CAPITAL MARKETS:

Meaning:
Capital markets are markets where people, companies, and governments with more funds
than they need (because they save some of their income) transfer those funds to people,
companies, or governments who have a shortage of funds (because they spend more than
their income). Stock and bond markets are two major capital markets. Capital markets
promote economic efficiency by channelling money from those who do not have an
immediate productive use for it to those who do.
Capital markets carry out the desirable economic function of directing capital to
productive uses. The savers (governments, businesses, and people who save some portion
of their income) invest their money in capital markets like stocks and bonds. The
borrowers (governments, businesses, and people who spend more than their income)
borrow the savers' investments that have been entrusted to the capital markets.
For example, suppose A and B make Rs. 50,000 in one year, but they only spend
Rs.40,000 that year. They can invest the 10,000 - their savings - in a mutual fund
investing in stocks and bonds all over the world. They know that making such an
investment is riskier than keeping the 10,000 at home or in a savings account. But they
hope that over the long-term the investment will yield greater returns than cash holdings
or interest on a savings account. The borrowers in this example are the companies that
issued the stocks or bonds that are part of the mutual fund portfolio. Because the
companies have spending needs that exceeds their income, they finance their spending
needs by issuing securities in the capital markets.

The Structure of Capital Markets

Primary MarketThe primary market is that part of the capital markets that deals with the issuance of new
securities. Companies' governments or public sector institutions can obtain funding
through the sale of a new stock or bond issue. This is typically done through a syndicate
of securities dealers. The process of selling new issues to investors is called underwriting.
In the case of a new stock issue this sale is an initial public offering (IPO). Dealers earn a
commission that is built into the price of the security offering; through it can be found in
the prospectus. In simple word The Primary Market is where financial instruments are
sold from the issuer to investors
Benefits of Primary Market1.

Manipulation of price is smaller so invest in primary market is safer.

2.

No need to time the market the investors get the share at the same price.

3.

It is secure because of primary research data is collected directly by the

organization that deploys the research

4.

The company receives the money and issue new security certificates to the
investors
Secondary MarketsThe secondary market is the financial market for trading of securities that have already
been issued in an initial private or public offering. Alternatively secondary market can
refer to the market for any kind of used goods. The market that exists in a new security
just after the new issue is often referred to as the aftermarket. Once a newly issued stock
is listed on a stock exchange, investors and speculators can easily trade on the exchange,

as market markers provide bids and offers in the new stock. In short The Secondary
Market is where financial instruments are sold from investor to investor.
Benefits of Secondary Market1.

The investors can recover their investments to a certain extent, provided their
economic status undergoes a change.

2.

In such cases the investors may refrain from making long term investments.

3.

Investor can get large interest by invest for a longer period of time.

Advantages and Disadvantages of Capital MarketAdvantages1.

1.

Effective Risk Management-

Manage security exposure, market, and operations risk.

Handle compliance issues, regulatory requirements, security, and other

operational risks without burdening existing operations

1.

2.

Customer-centric Business Model-

Capture investment profiles to target offers and leads, while shortening sales
cycles and increasing investment offers.

Personalize customer experience across channels

1.

3.

Manage security exposure, market and operations risk. and Provide Real time and

Operational Effectiveness-

near real time actionable customer and product profitable insight, delivered to the front
office.

Profitable for Investor- The resulting advantages include that innovation is driven
forward in a free, capitalist economy, with investors receiving dividends from successful
ventures. This money can then be used in other projects that an investor might be
passionate and enthusiastic about.
Disadvantages-

1.

Volatility is another issue - and with long-term investments.

2.

May be high charges which reduce earnings from investment returns.

3.

No guarantee of returns

4.

Risk of losing your money.

Internationalization of Capital Markets in the Late 1990s

One of the most important developments since the 1970s has been the
internationalization, and now globalization, of capital markets. Let's look at some of the
basic elements of the international capital markets.
1. The International Capital Market of the Late 1990s was composed of a Number of
Closely Integrated Markets with an International Dimension:
Basically, the international capital market includes any transaction with an international
dimension. It is not really a single market but a number of closely integrated markets that
include some type of international component.
The foreign exchange market was a very important part of the international capital
market during the late 1990s. Internationally traded stocks and bonds have also been part
of the international capital market. Since the late 1990s, sophisticated communications
systems have allowed people all over the world to conduct business from wherever they
are. The major world financial centres include Hong Kong, Singapore, Tokyo, London,
New York, and Paris, among others.
Foreign bonds are a typical example of an international security. A bond sold by a Korean
company in Mexico denominated in Mexican pesos is a foreign bond. Eurobonds are
another example.

2. The Need to Reduce Risk Through Portfolio Diversification Explains in Part the
Importance of the International Capital Market During the Late 1990s:
A major benefit of the internationalization of capital markets is the diversification of risk.
Individual investors, major corporations, and individual countries all usually try to
diversify the risks of their financial portfolios. The reason is that people are generally
risk-averse. They would rather get returns on investments that are in a relatively narrow
band than investments that have wild fluctuations year-to-year. All portfolio investors
look at the risk of their portfolios versus their returns. Higher risk investments generally
have the potential to yield higher returns, but there is much more variability.

Here is an example:
Suppose Corporation XYZ in 1996 had the following portfolio:

1000 shares of Japanese utility company stock;

1000 shares of Mexican petroleum company stock;
German government bonds valued at 8000 deutsche marks (today called
euros);

1000 shares of a Moroccan mutual fund;

Canadian municipal bonds valued at 8000 Canadian dollars.
Suppose Corporation ABC in 1996 had the following portfolio:

10,000 shares of Swedish steel company.

