Financial Markets

Financial Markets
Difference between two assets classes
Real Assets Financial Assets

Determine the productive Claims on real assets, do not
capacity and net income of the contribute directly to the
economy productive capacity of the
Examples: Land, buildings, economy.
machines, knowledge used to Examples: Stocks, bonds
produce goods and services
Financial Assets
Fixed income or debt
Promise either a fixed stream of income or a stream of income determined by
a specified formula
Common stock or equity

Represent an ownership share in the corporation
Derivative securities
Provide payoffs that are determined by the prices of other assets
Alternative Investments
Investment in currency
Investment in real assets through commodity futures
Corporations invest in the commodity futures to hedge the risk
Financial Markets and the Economy
The Informational Role
Capital flows to companies with best prospects
Consumption Timing
Use securities to store wealth and transfer consumption to
the future
Allocation of Risk
Investors can select securities consistent with their tastes
for risk, which benefits the firms that need to raise capital as
security can be sold for the best possible price
Separation of Ownership and Management
Agency problems arise when managers start pursuing their own
interests instead of maximizing firm's value
Mechanisms to mitigate agency problems:
Tie managers' income to the success of the firm (stock options)
Monitoring from the board of directors
Monitoring from the large outside investors and security analysts
Takeover threat
Corporate Governance and Corporate Ethics
Accounting Scandals
Examples Enron, Rite Aid, HealthSouth
Auditors: Watchdogs of the firms
Analyst Scandals
Arthur Andersen
Sarbanes-Oxley Act
Tighten the rules of corporate governance
The Investment Process
Portfolio: Collection of investment assets.
Asset allocation
Choice among broad asset classes
Security selection
Choice of securities within each asset class
The Investment Process
Top-down approach
Asset allocation followed by security analysis to evaluate which particular
securities to be included in the portfolio
Bottom-up approach
Investment based solely on the price-attractiveness, which may result in
unintended heavy weight of a portfolio in only one or another sector of the
economy
Markets are competitive
Risk-Return Trade-Off
Higher-risk assets are priced to offer higher expected returns than lower-risk
assets
Efficient Markets
In fully efficient markets when prices quickly adjust to all relevant
information, there should be neither underpriced nor overpriced securities
Markets are competitive
Passive Management
Holding a highly diversified portfolio
No attempt to find undervalued securities
No attempt to time the market
Active Management
Finding mispriced securities
Timing the market
The Players
Demanders of capital Firms
Suppliers of capital Households
Governments Can be both borrowers or lenders
The Players
Financial Intermediaries: Pool and invest funds
Investment Companies
Banks
Insurance companies
Credit unions
Financial Crisis
Antecedents of the Crisis:
The Great Moderation: A time in which the U.S. had a
stable economy with low interest rates and a tame
business cycle with only mild recessions
Historic boom in housing market
Interest Rates (%)
0
1
2
3
4
5
6
7
8
Jan-96
Jul-96
Jan-97
TED Spread
Jul-97
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
TED spread
3-month T-bill
Jul-07
3-month LIBOR
Figure 1.1 Short-Term LIBOR and Treasury-Bill Rates and the
Jan-08
Jul-08
Index (January 2000 = 100)
100
150
200
250
0
50
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
Case Shiller Index on Housing Prices
2009
2011
2013
Changes in Housing Finance
Old Way New Way
Local thrift institution Securitization: Fannie Mae
made mortgage loans to and Freddie Mac bought
homeowners mortgage loans and bundled
Thrifts major asset: A them into large pools
portfolio of long-term Mortgage-backed securities
mortgage loans are tradable claims against
Thrifts main liability: the underlying mortgage pool
Deposits Originate to distribute
Originate to hold
Changes in Housing Finance
Securitization: Buying mortgage loans from originators and bundling

them into mortgage-backed securities
Replacement of low-risk conforming mortgages with nonconforming
subprime loans
Trend toward low-documentation and then no-documentation loans
and rising allowed leverage on home loans (loan-to-value ratio)
Low adjustable-rate mortgages (ARMs) that maxed out borrowers'
paying capacity at low rates
Mortgage Derivatives
Collateralized debt obligations (CDOs)
Mortgage pool divided into slices or tranches to concentrate default risk
Senior tranches: Lower risk, highest rating (AAA)
Junior tranches: High risk, low or junk rating
Estimated ratings significantly underestimated the inherent risk
Primary Reason for the default
Default probabilities were estimated on the historical data covering
the rising housing market
Geographic diversification did not reduce risk as much as anticipated
Agency problems with rating agencies
Rise of Systemic Risk
Systemic Risk: A potential breakdown of the financial system in which

problems in one market spill over and disrupt others
One default may set off a chain of further defaults

Waves of selling may occur in a downward spiral as asset prices drop
Potential contagion from institution to institution, and from market to market
Banks had a mismatch between the maturity and liquidity of their

assets and liabilities
Liabilities were short and liquid
Assets were long and illiquid
Constant need to refinance the asset portfolio
Banks were very highly levered, giving them almost no margin of
safety
Investors relied too much on credit enhancement through structured

products like CDS
CDS traded mostly over-the-counter, with no posted margin
requirements and little transparency
Opaque linkages between financial instruments and institutions
The shoe drops
2000-2006: Sharp increase in housing prices caused many investors to
believe that continually rising home prices would bail out poorly
performing loans
2004: Interest rates began rising
2006: Home prices peaked
2007: Housing defaults and losses on mortgage-backed securities
surged
The shoe drops
2008: Troubled firms include Bear Stearns, Fannie Mae, Freddie Mac,
Merrill Lynch, Lehman Brothers, and AIG
Money market breaks down
Credit markets freeze up
Federal bailout to stabilize financial system
RISK MITIGATION
Mechanisms to mitigate systemic risk
Stricter rules for bank capital, liquidity, and risk management practices
Increased transparency, especially in derivatives markets (eg.: standardize
CDS contracts so they can trade in centralized exchanges)
Office of Credit Ratings within the SEC to oversee the credit rating agencies
Indian Capital Markets
Factors affecting performance of Stock Exchange
On-line trading facility
Liquidity
FDI & FII
Volatility
Terrorism
Factors affecting performance of Stock Exchange
Government Policies
Geographical coverage
Number of Listed securities
Market Capitalisation
The age of the stock exchange

