for an ownership stake in the company, often taking a seat on the company’s board of directors and playing an active role in its management and growth strategy. Venture capital firms typically invest in companies with innovative technologies or business models that have the potential to disrupt existing markets and create new ones.
Venture capital investments are high risk, high reward, with the potential for significant returns if the company is successful but also the risk of losing the entire investment if the company fails. Venture capital firms typically invest in companies over multiple rounds of financing, with the goal of helping the company grow and eventually go public or be acquired by another company.
Angel investors are wealthy individuals who provide early-stage funding to startups and other small businesses in exchange for an ownership stake in the company. Angel investors typically invest their own personal funds and may also provide mentorship, industry expertise, and networking opportunities to the companies they invest in. Angel investors are often willing to invest in startups and other small businesses that are too risky or unproven for traditional sources of funding, such as banks or venture capital firms. Angel investments are typically made in the seed or early stages of a company’s development when the company is still in the process of developing its product or service and has not yet generated significant revenue. Angel investors are different from venture capitalists in that they typically invest smaller amounts of money and are less likely to take an active role in the management of the company.
Hundi is an informal system of transferring money used in some parts of South Asia, particularly in India, Pakistan, Bangladesh, and Nepal. The hundi system is based on trust and is often used for cross-border transactions and for those who do not have access to formal banking services. In the hundi system, a person who wants to transfer money gives cash to a hundi dealer or broker who then provides a code or a written note to the recipient of the money. The recipient can then take the note or code to a hundi dealer in their area and exchange it for the equivalent cash amount, minus a commission fee charged by the hundi dealer. Hundi transactions are not recorded in any formal system, and there is no physical transfer of money between banks or other financial institutions. Instead, the hundi system relies on a network of trust between hundi dealers and their clients.
A chit fund is a type of savings and investment scheme that is popular in India and other parts of South Asia. In a chit-fund, a group of individuals pools their money together to form a fund that is managed by a chit-fund company or organizer. Each member of the group contributes a fixed amount of money to the fund on a regular basis, such as weekly or monthly. The chit fund company then conducts a series of auctions, in which the total amount of money in the fund is awarded to one or more members of the group through a bidding process. The bidding process allows members to access the funds earlier than they would have been able to if they had waited for the end of the cycle. Chit funds are often used as a means of saving and investing money, particularly in rural areas where formal banking services may be limited.
Non-Banking Financial Company (NBFC)
A Non-Banking Financial Company (NBFC) is a financial institution that provides financial services similar to those of traditional banks but does not hold a banking license. NBFCs are regulated by the Reserve Bank of India (RBI) in India and by other financial regulatory authorities in other countries. NBFCs offer a range of financial services such as loans, credit facilities, wealth management services, investment advice, and insurance products. They typically serve individuals and businesses that may not have access to traditional banking services or may not meet the eligibility criteria of traditional banks. Unlike banks, NBFCs are not allowed to accept demand deposits from customers. They are also subject to stricter regulatory requirements than other types of financial institutions, as they deal with a wider range of financial products and services.
Credit Default Swap (CDS)
A Credit Default Swap (CDS) is a financial instrument that acts as insurance against the risk of default on a particular debt instrument, such as a corporate bond or loan. CDS contracts are traded over-the-counter (OTC) between two parties, typically a buyer and a seller, with the buyer paying a premium to the seller in exchange for protection against default. In a CDS contract, the buyer of protection pays a premium to the seller of protection, who agrees to pay the buyer a predetermined amount in the event of a default by the issuer of the underlying debt instrument. The amount paid out by the seller is typically equal to the face value of the underlying debt instrument, minus any recovery value. CDS contracts are used by investors and financial institutions to hedge against the risk of default on a particular debt instrument or to speculate on the creditworthiness of a particular issuer.
Infrastructure Debt Funds (IDFs)
Infrastructure Debt Funds (IDFs) are investment funds that are focused on investing in the infrastructure sector. IDFs are typically structured as mutual funds or alternative investment funds and are managed by asset management companies that specialize in infrastructure investments. The primary objective of IDFs is to provide long-term debt financing for infrastructure projects, such as roads, airports, ports, power plants, and other public utilities. IDFs are an important source of funding for infrastructure projects, as they offer long-term financing solutions that are not readily available through traditional sources of debt financing, such as banks or bond markets. IDFs typically invest in debt instruments such as bonds, debentures, and other debt securities issued by infrastructure companies. These debt instruments are typically rated investment grade by credit rating agencies, and offer a relatively stable rate of return to investors.
FIIs Investment in Debt
Foreign Institutional Investors (FIIs) are institutional investors that invest in the financial markets of a country outside their home country. When FIIs invest in debt instruments, they are typically referred to as Foreign Portfolio Investments (FPIs) in debt. FIIs or FPIs can invest in debt instruments such as government securities, corporate bonds, and money market instruments issued by Indian entities. The investment limit for FPIs in debt is set by the Reserve Bank of India (RBI), and it is periodically reviewed and revised based on market conditions. Investing in debt instruments can provide FIIs with a relatively stable source of income through interest payments, while also providing diversification to their portfolio. The Indian debt market is attractive to FIIs due to its high yields and the country’s strong economic growth potential.