If the steel company in Sweden has a poor year for sales and profits, its stock
value decreases. Corporation ABC, which has not diversified, will have a terrible return
on its portfolio. The next year, the steel company may have a great year, so ABC will
have a terrific portfolio return.
Corporation XYZ, with a diversified portfolio, can overcome a single poor return
and still have a good overall return on the portfolio. If utilities in Japan have a poor year,
but Morocco is experiencing strong economic growth, the Moroccan gain can offset the
Japanese stock loss. Then, the next year, perhaps the reverse would occur (Morocco
experiences a slowdown while the Japanese utility realizes higher profits than
anticipated). The year-to-year return would fluctuate much less for Corporation XYZ
than for ABC.
3. The Principal Actors in the International Capital Markets of the Late 1990s were
Banks, Non-Bank Financial Institutions, Corporations, and Government Agencies:
Commercial banks powered their way to a place of considerable influence in international
markets during the late 1990s. Commercial banks undertook a broad array of financial
activities during the late 1990s. They granted loans to corporations and governments,
were active in the bond market, and held deposits with maturities of varying lengths.
Special asset transactions, like underwriting were undertaken by commercial banks.
Non-bank financial institutions became another fast-rising force in international markets
during the late 1990s. Insurance companies, pension and trust funds, and mutual funds
from many countries began to diversify into international markets in the 1990s. Together,
portfolio enhancement and a widespread increase in fund contributors have accounted for
the strength these funds had in the international marketplace.
Government agencies, including central banks, were also major players in the
international marketplace during the late 1990s. Central banks and other government
agencies borrowed funds from abroad. Governments of developing countries borrowed
from commercial banks, and state-run enterprises also obtained loans from foreign
commercial banks.
7

4. Changes in the International Marketplace Resulted in a New Era of Global

Capital Markets during the Late 1990s, which were Critical to Development.
Many observers say we entered an era of global capital markets in the 1990s. The process
was attributable to the existence of offshore markets, which came into existence decades
prior because corporations and investors wanted to escape domestic regulation. The
existence of offshore markets in turn forced countries to liberalize their domestic markets
(for competitive reasons). This dynamic created greater internationalization of the capital
markets. Three primary reasons account for this phenomenon.
First, citizens around the world (and especially the Japanese) began to increase their
personal savings. Second, many governments further deregulated their capital markets
since 1980. This allowed domestic companies more opportunities abroad, and foreign
companies had the opportunity to invest in the deregulated countries. Finally,
technological advances made it easier to access global markets. Information could be
retrieved quicker, easier, and cheaper than ever before.
Developing countries, like all countries, must encourage productive investments to
promote economic growth. Thus, foreign savings, which many people simply call foreign
investment, can benefit developing countries.
In Indian context:
The international capital market as it has been evolving provides an opportunity for
developing countries like India to attract the required capital inflow for accelerating their
pace of development, manage their foreign exchange assets and liabilities to their
advantage and develop export capabilities in the field of financial services. Active
participation in this market would not only improve their access to the market but also
indicate the institutional and policy framework essential for developing effective and
efficient domestic financial markets. The possibilities of such participation would be
enhanced if the developing countries like India take a constructive stand with regard to
the multilateral negotiations in respect of trade in services under the Uruguay Round.

Recent situation
Recent financial problems in emerging economies have led to calls for a new
international financial architecture. Some of the problems are:
1. Inflation concerns are increasingly taking hold of the international capital markets;
there are fears of a repetition of the 1970s, when industrialized countries endured doubledigit rates of inflation.
2. Higher energy and food prices, rising wages in emerging markets and the weak US
dollar which is driving up US import prices.
3. In emerging markets like India inflation is being driven above all by rising food prices.
4. In recent months oil has breached the 130 US dollar per barrel mark, and thus been a
main driver of global inflationary pressure. Declining reserves in the oil-producing
countries, and low levels of investment and political problems could tighten the supply
situation still further, countering any efforts to improve energy efficiency and further
develop alternative energy sources. Production will not be able to keep pace with
growing demand, especially from Asia. So the oil price is likely to remain high and
continue

rising

in

the

long

term."

5. Still it is believed that there may not be a recession in the USA, but a there may not be
a quick recovery either. In the Euro zone we are likely to see a cooling-off of the
economy in 2008 and 2009. Emerging markets should be able to decouple further from
the US economy and consolidate their growth at a high level.
In the above conditions, International capital flows should not be restricted; they benefit
entrepreneurs and savers alike, with lower borrowing costs and greater returns. The
international flow of capital improves risk management, allows consumption smoothing,
improves financial-sector efficiency, and leads to greater overall market discipline.
Furthermore, capital flows have a stabilizing effect on financial markets. Restricting
9

international investment denies a country those benefits; the result is slower growth and
reduced standards of living.

Importance of capital market:

1. The capital market serves as an important source for the productive use of economys
savings. It mobilizes the saving of the people for further investment and thus avoids
their wastage in unproductive uses.
2. It provides incentives to saving and facilitates capital formation by offering suitable
rates of interest as the price of capital.
3. It provides an avenue for investors, particularly the household sector to invest in
financial assets which are more productive than physical assets.
4.

It facilitates increase in production and productivity in the economy and thus,

enhances the economic welfare of the society. Thus it facilitates the movement of
stream of command over capital to the point of highest yield towards those who can
apply them productively and profitably to enhance the national income in the
aggregate.