Capital Markets/Securities Market
The capital markets are relatively for long term (greater than one year
maturity) financial instruments (e.g. bonds and stocks). Their role can be
summarized as follows:
The Capital Market is the indicator of the inherent strength of the economy.
It is the largest source of funds with long and indefinite maturity for
companies and thereby enhances the capital formation in the country.
It offers a number of investment avenues to investors.
It helps in channeling the savings pool in the economy towards optimal
allocation of capital in the country.
The securities / capital market is divided into two parts, namely, primary and
secondary stock market. The relationship between these parts of the
markets provides an insight into its organization.
Primary/Secondary markets
Primary Market: A market where new securities are bought and sold for the first
time is called the New Issues market or the IPO market. In other words, the first
public offering of equity shares or convertible securities by a company, which is
followed by the listing of a companys shares on a stock exchange, is known as an
initial public offering (IPO). The Primary market also includes issue of further
capital by companies whose shares are already listed on the stock exchange.
There are different types of intermediaries operating in the capital market. They
play a crucial role in the development of capital market by providing a variety of
services. These intermediaries viz., merchant bankers, brokers, bankers to issues,
debenture trustees, portfolio managers, registrars to issues and share transfer
agents, etc., are regulated by SEBI.
Secondary Market: A market in which an investor purchases a security from
another investor rather than the issuer, subsequent to the original issuance in the
primary market. So, it can be stated that secondary markets are the stock
exchanges and the over-the-counter market. When the securities are traded from
that first holder to another, the issues trade in these secondary markets.
(a) Nature of Securities: The primary markets deal with new securities,
that is, securities, which were not previously available and are,
therefore, offered to the investing public for the first time. The stock
market, on the other hand, is a market for old securities, i.e. securities
which have been issued already and granted stock exchange quotation.
The stock exchanges, therefore, provide a regular and continuous
market for buying and selling of securities.
(b) Nature of Financing: Another aspect is the nature of their contribution to
industrial financing. Primary market provides additional funds to the issuing
companies either for starting a new enterprise or for the expansion or
diversification of the existing one and, therefore, its contribution to
company financing is direct. In contrast, the secondary markets can in no
circumstance supply additional funds since the company is not involved in
the transaction. This, however, does not mean that the stock markets do not
have relevance in the process of transfer of resources from savers to
investors. Their role regarding the supply of capital is indirect. The existence
of secondary markets provides institutional facilities for the continuous
purchase and sale of securities and lends liquidity and marketability thus,
playing an important part in the process.
Organisational Differences: The stock exchanges have physical existence
and are located in a particular geographical area. The primary market
is not rooted in any particular spot and has no geographical existence.
The primary market has neither any tangible form of any
administrative organizational setup like that of stock exchanges, nor is
it subjected to any centralized control and administration for the
consummation of its business. It is recognized only by the services that
it renders to the lenders and borrowers of capital funds at the time of
any particular operation.
ROLE AND CHARACTERISTICS OF THE EXCHANGES IN THE ECONOMY
1. Market for securities : Stock exchange is a market, where securities of corporate

bodies, government and semi-government bodies are bought and sold.
2. Deals in second hand securities : It deals with shares, debentures bonds and such
securities already issued by the companies. In short it deals with existing or second
hand securities and hence it is called secondary market.
3. Regulates trade in securities : Stock exchange does not buy or sell any securities on
its own account. It merely provides the necessary infrastructure and facilities for trade
in securities to its members and brokers who trade in securities. It regulates the trade
activities so as to ensure free and fair trade
4. Allows dealings only in listed securities : In fact, stock exchanges maintain an
official list of securities that could be purchased and sold on its floor. Securities which
do not figure in the official list of stock exchange are called unlisted securities. Such
unlisted securities cannot be traded in the stock exchange.
5. Transactions effected only through members : All the transactions in securities at

the stock exchange are effected only through its authorised brokers and members.
Outsiders or direct investors are not allowed to enter in the trading circles of the stock
exchange. Investors have to buy or sell the securities at the stock exchange through
the authorised brokers only.
6. Association of persons : A stock exchange is an association of persons or body of
individuals which may be registered or unregistered.
7. Recognition from Central Government : Stock exchange is an organised market. It
requires recognition from the Central Government.
8. Working as per rules : Buying and selling transactions in securities at the stock
exchange are governed by the rules and regulations of stock exchange as well as
SEBI Guidelines. No deviation from the rules and guidelines is allowed in any case.
9. Specific location : Stock exchange is a particular market place where authorised