Take-out financing (TOF) refers to a type of long-term financing used by businesses to repay short-term loans or bridge loans used to fund capital projects, acquisitions, or working capital requirements. The TOF is typically arranged before the completion of the project and is used to pay off the short-term financing once the project is completed. TOF is a popular form of financing in the real estate and infrastructure sectors, where large capital projects require significant upfront investments. In such cases, short-term loans or bridge financing may be required to fund the initial stages of the project until long-term financing can be arranged. TOF is generally provided by financial institutions such as banks or private equity firms, and it is typically structured as a term loan or a bond issue with a long-term maturity. The terms of the TOF are typically based on the underlying assets or cash flows of the project and may be secured against the assets of the project.
External Sources of Finance for India
External sources of finance for India include foreign direct investment (FDI), foreign institutional investment (FII), external commercial borrowings (ECB), and multilateral and bilateral loans. These sources of finance play a crucial role in funding India’s growth and development and are closely monitored by regulatory authorities to ensure that they are in line with the country’s economic objectives. FDI and FII are the largest sources of external finance for India, followed by ECBs and multilateral and bilateral loans.
External Sources of Finance for India
External sources of finance for India refer to the funds or capital that are obtained by the Indian government, corporates, or individuals from sources outside the country. These sources of finance play an essential role in the economic development of India, as they provide access to capital that is not available domestically.
The main external sources of finance for India include:
- Foreign Direct Investment (FDI): FDI refers to investment in Indian companies by foreign entities. FDI can be in the form of equity, debt, or reinvestment of earnings. FDI is an essential source of long-term capital for India and plays a significant role in the development of various sectors, such as manufacturing, services, and infrastructure.
- Foreign Institutional Investment (FII): FIIs refer to institutional investors such as mutual funds, pension funds, and hedge funds that invest in Indian securities markets. FIIs provide liquidity to the Indian markets and can be a source of short-term capital for India.
- External Commercial Borrowings (ECB): ECBs are loans raised by Indian corporates from foreign entities, including banks and institutional investors. ECBs can be in the form of loans, bonds, or other debt instruments and are typically used to fund capital expenditures, working capital requirements, or refinancing existing debt.
- Multilateral and Bilateral Loans: Multilateral and bilateral loans are provided by international organizations such as the World Bank, International Monetary Fund, and Asian Development Bank, as well as foreign governments. These loans are typically used to fund infrastructure projects or to support social and economic development initiatives.
External Commercial Borrowings (ECBs)
External Commercial Borrowings (ECBs) are a type of loan that Indian corporates and public sector undertakings can borrow from foreign lenders such as banks, financial institutions, and international capital markets. These borrowings can be in the form of bank loans, buyer’s credit, and foreign currency convertible bonds (FCCBs). ECBs are usually used to fund long-term capital expenditures such as new projects, expansion, modernization, or refinancing of existing debt. They can also be used to meet short-term working capital requirements. The interest rate on ECBs is generally lower than the interest rate on domestic loans, making it an attractive source of financing for Indian corporates.
External Commercial Borrowings (ECBs) can be raised through two routes:
- Automatic Route: The Automatic Route allows Indian corporates to raise ECBs without prior approval from the Reserve Bank of India (RBI). Under this route, eligible borrowers can raise ECB up to USD 750 million per financial year for specific end-uses such as new projects, modernization, expansion of existing units, etc. This limit is USD 1 billion for companies in the infrastructure sector. The borrower needs to comply with certain conditions related to minimum maturity, all-in-cost ceiling, and reporting requirements.
- Approval Route: The Approval Route requires prior approval from the RBI for raising ECBs. Borrowers who do not meet the eligibility criteria of the Automatic Route, or require ECBs for end-uses that are not permitted under the Automatic Route, must apply for approval from the RBI. The approval process involves submitting an application along with relevant documents, and the RBI assesses the borrower’s creditworthiness, the end-use of funds, and other factors before granting approval.
Euro issues refer to the issuance of securities in the euro currency by non-European entities in international financial markets. These securities may include bonds, notes, or other debt instruments. The proceeds of euro issues are typically used to fund investments or projects in Europe or to take advantage of the low borrowing costs in the eurozone. Euro issues are subject to regulatory requirements in the European Union, and the issuance process may involve coordination with eurozone banks and other intermediaries.
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FAQs on Instruments and Dynamics of Money Market and Capital Market.
What is the money market?
The money market is a financial market where short-term borrowing and lending of funds take place.
What is the full form of DFHI?
The full form of DFHI is Discount and Finance House of India.
What is the full form of LIBOR?
The full form of LIBOR is London Interbank Offered Rate.
What are the main Components of the capital market?
The capital market in India comprises two main components: the primary market and secondary market.