5. The operations of different institutions in the capital market induce economic growth.
They give quantitative and qualitative directions to the flow of funds and bring about
rational allocation of scarce resources.
6. A healthy capital market consisting of expert intermediaries promotes stability in
values of securities representing capital funds.
7. Moreover, it serves as an important source for technological up gradation in the
industrial sector by utilizing the funds invested by the public.
Thus, a capital market serves as an important link between those who save and those
who aspire to invest their savings.

10

DRAWBACKS OF FOREIGN CAPITAL

1) Foreign capital usually does not produce an efficient because of the
microeconomic distortions and macro economics instability it generates. In fact it
has been found that the increasing volume of international financial flows has
been associated with a decline in the trade volume due to higher costs.
2) Another harmful impact of these flows has been to increase the instability of
volatility in the exchange rates, assets prices, interest rates and the whole
economical system of the recipient countries.

3) The global capital flows reduce the effectiveness of monetary policy they are
associated with the loss of monetary control at home. The current surge in these
flows has created a major worry for the regulatory authorities about the global
money.
4) The cost of foreign is rather difficult to measure and it is subject to a great
variability. Foreign currency borrowings imply a series of uncertainties due to
floating interest and vary margins. This is an important reason for exercising
utmost restraint while seeking to raise funds abroad.
5) The non economical costs of the foreign capital are also unaffordable. It is well
known but conveniently forgotten that the foreign capital creates a larger number
of very serious problems of foreign ownership and control dumping of technology
loss of autonomy of domestic policies dependence hegemony and neocolonialism.
6) The existence of a contrary belief notwithstanding the foreign capital is not nor
free the costs and harmful effects discussed above. In fact the relevance of what
has just been said is all the greater in its case.

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CAPITAL MARKET IN INDIA: Coming to Indian context, the term capital market refers to only stock markets as per the
common man's ideology, but the capital markets have a much broader sense. Where as in
global scenario, it consists of various markets such as:
1. Government securities market
2. Municipal bond market
3. Corporate debt market
4. Stock market
5. Depository receipts market
6. Mortgage and asset-backed securities market
7. Financial derivates market
8. Foreign exchange market

Indias presence in International Markets:

India has made its presence felt in the IFMs only after 1991-92. At present there are over
50 companies in India, which have accessed the GDR route for raising finance. The
change in situation has been due to the following factors:
1. Improved perception of Indias economic reforms.
2. Improved export performance.
3. Healthy economic indicator.
4. Inflation at single digit.
5. Improved forex reserves.
6. Improved performance of Indian companies.
7. Improved confidence of FIIs.
Reliance was the first Indian company to issue GDR in 1992. Since 1993, number of
Indian companies successfully tapped the global capital markets & raised capital through
GDR or foreign currency bond issues. Though there was a temporary setback due to
12

Asian crisis in 1997. Since 1999 even IT majors have stepped the bandwagon of
international markets & raised capital. The average size of the issue was around 75USD.
And the total amount raised was around USD 6.5billion. India has the distinction of
having the largest number of GDR/ADR issues by any country.

INTERMEDIARIES INVOLVED IN INTERNATIONAL CAPITAL MARKET:

Lead & co-lead managers:
The responsibilities of a lead manager include undertaking due diligence & preparing the
offered document , marketing the issues , arrangement & conducting road shows.
Mandate is given by the issuer to the lead manager.
Underwriters:
The lead manager & co managers act as underwriters to the issue , taking on the risk of
interest rates /markets moving against them before they have placed bonds/DRs. Lead
Managers may also invite additional investment banks to act as sub-underwriters , thus
forming a larger underwriting group. The underwriters undertake to subscribe to the
unsubscribed portion of the issue .
Agents & Trustees:
These intermediaries are involved in the issue of bonds/convertibles. The issuer of bonds
convertible in association with the lead manager must appoint paying agents in different
fifnacial centers, who will arrange for the payment of interest & principal due to investor
under the terms of the issue. These paying agents will be banks.
Lawyers & Auditors:
The lead manager will appoint a prominenet firm of solicitors to draw up documentation
evidencing the bond/DRs issue. The various draft documents will vetted by the solicictors
acting for the issuer. Many of these documents are prepared in standard forms with a

13

careful review to the satisfaction of the parties. The legal advisors will advise the issuer
pertaining to the local & foreign laws.
Similarly, Auditors are required for preparation of the financial statements, cash flows,
and audit reports. The Auditors provide a comfort letter to the lead manager on the
financial health of the company. They also prepare the financial statement as per GAAP
requirements wherever necessary.
Listing Agents & Stock Exchanges:
The listing Agent helps facilitate the documentation & listing process for listing on stock
exchange & keep file information regarding the issuer such as Annual reports, depository
agreements, articles of association,etc. The stock exchange reviews the issuers
application for listing of bonds/GDRs & provides comments on offering circular prior to
accepting the security for listing.
Depository Bank:
It is involved only in the issue of GDRs. It is responsible for issuing the actual GDRs
,disseminating information from the issuer to the DR holders, paying any dividends or
other distributions & facilitating the exchange of GDRs into underlying shares when
presented for redemption.
Custodian:
The Custodian holds the shares underlying the GDRs on behalf of the depository &is
responsible for collecting rupee dividends on the underlying shares & repatriation of the
same to the depository in US dollars/foreign currency.