brokers come together daily (i.e. on working days) on the floor of market called
trading circles and conduct trading activities. The prices of different securities
traded
are shown on electronic boards. After the working hours market is closed. All the
working of stock exchanges is conducted and controlled through computers and
electronic system.
10. Financial Barometers : Stock exchanges are the financial barometers and
development indicators of national economy of the country. Industrial growth and
stability is reflected in the index of stock exchange.
FOREIGN STOCK EXCHANGES
NYSE
New York Stock Exchange (NYSE): The New York Stock Exchange was
established more than 200 years ago in 1792. NYSE is the worlds
foremost securities marketplace.
Each day on the NYSE trading floor an auction takes place. Open bid
and offers are managed on The Trading Floor by Exchange members
acting on behalf of institutions and individual investors. Buy and sell
orders for each listed security meet directly on the trading floor in
assigned locations. Prices are determined through supply and demand.
Stocks buy and sell orders funnel through a single location, ensuring
that the investor, no matter how big or small, is exposed to a wide
range of buyers and sellers.
NASDAQ
Nasdaq: Nasdaq is known for its growth, liquidity, depth of market and the
worlds most powerful, forward-looking technologies. All these make
Nasdaq choice of the leading companies worldwide. Since its inception in
1971, Nasdaq has steadily outpaced the other major markets to become
the fastest-growing stock market in the U.S. Nasdaq is a screen- based
market, operating in an efficient, highly competitive electronic trading
environment.
As the market for Nasdaqs largest and most actively traded securities, the
Nasdaq National Market lists more than 4,000 securities. To be listed on the
National Market, a company must satisfy stringent financial, capitalization,
and corporate governance standards. Nasdaq National Market companies
include some of the largest, best known companies in the world.
LONDON STOCK EXCHANGE
London Stock Exchange: Its history goes back to 1760 when 150
brokers kicked out of the Royal Exchange for rowdiness formed a club
at Jonathans Coffee House to buy and sell shares. In 1773, members
voted to change the name to Stock Exchange and 2000 shareholders
voted it to become a public limited company and thus London Stock
Exchange plc was formed. Dealing in shares is conducted via an off-
market trading facility operated by Cazenove and Co.
Market Structures
Stock Exchange Functions
(a) Liquidity and Marketability of Securities: The basic function of the
stock market is the creation of a continuous market for securities,
enabling them to be liquidated, where investors can convert their
securities into cash at any time at the prevailing market price. It also
provides investors the opportunity to change their portfolio as and
when they want to change,
i.e. they can at any time sell one security and purchase another, thus
giving them marketability.
Fair Price Determination: This market is almost a perfectly competitive
market as there are large number of buyers and sellers. Due to nearly
perfect information, active bidding take place from both sides. This
ensures the fair price to be determined by demand and supply forces.
Source for Long term Funds: Corporates, Government and public
bodies raise funds from the equity market. These securities are
negotiable and transferable. They are traded and change hands from
one investor to the other without affecting the long-term availability of
funds to the issuing companies.
Helps in Capital Formation: There is nexus between the savings and the
investments of the community. The savings of the community are
mobilized and channeled by stock exchanges for investment into those
sectors and units which are favoured by the community at large, on
the basis of such criteria as good return, appreciation of capital, and so
on. It is the preference of investors for individual units as well as
industry groups, which is reflected in the share price, that decides the
mode of investment. Stock exchanges render this service by arranging
for the preliminary distribution of new issues of capital, offered
through prospectus, as also offers for sale of existing securities, in an
orderly and systematic manner
Settlement structure
Rolling Settlement Cycle: SEBI introduced a new settlement cycle
known as the rolling settlement cycle. This cycle starts and ends on
the same day and settlement takes place on the T+X days where X is
2 days, which is the business days from the date of the transactions.
Thus unlike periodic settlement cycle in a rolling settlement the
decision has to be made at the conclusion of the trading session, on
the same day.
Settlement structure
NSE Settlement Cycle: The NSE follows a T+2 rolling settlement cycle. In this
settlement for all trade executed on trading day i.e. T day. The obligations
are determined on T+1 day and settlement on T+2 basis i.e. on the 2nd
working day.
BSE Settlement Cycle: The BSE settlement cycle is similar to that of the NSE
T+2 i.e. rolling settlement.
Advantages of Rolling Settlements: In rolling settlements, payments are
quicker than in weekly settlements. Thus, investors benefit from increased
liquidity. From an investor's perspective, rolling settlement reduces delays.
This also reduces the tendency for price trends to get exaggerated. Hence,
investors not only get a better price but can also act at their leisure.
Financial Instruments
Most Popular Instruments
Equity Shares
Preference Shares
Debentures/ Bonds
ADRs
GDRs
Derivatives
Masala Bonds ( Recent Addition)
Equity Shares
Equity share is a type of security, which signifies ownership in a corporation
and represents a claim on the part of the corporations assets and earnings.
It is a share in the ownership of a company. It represents a claim on the
company's assets and earnings. As one acquires more stock, his or her
ownership stake in the company becomes greater.
There are two main types of shares equity shares and preference shares.
Equity share usually entitles the owner to vote at shareholders' meetings
and to receive dividends.
Preference shares generally do not have voting rights, but have a higher
claim on assets and earnings than the equity shares. For example, owners of
Preference shares receive dividends before equity shareholders and have
priority in the event that a company goes bankrupt and is liquidated.
Equity Shares
Right to Income: Equity shareholders, on the other hand, have no legal
recourse to a company for not distributing profits. Only if
management, the board of directors, or both are engaged in fraud
may shareholders take their case to court and possibly force the
company to pay dividends.
Voting Rights: The equity shareholders of a company are its owners and
they are entitled to elect a board of directors. In a large corporation,
shareholders usually exercise only indirect control through the board
of directors they elect. The board, in turn, selects the management,
and management actually controls the operations of the company. In a
sole proprietorship partnership, or small corporation, the owners
usually control the operation of the business directly.
Equity Shares
Proxies and Proxy Contests: Equity shareholders are entitled to one vote for each
share that they own. It is usually difficult, both physically and financially, for most
shareholders to attend a corporations annual meetings. Because of this, many
shareholders vote by means of a proxy, a legal document by which shareholders
assign their right to vote to another person.
Voting Procedures: Depending on the corporate charter, the board of directors is
elected under either a majority-rule voting system or a cumulative voting system.
Under the majority-rule system, shareholders have one vote for each share that
they own, and they must vote for each director position that is open. Under a
cumulative voting system, a shareholder is able to accumulate votes and cast them
for less than the total number of directors being elected. The total number of
votes for each shareholder is equal to the number of shares the stockholder times
the number of directors being elected.
Preference Shares
These shares form part of the share capital of the company which
carry a preferential right to be paid in case a company goes bankrupt or
is liquidated. They do not have voting rights but have a higher claim on
the assets and earnings of the company. A preference share may also
sometimes be convertible partly/fully into equity shares/debentures at
a certain ratio during a specified period.
Debentures/ Bonds
A bond is a long-term debt security. It represents debt in that the bond
buyer actually lends the face amount to the bond issuer. The certificate itself
is evidence of a lender-creditor relationship. It is a security because unlike
a car loan or home- improvement loan, the debt can be bought and sold in
the open market.
In fact a bond is a loan intended to be bought and sold. It is long-term by
definition; in order to be called a bond. The term must be longer than five
years. Debt securities with maturities under five years are called bills, notes
or other terms. Since bonds are intended to be bought and sold, all the
certificates of a bond issue contain a master loan agreement. This agreement
between issuer and investor (or creditor and lender), called the bond
indenture or deed of trust, contains all the information you would
normally expect to see in any loan agreement, including the following:
Debentures/ Bonds
Amount of the Loan: The face amount par value. or principal is the amount of the loan - the
amount that the bond issuer has agreed to repay at the bonds maturity.
Rate of Interest: Bonds are issued with a specified coupon or nominal rate, which is
determined largely by market conditions at the time of the bonds primary offering. Once
determined, it is set contractually for the life of the bond. The amount of the interest payment can
be easily calculated by multiplying the rate of interest (or coupon) by the face value of the bond.
For instance, a bond with a face amount of ` 1000 and a coupon of 8% pays the bondholder ` 80 a
year.
Schedule or Form of Interest Payments: Interest is paid on most bonds at six-month intervals,
usually on either the first or the fifteenth of the month. The ` 80 of annual interest on the bond in
the previous example would probably be paid In two installments of ` 40 each.
Term to Maturity : A bonds maturity, or the length of time until the principal is repaid varies
greatly but is always more than five years. Debt that matures in less than a year is a money
market instrument - such as commercial paper or bankers acceptances. A short-term bond, on
the other hand, may have an initial maturity of five years. A long- term bond typically matures in
20 to 40 years. The maturity of any bond is predetermined and stated in the trust indenture.
Debentures/ Bonds
Call Feature (if any): A call feature, if specified in the trust indenture,
allows the bond issuer to call in the bonds and repay them at a
predetermined price before maturity. Bond issuers use this feature to protect
themselves from paying more interest than they have to for the money they
are borrowing.
Companies call in bonds when general interest rates are lower than the
coupon rate on the bond, thereby retiring expensive debt and refinancing it
at a lower rate.
American Depository Receipt (ADRs):
An American Depository Receipt (ADR) is a negotiable receipt which represents one or more
depository shares held by a US custodian bank, which in turn represent underlying shares of non-
US issuer held by a custodian in the home country. ADR is an attractive investment to US investors
willing to invest in securities of non US issuers for following reasons:
ADRs provide a means to US investors to trade the non-US companys shares in US dollars. ADR is a
negotiable receipt (which represents the non US share) issued in US capital market and is traded in
dollars. The trading in ADR effectively means trading in underlying shares.
ADRs facilitates share transfers. ADRs are negotiable and can be easily transferred among the
investors like any other negotiable instrument. The transfer of ADRs automatically transfers the
underlying share.
The transfer of ADRs does not involve any stamp duty and hence the transfer of underlying share
does not require any stamp duty.
The dividends are paid to the holders of ADRs in U.S. dollars.
A non U.S. issuer has to work with its US investment bankers, US depository bank, US and non US
legal counsel and independent accountant to prepare the registration documents and offering
materials.
American Depository Receipt (ADRs):
The listing of such an issue is done on the NYSE or AMEX to enable
trading. Quotations on NASDAQ can also be used for trading purposes.
Any requirement with respect to Blue Sky Law, if not exempted, has to
be fulfilled.
Specified document and information must be provided to NASDAQ to
enable it to review the terms of the offering and determine whether
the underwriting arrangements are fair and reasonable. The filing
documents with NASDAQ are the responsibility of managing
underwriter
Global Depository Receipts
Global Depository Receipts are negotiable certificates with publicly
traded equity of the issuer as underlying security. An issue of
depository receipts would involve the issuer, issuing agent to a foreign
depository. The depository, in turn, issues GDRs to investors
evidencing their rights as shareholders. Depository receipts are
denominated in foreign currency and are listed on an international
exchange such as London or Luxembourg.
GDRs enable investors to trade a dollar denominated instrument on
an international stock exchange and yet have rights in foreign shares.
Global Depository Receipts
GDRs are also issued with warrants attached to them. Warrants give
the investors an option to get it converted into equity at a later date.
Warrants help the issuer to charge some premium on the GDRs sold
and it also helps to increase the demand of the GDR issue.
The other advantage to the issuer is that it will not have to pay
dividends on the warrants till the conversion option is exercised. The
disadvantage to the issuer lies in delayed receipt of full proceeds from
the issue and in case the conversion option is not exercised the
expected proceeds will not be realized.
Derivatives
A derivative is a financial instrument which derives its value from some
other financial price. This other financial price is called the
underlying.
The most important derivatives are futures and options. Here we will
discuss derivatives as financial derivatives and embedded derivatives.
Financial Derivatives
Under financial derivatives:
stock futures
stock options
index futures
index options
Forward Contract
Consider a Punjab farmer who grows wheat and has to sell it at a profit. The simplest and
the traditional way for him is to harvest the crop in March or April and sell in the spot
market then. However, in this way the farmer is exposing himself to risk of a downward
movement in the price of wheat which may occur by the time the crop is ready for sale.
In order to avoid this risk, one way could be that the farmer may sell his crop at an agreed-
upon rate now with a promise to deliver the asset, i.e., crop at a pre-determined date in
future. This will at least ensure to the farmer the input cost and a reasonable profit.
Thus, the farmer would sell wheat forward to secure himself against a possible loss in
future. It is true that by this way he is also foreclosing upon him the possibility of a
bumper profit in the event of wheat prices going up steeply. But then, more important is
that the farmer has played safe and insured himself against any eventuality of closing
down his source of livelihood altogether. The transaction which the farmer has entered
into is called a forward transaction and the contract which covers such a transaction is
called a forward contract.
Forward Contract
A forward contract is an agreement between a buyer and a seller
obligating the seller to deliver a specified asset of specified quality and
quantity to the buyer on a specified date at a specified place and the
buyer, in turn, is obligated to pay to the seller a pre-negotiated price in
exchange of the delivery.
This means that in a forward contract, the contracting parties negotiate
on, not only the price at which the commodity is to be delivered on a
future date but also on what quality and quantity to be delivered and
at what place. No part of the contract is standardised and the two
parties sit across and work out each and every detail of the contract
before signing it.
Forward Contract
For example, in case a gold bullion forward contract is being negotiated between two