14

Sources of Capital
There are two sources of capital:
1. Private sources
2. Public sources
Both sources are very important to the economies of the world. Capital flows result when
funds are transferred across borders; the flows are recorded in the balance of payments
account. Read on for definitions, examples, and trends in capital flows.

1. Private Sources of Capital.

Important sources of private capital are
a. Foreign direct investment
b. Portfolio investment (both debt and equity flows)
Each is defined below.
2. Public Sources of Capital.
Public sources of capital include
a. Official non-concessional loans of both multilateral and bilateral aid b. Official
development assistance (ODA).
Each is discussed in turn below.

15

a. Official non-concessional loans: multilateral & bilateral aid.

Official non-concessional multilateral aid consists of loans from the World Bank, regional
development banks, and other intergovernmental agencies such as multilateral
organizations. The term "non-concessional" refers to the fact that these loans are based on
market rates, must be repaid, and are not partly grants. By contrast, official nonconcessional bilateral aid is loans from governments and their central banks or other
agencies. Export credit agency loans are also included here. "Bilateral" refers to the fact
that the entities providing the funding provide aid only in their home country.

b. ODA: official grants and concessional loans.

ODA refers in part to official public grants that are legally binding commitments and
provide a specific amount of capital available to disburse (give out) for which no
repayment is required. Concessional bilateral aid refers to aid from governments, central
banks, and export credit agencies that contains a partial grant element (25% or more), or
partially forgives the loan.

16

Instruments in capital markets

Instruments in
International Capital
Markets:

International Bond
Market

International Equity
Markets

FOREIGN BOND

GDRs

EURO BOND

ADRs

FCCB

ECB

17

International Bond Markets:

What is a bond?
Bonds are debt. They are debt because when an investor buys a bond they are effectively
loaning the bonds issuer a sum of money and that issuer is incurring a debt. So the issuer
or seller of the bond - is a borrower and the investor - or buyer of the bond - is a lender.

The price paid for the bond is the money the investor is loaning the issuer. And, like most
other loans, when you buy a bond the borrower pays you interest for as long as the loan is
outstanding and then at the end of the agreed period of the loan pays you the loan
back.

The Bond Market

The bond market (also known as the debt, credit, or fixed income market) is a
financial market where participants buy and sell debt securities, usually in the form of
bonds. As of 2006, the size of the international bond market is an estimated $45 trillion,
of which the size of the outstanding U.S. bond market debt was $25.2 trillion. Average
daily trading volume in the U.S. bond market takes place between broker-dealers and
large institutions in a decentralized, over-the-counter (OTC) market. However, a small
number of bonds, primarily corporate, are listed on exchanges.
18

Market structure:
Bond markets in most countries remain decentralized and lack common exchanges like
stock, future and commodity markets. This has occurred, in part, because no two bond
issues are exactly alike, and the number of different securities outstanding is far larger.
However, the New York Stock Exchange (NYSE) is the largest centralized bond market,
representing mostly corporate bonds. The NYSE migrated from the Automated Bond
System (ABS) to the NYSE Bonds trading system in April 2007 and expects the number
of traded issues to increase from 1000 to 6000.
The bonds can be broadly classified as:
1. Foreign bonds:
These bonds are issued within a particular country and denominated in the currency of
that country, but the issuer is a non-resident.
Dollar denominated bonds issued in US domestic markets by non US companies are
known as Yankee bonds
Yen denominated bonds issued in Japanese domestic markets by non Japanese companies
are known as Samurai bonds
Pound denominated bonds issued in UK domestic markets by non UK companies are
known as Bulldog bonds
2. Eurobonds:

19

These are bonds issued outside the country of the currency in which such bonds are
denominated. For instance US dollars denominated bonds issued in Europe, called as
Eurodollar Bonds.
What is the difference between Eurobonds and foreign bonds?
Eurobonds are bonds which are underwritten by a multinational syndicate of banks and
sold simultaneously in many countries other than the country of the issuing entity.
Foreign bonds are bonds which are sold in a particular country by a foreign borrower, and
underwritten by a syndicate of members from that country; foreign bonds are
denominated in the currency of that country.
Evolution of euro currency
During 1950s, Russians were earning dollars from the sell of gold and other commodities
and wanted to use them to buy grains and other products from the west, mainly from the
US. However, they didnt want to keep these dollars on deposits with the banks in New
York, as they were apprehensive that the US government might freeze the deposits if the
cold war intensified. They approached the banks in Britain and France who accepted
these dollar deposits. These deposits were in Europe, so euro and were dollar deposits
so, EuroDollar deposits. Later on till 1980s, such deposits were by and large in Europe
only. Since 1990, the markets have expanded geographically and also in volume, but the
prefix Euro has still remained. It strictly and really means offshore and not necessarily
always referred to Europe.
Eurodollar or Eurocurrency refers to bank time deposits in a currency other than that of
the country in which the bank or bank branch is located. Euro currency market is the
market for such deposits.
Euronotes are notes issued outside the country in whose currency they are denominated.
Euronotes consist of Euro-commercial paper (ECPs) and Euro-Medium-term notes
(EMTNs). Commercial papers are unsecured short-term promissory notes issued by
finance companies and some industrial companies. EMTNS are medium-term funds
20

guaranteed by financial institutions with the short-term commitment by investors. Global