parties, they would negotiate each of the following features of the contract:
the weight of the gold bullion to be delivered
the fineness of the metal to be delivered
the place at which the delivery is to be made
the period after which the delivery is to be made
the price which the buyer would pay.
Suppose a buyer L and a seller S agrees to do a trade in 100 tolas of gold on 31 Dec 2018 at
` 30,000/tola. Here, ` 30,000/tola is the forward price of 31 Dec 2018 Gold. The buyer L is
said to be long and the seller S is said to be short. Once the contract has been entered into,
L is obligated to pay S ` 30 lakhs on 31 Dec 2018, and take delivery of 100 tolas of gold.
Similarly, S is obligated to be ready to accept ` 30 lakhs on 31 Dec 2018, and give 100 tolas
of gold in exchange.
Future Contract
A futures contract is an agreement between two parties that commits
one party to buy an underlying financial instrument (bond, stock or
currency) or commodity (gold, soybean or natural gas) and one party
to sell a financial instrument or commodity at a specific price at a
future date. The agreement is completed at a specified expiration date
by physical delivery or cash settlement or offset prior to the expiration
date. In order to initiate a trade in futures contracts, the buyer and
seller must put up "good faith money" in a margin account.
Regulators, commodity exchanges and brokers doing business on
commodity exchanges determine margin levels.
Stock Futures Contract
A stock futures contract is an agreement to buy or sell shares or stock such as
Microsoft, Intel, ITC, or Tata Steel at a point in the future. The buyer has an
obligation to purchase shares or stock and the seller has an obligation to sell shares
or stock at a specific price at a specific date in the future.
Thus a stock futures contract is a standardized contract to buy or sell a specific
stock at a future date at an agreed price. Single-stock futures contracts are
completed via offset or the delivery of actual shares at expiration. Margin on a
single- stock futures contract is expected normally to be 20% of notional value.
Each Stock Future contract is standardized and includes basic specifications. The
terms of the contract call for delivery of the stock by the seller at some time
specified in the future. However, most contracts are not held to expiration. The
contracts are standardized, making them highly liquid. To get out of an open long
(buying) position, the investor simply takes an offsetting short position (sells).
Conversely, if an investor has sold (short) a contract and wishes to close it out, he
or she buys (goes long) the offsetting contract.
Hedging
To hedge, the investor takes a stock future position exactly opposite to
the stock position. That way, any losses on the stock position will be
offset by gains on the future position. However, this is only a
temporary solution because the future will expire.
DERIVATIVES
Risks involved in Derivatives
The different types of derivative risks are:
(a) Credit risk: Credit risk is the risk of loss due to counterpartys failure to
perform on an obligation to the institution. Credit risk in derivative
products comes in two forms:
i. Pre-settlement risk: It is the risk of loss due to a counterparty defaulting on a
contract during the life of a transaction. The level of exposure varies throughout
the life of the contract and the extent of losses will only be known at the time of
default.
ii. Settlement risk: It is the risk of loss due to the counterparty's failure to perform on
its obligation after an institution has performed on its obligation under a contract
on the settlement date. Settlement risk frequently arises in international
transactions because of time zone differences. This risk is only present in
transactions that do not involve delivery versus payment and generally exists for a
very short time (less than 24 hours).
(b) Market risk: Market risk is the risk of loss due to adverse changes in
the market value (the price) of an instrument or portfolio of
instruments. Such exposure occurs with respect to derivative
instruments when changes occur in market factors such as underlying
interest rates, exchange rates, equity prices, and commodity prices or
in the volatility of these factors.
(c) Liquidity risk: Liquidity risk is the risk of loss due to failure of an
institution to meet its funding requirements or to execute a
transaction at a reasonable price. Institutions involved in derivatives
activity face two types of liquidity risk : market liquidity risk and
funding liquidity risk.
(i) Market liquidity risk: It is the risk that an institution may not be able
to exit or offset positions quickly, and in sufficient quantities, at a
reasonable price. This inability may be due to inadequate market
depth in certain products (e.g. exotic derivatives, long-dated options),
market disruption, or inability of the bank to access the market (e.g.
credit down-grading of the institution or of a major counterparty).
(ii) Funding liquidity risk: It is the potential inability of the institution to
meet funding requirements, because of cash flow mismatches, at a
reasonable cost. Such funding requirements may arise from cash flow
mismatches in swap books, exercise of options, and the
implementation of dynamic hedging strategies.
Operational risk: Operational risk is the risk of loss occurring as a result of
inadequate systems and control, deficiencies in information systems, human
error, or management failure.
Legal risk: Legal risk is the risk of loss arising from contracts which are not
legally enforceable (e.g. the counterparty does not have the power or
authority to enter into a particular type of derivatives transaction) or
documented correctly.
Regulatory risk: Regulatory risk is the risk of loss arising from failure to
comply with regulatory or legal requirements.
Reputation risk: Reputation risk is the risk of loss arising from adverse public
opinion and damage to reputation.
Trading Examples
Example Margin Requirements
In a stock future contract on ITC stock at ` 120, both the buyer and
seller have a margin requirement of 20% or ` 2400. If ITC stock goes up
to ` 122, the account of the long contract is credited with ` 200 (` 122-`
120 = ` 2 X 100 = ` 200) and the account of the seller (seller) is debited
by the same ` 200. This indicates that investors in stock futures must be
very vigilant - they must keep close track of market movements.
Trading Examples
Speculation For simplicity we'll be using one contract and the basic 20%.
Commissions and transaction fees are not taken into account.
Example- Going Long on Future Contract
Suppose an investor is bullish on McDonald's (MCD) and goes long one September
stock future contract on MCD at ` 80. At some point in the near future, MCD is
trading at ` 96. At that point, the investor sells the contract at ` 96 to offset the
open long position and makes a ` 1600 gross profit on the position.
This example seems simple, but lets examine the trades closely. The investor's
initial margin requirement was only ` 1600 (` 80 x 100 = ` 8,000 x 20% = ` 1600).
This investor had a 100% return on the margin deposit. This dramatically illustrates
the leverage power of trading futures. Of course, had the market moved in the
opposite direction, the investor easily could have experienced losses in excess of
the margin deposit.
Trading Examples
Example- Going Short on Future Contract
An investor is bearish in Kochi Refinery (KR) stock for the near future and
goes short an August stock future contract on KR at ` 160. KR stock performs
as the investor had guessed and drops to ` 140 in July. The investor offsets
the short position by buying an August stock future at ` 140. This represents
a gross profit of ` 20 per share, or a total of ` 2,000.
Again, let's examine the return the investor had on the initial deposit. The
initial margin requirement was ` 3,200 (` 160 x 100 = ` 16,000 x 20% = `
3,200) and the gross profit was ` 2,000. The return on the investor's deposit
was more than 60% - a terrific return on a short- term investment.
Trading Examples
Consider an investor who has bought 100 shares of Tata Steel (TS) at `
300. In July, the stock is trading at ` 350 The investor is happy with the
unrealized gain of ` 50 per share but is concerned that in a stock as
volatile as TS, the gain could be wiped out in one bad day. The investor
wishes to keep the stock at least until September, however, because of
an upcoming dividend payment.
To hedge, the investor sells a ` 350 September stock future contract -
whether the stock rises or declines, the investor has locked in the ` 50-
per-share gain.
Stock Index Futures
Trading in stock index futures contracts was introduced by the Kansas City Board of
Trade on February 24, 1982.
A contract for stock index futures is based on the level of a particular stock index
such as the S&P 500 or the Dow Jones Industrial Average or NIFTY or BSE sensex.
The agreement calls for the contract to be bought or sold at a designated time in
the future. Just as hedgers and speculators buy and sell futures contracts and
options based on a future price of corn, foreign currency, etc, they mayfor
mostly the same reasonsbuy and sell such contracts based on the level of a
number of stock indexes.
Stock index futures may be used to either speculate on the equity market's general
performance or to hedge a stock portfolio against a decline in value. Generally,
these contracts expire within one year. Unlike commodity futures, however, stock
index futures are not based on tangible goods, thus all settlements are in cash.
Because settlements are in cash, investors usually have to meet liquidity or income
requirements to show that they have money to cover their potential losses.
Stock Index Futures
Stock index futures also allow investors to separate market timing from
market selection decisions. For instance, investors may want to take
advantage of perceived immediate increases in an equity market but are not
certain which securities to buy; they can do this by purchasing stock index
futures.
If the futures contracts are bought and the present value of the money used
to buy them is invested in risk-free securities, investors will have a risk
exposure equal to that of the market. Similarly, investors can adjust their
portfolio holdings at a more leisurely pace.
For example, assume the investors see that they have several undesirable
stocks but do not know what holdings to buy to replace them. They can sell
the unwanted stocks and, at the same time, buy stock index futures to keep
their exposure to the market. They can later sell the futures contracts when
they have decided which specific stocks they want to purchase.
The Indian Scenario
S&P CNX Nifty Index Futures
The NSE Nifty futures contract is a forward contract, which was traded on the National Stock
Exchange (NSE) on June 12, 2000. The index futures contracts are based on the popular market
benchmark S&P CNX Nifty index.
Trading cycle: S&P CNX Nifty futures contracts have a maximum of 3-month trading cycle - the near
month (one), the next month (two) and the far month (three). A new contract is introduced on the
trading day following the expiry of the near month contract. The new contract will be introduced
for a three month duration. This way, at any point in time, there will be 3 contracts available for
trading in the market i.e., one near month, one mid month and one far month duration
respectively.
Expiry day: S&P CNX Nifty futures contracts expire on the last Thursday of the expiry month. If the
last Thursday is a trading holiday, the contracts expire on the previous trading day.
Trading Parameters/ Contract size: The value of the future contract may not be less than 2 lakhs at
the time of introduction. The permitted lot size for future and option contract is the same for given
underlying or such lot size as may be stipulated by Exchange from time to time.
Price steps: The price step in respect of S&P CNX Nifty futures contracts is Re.0.05.
S&P CNX Nifty Index Futures
Quantity freeze: Quantity Freeze for S&P CNX Nifty futures contracts would be
15,000 units or greater.
Uses/Advantages of Stock Index Futures
Investors commonly use stock index futures to change the weightings
or risk exposures of their investment portfolios. A good example of
this is investors who hold equities from two or more countries.
Suppose these investors have portfolios invested in 60 percent U.S.
equities and 40 percent Japanese equities and want to increase their
systematic risk to the U.S. market and reduce these risks to the
Japanese market. They can do this by buying U.S. stock index futures
contracts in the indexes underlying their holdings and selling
Japanese contracts (in the Nikkei Index).
Stock index futures also allow investors to separate market timing from
market selection decisions. For instance, investors may want to take
advantage of perceived immediate increases in an equity market but are not
certain which securities to buy; they can do this by purchasing stock index
futures. If the futures contracts are bought and the present value of the
money used to buy them is invested in risk-free securities, investors will
have a risk exposure equal to that of the market.
Similarly, investors can adjust their portfolio holdings at a more leisurely
pace.
For example, assume the investors see that they have several undesirable
stocks but do not know what holdings to buy to replace them. They can sell
the unwanted stocks and, at the same time, buy stock index futures to keep
their exposure to the market. They can later sell the futures contracts when
they have decided which specific stocks they want to purchase.
Investors often use stock index futures to hedge the value of their
portfolios. Provide hedging or insurance protection for a stock
portfolio in a falling market. To implement a hedge, the instruments in
the cash and futures markets should have similar price movements.
Also, the amount of money invested in the cash and futures markets
should be the same. To illustrate, while investors owning well-
diversified investment portfolios are generally shielded from
unsystematic risk (risk specific to particular firms), they are fully
exposed to systematic risk (risk relating to overall market fluctuations).
A cost- effective way for investors to reduce the exposure to systematic
risk is to hedge with stock index futures, similar to the way that people
hedge commodity holdings using commodity futures
Stock Options
A Stock Option may be understood as a privilege, sold by one party to
another, that gives the buyer the right, but not the obligation, to buy (call) or
sell (put) a stock at an agreed-upon price within a certain period or on a
specific date regardless of changes in its market price during that period.
The various kinds of stock options include put and call options, which may
be purchased in anticipation of changes in stock prices, as a means of
speculation or hedging.
A put gives its holder an option to sell, or put, shares to another party at a
fixed price even if the market price declines.
A call gives the holder an option to buy, or call for, shares at a fixed price
even if the market price rises
Stock Index Options
Stock Index Option: It is a call or put option on a financial index.
Investors trading index options are essentially betting on the overall
movement of the stock market as represented by a basket of stocks.
Options on the S&P 500 are some of the most actively traded options
in the world.
Factors Affecting Value of an Option
Price of the Underlying
Time
Volatility
Interest rate
What is a commodity ???
93
Common definition of a commodity
Goods that are widely used and have a ready market
Goods that are of standard variety in a particular geographical region
Goods that have a long shelf life ( durable goods)
Traded at a price depending on the demand and supply
94
Basis of grade
The commodity has to have the characteristics of a minimum accepted
standard.
The Basis grade is fixed to define the minimum accepted standard that
a deliverable commodity must meet in order to be suitable for trading
95
Bullion Metals Energy Oil & Oil seeds Cereals Fiber
Gold Aluminium ATF Crude Palm Oil Barley Kapas
Gold Guinea Aluminium Mini Brent Crude Oil Kapasia Khalli Wheat Cotton (29mm)
Gold M Copper Crude Oil Refined Soya Oil Maize-Feed /
Gold Petal Copper Mini Electricity Soya Bean Industrial Grade
Gold Petal Iron Ore Monthly &
(New Delhi) Lead Weekly
Platinum Lead Mini Gasoline
Silver Mild Steel Heating Oil
Silver M Ingot,Billets Imported
Silver Micro Nickel Thermal Coal
Silver 1000 Nickel Mini Natural Gas
Tin
Zinc
Zinc Mini
SPICES OTHER
Cardamom Almond
Coriander Gaur Seed
Turmeric Melted Menthol
Flakes
Mentha Oil
Potato (Agra)
Potato
(Tarkeshwar)
Sugar M
96
The Government interaction
Primarily trade bodies
Commodity Boards
Majority of the developing nations have Ministries that have an