bonds are bonds sold inside as well as outside the country in whose currency they are
denominated.
EUROCURRENCY MARKETS:
A Eurocurrency is a dollar or other freely convertible currency deposited in a bank
outside the country of its origin. Thus US dollars on deposit in London become
Eurodollars. The Eurocurrency market consists of those banks called Euro banks- that
accept deposits and make loans in foreign currencies.
The Eurocurrency markets enables investors to hold short-term claims on commercial
banks, which then act as intermediaries to these deposits into long term claims on final
borrowers.
The dominant euro currency is US dollars with dollar weakness other currency
particularly the Deutcshe mark and Swiss Frank- increased in importance. In Eurodollar
markets, banks accept deposits from depositors, mainly corporate depositors. They also
place these Eurodollars to other banks.
For instance, Citibank may accept deposit from a company Alcoa. Citibank would place
this as a deposit to Barclays bank. Barclays to Chase bank. Chase may ultimately lend it
to Unilever group, a corporate house. Eurocurrency transactions may be classified as
corporate to bank on one hand and bank to another bank on the other hand.

21

Types of bond markets:

The Securities Industry and Financial Markets Association classifies the broader bond
market into five specific bond markets.

Corporate

Government & Agency

Municipal

Mortgage Backed, Asset Backed, and Collateralized debt obligation

Funding

Bond market participants

Bond market participants are similar to participants in most financial markets and are
essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often
both.
Participants include:

Institutional investors;

Governments;

Traders; and

Individuals

Because of the specificity of individual bond issues, and the lack of liquidity in many
smaller issues, the majority of outstanding bonds are held by institutions like pension
funds, banks and mutual funds. In the United States, approximately 10% of the market is
currently held by private individuals.

22

Bond market volatility:

For market participants who own a bond, collect the coupon and hold it to maturity,
market volatility is irrelevant; principal and interest are received according to a predetermined schedule.
But participants who buy and sell bonds before maturity are exposed to many risks, most
importantly changes in interest rates. When interest rates increase, the value of existing
bonds falls, since new issues pay a higher yield. Likewise when interest rates decrease,
the value of existing bonds rise since new issues pay a lower yield. This is the
fundamental concept of bond market volatility: changes in bond prices are inverse to
changes in interest rates. Fluctuating interest rates are part of a country's monetary policy
and bond market volatility is a response to expected monetary policy and economic
changes.

Bond indices:
A number of bond indices exist for the purposes of managing portfolios and measuring
performance, similar to the S&P 500 or Russell Indexes for stocks. The most
common American benchmarks are the Lehman Aggregate, Citigroup BIG and
Merrill Lynch Domestic Master. Most indices are parts of families of broader
indices that can be used to measure global bond portfolios, or may be further
subdivided by maturity and/or sector for managing specialized portfolio Issuing
bonds

Bonds are issued by public authorities, credit institutions, companies and supranational
institutions in the primary markets. The most common process of issuing bonds is
through underwriting. In underwriting, one or more securities firms or banks, forming a
23

syndicate, buy an entire issue of bonds from an issuer and re-sell them to investors.
Government bonds are typically auctioned.

24

Features of bonds:
The most important features of a bond are:
1. Nominal, principal or face amount:
The amount on which the issuer pays interest and which has to be repaid at the end.
2. Issue price
The price at which investors buy the bonds when they are first issued, typically
$1,000.00. The net proceeds that the issuer receives are calculated as the issue price, less
issuance fees, times the nominal amount.
3. Maturity date
The date on which the issuer has to repay the nominal amount. As long as all payments
have been made, the issuer has no more obligations to the bond holders after the maturity
date.

4. Tenure
The length of time until the maturity date is often referred to as the term or tenure or
maturity of a bond. The maturity can be any length of time, although debt securities with
a term of less than one year are generally designated money market instruments rather
than bonds. Most bonds have a term of up to thirty years. Some bonds have been issued
with maturities of up to one hundred years, and some even do not mature at all. In early
2005, a market developed in euros for bonds with a maturity of fifty years. In the market
for U.S. Treasury securities, there are three groups of bond maturities:
short term (bills): maturities up to one year;
medium term (notes): maturities between one and ten years;
25

 Long term (bonds): maturities greater than ten years.

Types of bonds:
1. Fixed rate bonds have a coupon that remains constant throughout the life of the bond.
2. Floating rate notes (FRN's) have a coupon that is linked to an Index. Common Indices
include: money market indices, such as LIBOR or Euribor, or CPI (the Consumer Price
Index). Coupon examples: three month USD LIBOR + 0.20%, or twelve month CPI +
1.50%. FRN coupons reset periodically, typically every one or three months. In theory,
any Index could be used as the basis for the coupon of an FRN, so long as the issuer and
the buyer can agree to terms.
3. High yield bonds are bonds that are rated below investment grade by the credit rating
agencies. As these bonds are more risky than investment grade bonds, investors expect to
earn a higher yield. These bonds are also called junk bonds.
4. Zero coupon bonds do not pay any interest. They are issued at a substantial discount
from par value. The bond holder receives the full principal amount on the redemption
date.
An example of zero coupon bonds are Series E savings bonds issued by the U.S.
government. Zero coupon bonds may be created from fixed rate bonds by a financial
institutions separating "stripping off" the coupons from the principal. In other words, the
separated coupons and the final principal payment of the bond are allowed to trade
independently.
5. Inflation linked bonds: in which the principal amount is indexed to inflation. The
interest rate is lower than for fixed rate bonds with a comparable maturity. However, as
the principal amount grows, the payments increase with inflation. The government of the
United Kingdom was the first to issue inflation linked Gilts in the 1980s. Treasury
Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds
issued by the U.S. government.
26