interface for Essential Commodities and Metals
97
Examples in India http://goidirectory.nic.in/index.php
Coffee Board of India (indiacoffee.org)

Central Ministry of Agriculture
Central ministry of Mines
Ministry of Food Processing Industries
Ministry of Power
Ministry of Steel
Ministry of Textiles
Ministry of Water Resources
98
Differences in commodity and Equity Markets
Commodity Markets Equity Markets

Far larger in size Equity markets are smaller
Far more demanding in terms of Primarily local as majority of the

trading hours countries do not allow free flow
of capital
Far more varieties in trade Totally standardised trade, a
stock of a company is a stock (
some have A, B)
99

Factors to be watched are Factors to be watched are board
completely different from compositions, Income
equity; you watch weather, statements, balance sheets,
agricultural yields, soil erosions contracts
Commodity cycles precede
equity cycles as they deal with Equity cycles are a result of the
raw materials commodity cycles in many
industries
100

Delivery and warehousing terms There are no delivery and
form an important part of the warehousing terms in the
futures contract that have contract
physical settlement
Quality of the underlying Quality of the underlying is not
commodity is important in the an issue in the Equity Futures
commodity futures contract contract
101

Faces Government interventions No Government Intervention
from time to time except in case of massive fraud
MSP minimum support price is No concept of MSP-minimum

a concept widely used in support price, however there are
agricultural commodities in concepts like upper circuit and
emerging markets lower circuit
102

Delivery and warehousing terms There are no delivery and
form an important part of the warehousing terms in the
futures contract that have contract
physical settlement
Quality of the underlying Quality of the underlying is not
commodity is important in the an issue in the Equity Futures
commodity futures contract contract
103
Characteristics of some of the Commodities
traded
Maize
Wheat
Zinc
Aluminum
Gold
Crude Oil
104
Maize (NCDEX)
Contract Size 10 MT
Quoted size Rupees Per Quintal
Maximum order entry size 500 MT
Positional limit (client level) 20,000 MT
Positional Limit (member level) 100,000 MT or 15% of the market
wide position whichever is higher
Contract tenure One month
105
Wheat (NCDEX)
Contract Size 10MT
Quoted size Rs/quintal
Positional limit (client level) 1,00,000 MT or 15% of market wide open
position whichever is higher
Positional Limit (member level) 20,000 MT