Other indexed bonds, for example equity linked notes and bonds indexed on a business
indicator (income, added value) or on a country's GDP.
6. Asset-backed securities are bonds whose interest and principal payments are backed by
underlying cash flows from other assets. Examples of asset-backed securities are
mortgage-backed securities (MBS's), collateralized mortgage obligations (CMOs) and
collateralized debt obligations (CDOs).
7. Subordinated bonds are those that have a lower priority than other bonds of the issuer
in case of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the
liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are
those holding what is called senior bonds. After they have been paid, the subordinated
bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds
usually have a lower credit rating than senior bonds. The main examples of subordinated
bonds can be found in bonds issued by banks, and asset-backed securities.
8. Perpetual bonds are also often called perpetuities. They have no maturity date. The
most famous of these are the UK Consol, which are also known as Treasury Annuities or
Undated Treasuries. Some of these were issued back in 1888 and still trade today. Some
ultra long-term bonds (sometimes a bond can last centuries: West Shore Railroad issued a
bond which matures in 2361 (i.e. 24th century)) are sometimes viewed as perpetuities
from a financial point of view, with the current value of principal near zero.
9. Bearer bond is an official certificate issued without a named holder. In other words, the
person who has the paper certificate can claim the value of the bond. Often they are
registered by a number to prevent counterfeiting, but may be traded like cash. Bearer
bonds are very risky because they can be lost or stolen. Especially after federal income
tax began in the United States, bearer bonds were seen as an opportunity to conceal
income or assets. U.S. corporations stopped issuing bearer bonds in the 1960s, the U.S.
Treasury stopped in 1982, and state and local tax-exempt bearer bonds were prohibited in
1983.

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10. Bear bond, often confused with Bearer bond, is a bond issued in Russian roubles by
a Russian entity in the Russian market.
11. Registered bond is a bond whose ownership (and any subsequent purchaser) is
recorded by the issuer, or by a transfer agent. It is the alternative to a Bearer bond.
Interest payments, and the principal upon maturity, are sent to the registered owner.
12. Municipal bond is a bond issued by a state, U.S. Territory, city, local government, or
their agencies. Interest income received by holders of municipal bonds is often exempt
from the federal income tax and from the income tax of the state in which they are issued,
although municipal bonds issued for certain purposes may not be tax exempt.
13. Book-entry bond is a bond that does not have a paper certificate. As physically
processing paper bonds and interest coupons became more expensive, issuers (and banks
that used to collect coupon interest for depositors) have tried to discourage their use.
Some book-entry bond issues do not offer the option of a paper certificate, even to
investors who prefer them.
14. Lottery bond is a bond issued by a state, usually a European state. Interest is paid
like a traditional fixed rate bond, but the issuer will redeem randomly selected
individual bonds within the issue according to a schedule. Some of these redemptions
will be for a higher value than the face value of the bond.
15. War bond is a bond issued by a country to fund a war.
16. Convertible bond lets a bondholder exchange a bond to a number of shares of the
issuer's common stock.
17. Exchangeable bond allows for exchange to shares of a corporation other than the
issuer.

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Eligibility for issue of Convertible bonds or ordinary shares of issuing company

a. An issuing company desirous of raising foreign funds by issuing Foreign
Currency Convertible Bonds or ordinary shares for equity issues through Global
Depositary Receipt is required to obtain prior permission of the Department of
Economic Affairs, Ministry of Finance, Government of India.
b. An issuing company seeking permission under sub- paragraph (1) shall have a
consistent track record of good performance (financial or otherwise) for a
minimum period of three years, on the basis of which an approval for finalising
the issue structure would be issued to the company by the Department of
Economic Affairs, Ministry of Finance.
c. On the completion of finalisation of issue structure in consultation with the Lead
Manager to the issue, the issuing company shall obtain the final approval for
proceeding ahead with the issue from the Department of Economic Affairs.
Government Bonds
In general, fixed-income securities are classified according to the length of time before
maturity. These are the three main categories:

Bills - debt securities maturing in less than one year.

Notes - debt securities maturing in one to 10 years.
Bonds - debt securities maturing in more than 10 years.

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Corporate Bonds
A company can issue bonds just as it can issue stock. Large corporations have a lot of
flexibility as to how much debt they can issue: the limit is whatever the market will bear.
Generally, a short-term corporate bond is less than five years; intermediate is five to 12
years, and long term is over 12 years. Corporate bonds are characterized by higher yields
because there is a higher risk of a company defaulting than a government. The company's
credit quality is very important: the higher the quality, the lower the interest rate the
investor receives.
Other variations on corporate bonds include convertible bonds, which the holder can
convert into stock, and callable bonds, which allow the company to redeem an issue prior
to maturity.

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FUTURE PROSPECTS FOR CAPITAL INFLOWS

It has been argued that certain factors- the large size of the Indian market, the intrinsic
strength of Indian corporate and India well established and well functioning stock
exchanges are conductive to a substantial inflow or foreign equity buy not foreign debt.
The success of some Indian companies to float GDRs and euro convertibles during the
early 1990s is said to indicate this good potential.

There is a need to be circumspect in respect of such sanguine prognostications. The

question really is whether the dramatic levels of the total foreign capital will be available
to India? It may not be in the countrys interest if say more equity becomes available but
the inflow of bank loans and development. Assistance declines. The trends described
above should make it clear that the total availability of foreign capital is likely to be
strictly limited.

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Challenges of the Indian Capital Market

Indian Economy is the tenth largest economy in the world by nominal GDP and
the fourth largest by purchasing power parity (PPP). Following a strong economic reform
post-independence socialist economy, the countrys economic growth progressed at a
rapid pace, as the LPG policy was implemented in 1991 for international competition and
foreign investment. Despite fast economic growth, India still faces massive income
inequalities, high unemployment and malnutrition.
Following are the main challenges which act as a hurdle in the growth of capital market:

1) Inflation Inflation is the rate at which the prices for goods and services are rising
and subsequently, purchasing power is falling. The inflation situation in the economy
continues to be a cause of concern. Despite tightening of the monetary policy by the apex
of India, RBI and other steps taken by the government, inflation continues to remain
close to the double digit mark. High international oil prices, high global food prices are
some of the causes of high inflation.
2) GDP The growth figures for Indian economy are highly disappointing and highlight
an unmistakable downward trend. GDP is expected to grow by ~5-6% 2012-13. Sectors
like manufacturing and mining have seen a considerable erosion of growth momentum.
3) Index of Industrial Production Weakness in industrial production trend continues
to be a point of concern for the economy. The recent IIP numbers was registered below
expectation. Weakness was seen with growth in the capital goods segment, intermediate

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goods segment and consumer goods segment which slowed down drastically during these
months.
4) Population The current population of India is over 1.23 billion, making it the second
most populous country in the world after China, with over 1.35 billion people. India
represents almost 17.31% of the worlds population which is a serious concern. If the
trend of growth continues, the crown of the worlds most populous country will move on
India from China by 2030. The population growth rate is at 1.58% with which it is
predicted India would reach 1.5 billion mark by 2030.
Indias Population in 2012
Population of India in 1947

1.23 billion
350 million

5) Non uniform Tax reforms With the non uniformity in the tax system across the
states it is a difficult task to carry out the businesses which resulted in undergrowth of the
same. The different tax rates implemented in some states across pan India is a major
challenge to carry out the business smoothly and also it accounts for a reason of
increasing prices of goods and services.
6) Foreign Policy Foreign investment flows into India saw a dip of about 17% in the
year 2010-11 over the previous year. This dip is largely on account of a slowdown seen in
case of FDI. In 2009-10, FDI inflows totaled US$ 37.7 billion which was reduced to US$
27 billion in 2010-11. Of the top 25 sectors, 15 sectors have seen a dip in FDI flows
during April Feb 2010-11, compared to the same period in 2009-10. These sectors
involve

services,

construction, housing

and

real

estate, telecommunication and

agricultural services, where investment flows have slowed down considerably.

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7) Education and Unemployment 9.4 % of the population is unemployed which is yet

another alarming issue for the growing nation. The literacy rate in India is 74.04% as of
April 2011 which constitutes of 65.46% females and 82.14% males. The literacy rate is
increasing but the rate of increment is low, which again is a matter of concern.
8) Poverty About 37 % of Indian population lies below poverty line which is a very
alarming situation for a growing economy like India. The main reason for such diversity
is the uneven distribution of wealth in the economy where a handful of people are the
owner of maximum revenue and the majority of the population is too poor to even
arrange for their daily bread. The distribution of wealth in India resembles the pyramid
model. The pyramid states that the base of the pyramid is the poor people which is
maximum in number, while the high net worth people is very few in numbers which
resembles to the top of pyramid. As the wealth increases the number of people in the
category decreases.

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PROBLEMS AND CONSTRAINTS IN THE FUNCTIONING OF

INDIAN CAPITAL MARKET

Introduction

This broadly covers the major threats to the smooth functioning of the capital markets in
India. In the earlier chapters, an attempt has been made to bring out the phase-wise
development in respect of the capital markets in India. While this development was
taking place, there may have been some barriers causing hindrance to the development of
capital market. These problems or barriers may be political, socio-economic or
administrative in nature. All these problems are examined in this chapter. Throughout the
various phases, capital market in India has experienced growth and at the same time,
some bottlenecks were also experienced. This chapter shows how some of these problems
proved to be hindrance in development of capital market. Similarly, an attempt is also
made to study how these problems were overcome in the subsequent phases of
development. There is repetition of some of the problems as they are observed in various
phases.

Problems Observed During Inception Phase (1875-1914)

During this phase, there were inevitable, natural problems faced by the capital market.
Since this phase was just a beginning of the capital market in India, it experienced
following problems.

Unorganized Nature
During the inception phase, there was no formal structure of capital market. Even the
stock exchanges particularly BSE, were formed as a voluntary-non-profit making
associations1 , the operations and functions performed in the market were based on
practices developed by some of the brokers (called as Dalals). There was no formal
structural or functional system prevalent during the initial phase.

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Dominance Of Few Stock Exchanges

This initial phase was marked by concentration or domination of capital market activities
by only few exchanges2 , particularly BSE. It was almost a monopoly of BSE in respect
of operations and functions related to capital market. Up to 1914, there were only three
stock exchanged viz. Mumbai, Ahmadabad and Kolkata. But still, there was dominance
in activities of Mumbai stock exchange,(BSE). This led to imbalanced growth for both
corporate as well as investors intending to invest in the market.

Public Response
As that was just a beginning of the capital market activity in India, naturally, the response
from the public at large was very poor3 . Due to lack of information about the capital
market activities, there was no enthusiasm among the people towards capital market.
Initially, the capital market was looked as a place only for elite reach class in the society.
Hence, majority of the population which falls in middle class as well as lower middle
class was ignorant about the capital market. This problem also led to the liquidity crunch
in the market because only few players were present in the market. Thus, scope for
further growth was limited.

Problems Observed During 1914-1947

This phase was characterized by an umbrella growth. The number of stock exchanges
increased from three to seven during this phase. The number of companies listed in the
stock exchanges throughout the country also increased to over one thousand. As there
was quantitative growth in the Indian capital market, some inherent problems also
emerged during this phase.

Possibility Of Manipulation
The stock exchanges provided a facility to transfer securities freely and thereby some
procedures were also developed for transferring of securities. But the system prevalent at
that time left scope for operator to manipulate the trade.

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Conclusion
A study of capital markets significantly involves a study of problems which
emerged in various phases of development of capital market in India. This chapter has
presented these problems in a phased manner. Apart from this, an attempt has also been
made to analyze the frauds which have taken place during last one and half century. The
problems experienced in the Indian capital markets as well as the scams were significant
as they proved to be hindrances in the smooth functioning of capital markets. Due to
these hindrances a genuine investor has remained aloof from the market while more and
more speculators and institutional investors continued to dominate the capital markets in
India. This has also resulted into increased volatility in the Indian capital market. When
the financial sector reforms were initiated, it was also emphasized to have a strong
regulator for the Indian capital market. This task of regulation is being shouldered by
SEBI to a great extent along with other regulators like RBI, Department of Company
Affairs etc
Though it is very difficult to conclude about the capital market in short but still to
maintain the legacy it should go on like:
Indian market is a booming market; it has scope of development in sectors like
Pharmaceuticals, Retail industry, Automobiles, Education, etc. FDI should be allowed in
sectors to attract the foreign investors though keeping our own economy stable of its own
and not mostly dependent on global market. Inter and Intra terrestrial issues should be
dealt with proper policy making and divestment of PSUs and inviting private players in
sectors like Railways, Infrastructure should be done so as to boost the overall growth of
the economy and thus the market as it is the market which drives the economy and viceversa.
Market and Economy are the two sides of the same coin and cannot be separated

37

Key Terms and Concepts

Eurocurrency market consists of banks that accept deposits and make loans in foreign
currencies outside the country of issue.
Eurodollar could be broadly defined as dollar-denominated deposits in banks all over the
world except the United States.
Certificate of deposit (CD) is a negotiable instrument issued by a bank.
Revolving credit is a confirmed line of credit beyond one year.
London interbank offered rate (LIBOR) is British Banker's Association average of
interbank offered rates for dollar deposits in the London market based on quotations at 16
major banks.
Euro interbank offered rate (EURIBOR) is European Banking Federation-sponsored
rate among 57 euro-zone banks.
Euronote issue facilities (EIF) are notes issued outside the country in whose currency
they are denominated.
Euronotes are short-term debt instruments underwritten by a group of international
banks called a "facility".
Euro commercial paper (ECP) are unsecured short-term promissory notes sold by
finance companies and certain industrial companies.
Euro-medium-term notes (EMTNs) are medium-term funds guaranteed by financial
institutions with the short-term commitment by investors.

38

Contagion, as used in this chapter, is where problems at one bank affect other banks in
the market.
Bank for International Settlements is a bank in Switzerland that facilitates transactions
among central banks.
Federal funds are reserves traded among US commercial banks for overnight use.
Universal bank is one in which the financial corporation not only sells a full scope of
financial services but also owns significant equity stakes in institutional investors.
Keirutsu is a Japanese word that stands for a financially linked group of companies that
play a significant role in the country's economy.
Asian Currency Units (ACUs) is a section within a bank that has authority and separate
accountability for Asian currency market operations.
International capital market consists of the international bond market and the
international equity market.
International bonds are those bonds that are initially sold outside the country of the
borrower.
Foreign bonds are bonds sold in a particular national market by a foreign borrower,
underwritten by a syndicate of brokers from that country, and denominated in the
currency of that country.
Eurobonds are bonds underwritten by an international syndicate of brokers and sold
simultaneously in many countries other than the country of the issuing entity.

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Global bonds are bonds sold inside as well as outside the country in whose currency they
are denominated.
European Currency Unit (ECU) was a weighted value of a basket of 12 European
Community currencies and the cornerstone of the European Monetary System; the euro
replaced the ECU as a common currency for the European Union in January 1999.
Currency-option bonds are bonds whose holders are allowed to receive their interest
income in the currency of their option from among two or three predetermined currencies
at a predetermined exchange rate.
Currency-cocktail bonds are those bonds denominated in a standard "currency basket"
of several different currencies.
Amortization method refers to the retirement of a long-term debt by making a set of
equal periodic payments.
Warrant is an option to buy a stated number of common shares at a stated price during a
prescribed period.
Zero-coupon bonds provide all of the cash payment (interest and principal) when they
mature.
Primary market is a market where the sale of new common stock by corporations to
initial investors occurs.
Secondary market is a market where the previously issued common stock is traded
between investors.
Privatization is a situation in which government-owned assets are sold to private
individuals or groups.

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BIBLOGRAPHY
INTERNATIONAL BANKING K VISWANATHAN
FINANCIAL MARKETS AND INSTRUMENTS L M BHOLE
INTERNATIONAL FINANCE APTE
FINANCIAL MARKETS AND SERVICES GORDAN & NATRAJAN

WEBLOGRAPHY:
GOOGLE.COM
IMF.COM
YAHOO.COM
ANSWERS.COM

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