106
Zinc (MCX)
Contract Size 5 MT
Quoted size Rs per/kg
Positional limit (client level) 3600 MT
Positional Limit (member level) 18,000 MT or 15% of market wide
open position whichever is higher
Contract tenure Three month
107
Aluminum (MCX)January
Contract Size 5 MT
Quoted size 1 kg
Maximum order entry size 150MT
Positional limit (client level) 15000MT
Positional Limit (member level) 75000 MT or 15% of the total
open position which is higher
Contract tenure Three months
108
Gold (MCX)January
Contract Size One Kg
Quoted size Rupees/10 grams
Maximum order entry size 10 kg
Positional limit (client level) 2.5MT
Positional Limit (member level) 12.5 MT or 15% of market wide
open position whichever is higher
109
Crude Oil(MCX)
Contract Size 100 barrels
Quoted size Rs/ per barrel
Maximum order entry size 10,000 barrels
Positional limit (client level) 4,80,000 barrels
Positional Limit (member level) 24,00,000 barrels or 15% of the
market wide open position which
ever is higher
Contract tenure Six months
110
Typical Commodity Contract details
Trading Delivery
Trading period Delivery unit
Trading session Delivery margin
Trading unit Delivery centres
Quotation/Base value Quality specifications
Price quote If the seller offers a
delivery of a different
quality
Maximum order size Delivery logic
Tick size
Daily price limits
Initial margin
Special margin
Maximum allowable open
position
111
Typical Commodity Contract details
Settlement Settlement ( contd..)

Last day of trading Delivery pay-in
Tender period Delivery logic
Delivery period Funds pay-out
Buyers intention Funds pay-in
Tender days Delivery pay-out
Tender notice by seller Mode of communication
Dissemination of information on tendered Penal provision

delivery and buyer interest
Tender period margin Allocation of delivery
Exemption from tender and delivery period Delivery order rate

margins
Delivery logic Buyers obligation
All terms not included !!!!!!

112
Examples of futuristic commodities ???
113
Three Dimensions to Commodity
Production
Transport
Storage
114
Production
Dimensions of Production
Production Demand
Seasonal Through out the year
Through out the year Seasonal
Seasonal Seasonal ( but seasons dont match)
Through out the year Through out the year
115
Production and Demand
Production Demand Storage
Seasonal Through out the year ??????
Through out the year Seasonal ???????
Seasonal Seasonal ( but seasons ?????????

dont match)
Through out the year Through out the year ???????
116
What is Transport a function of ???
117
Transport is a function of
Geographical production spread as
compared to consumption
geographical spread
118
IN THE INTERNATIONAL ECONOMY OF TODAY
VERY RARELY WILL YOU FIND A SITUATION OF
WHERE THE PRODUCTION IS SPREAD OVER A
LARGE GEOGRAPHICAL AREA WHILE THE
CONSUMPTION IS CONFINED TO A SMALL REGION.
IN THE WORLD TODAY YOU WILL FIND THAT THE

PRODUCTION IS SPREAD OVER A LARGE
INTERNATIONAL AREA AND CONSUMPTION IS
ALSO SPREAD OVER A LARGE INTERNATIONAL
AREA
119
Demand Supply affecting the Price
Dimension
When there is a sudden surge in demand for a commodity what gets
affected ???
The spot price surges up
It will have a temporary upper limit if the demand is seasonal
It will not have a temporary upper limit if the demand is not seasonal and the
players who hold inventories will start demanding a convenience yield
120
Demand Supply affecting the Price
Dimension
What if the commodity cannot be stored nor produced in a short
period of time ????
e.g. Oranges of Florida or many other agro products that are essential
but have a short shelf life
To meet the demand the government ensures adequate supply stock
such that inflation is contained
121
Demand-supply affecting the Price Dimension
When there is a sudden glut in supply ???
Again the spot prices will get affected and now the major dimension
will be whether the production processes can be set back into action
to meet the demand or is the glut because of a chronic production
problem ???
122
U can thus see that Commodity market is far more dynamic than any other financial
market
The price is a function of international production costs and
international demand prices
The commodity price has two very important elements:

transport and storage
Financing is a common cost to all financial markets
The commodity price is also a function of the durability of the

commodity
123
Commodity Contracts
Ministry of Consumer Affairs and Public Distribution
Forward Market Commission
Commodity Exchange
Commodity Exchange
CLEARING HOUSE CLEARING BANKS
CLEARING
MEMBER
Warehousing
Development and
Regulatory Authority TRADING
MEMBER
Warehouse
BUYER/SELLER
Functions of FMC
It grants/withdraws recognition of commodity exchange or association
It gives permission/withdraws permission to trade a specific commodity at a
specific exchange
It prepares policy guidelines for appointing brokers and other intermediate,
formulates margin system, limit on price fluctuations, policy framework for
clearing and warehouses etc
It undertakes inspection of books of accounts and other documents of a
commodity exchange
It has the authority to suspend trading of any commodity in any specific exchange
or ban trading of a commodity all together
Example of action taken by FMC
In March 2012 FMC withdrew the launch of August 2012 and Sept.
2012 delivery contracts in respect to Guarseed and Guargum !!!!
Trading member
Trading members provide the same functions as that
of brokers in a stock market
Trading members could be individuals or institutions
Institutional trading members can appoint sub-
brokers
Trading members have to satisfy the NET WORTH
requirements and have to pay amounts towards
various deposits
To limit the exposure by each trading member,
exchanges set position limits
Clearing House/Clearing Members
Primary responsibility of the clearing house are post
trading functions
Trade clearing
Levying margin
Settling every trade
Distributing final payment
The act of the Clearing House taking a counterparty
position to every trade is called NOVATION
Clearing House/Clearing Members
Clearing house admits clearing members.
The Exchange imposes financial requirements for
institutions/individuals to become clearing members
Clearing members could also be trading members are known
as trading cum clearing members
The Exchange appoints Commercial Banks as clearing
members
Trading Clearing Settlement
activities activities activities
Order receipt and Novation Margin Payment and

verification receipt
Order matching and Margin Calculation Delivery payment and

execution based on Margin Reporting receipt on expiration
Price and time limits
Position Limits
Reporting of executed Clearing limits Auctioning in case

trades settlement failure
Commodity Spot Trading in India
In India, spot trading of commodities is mainly
undertaken at MANDIS or HAAT
The MANDIS are controlled by middlemen and they
form CARTELS
Every state has thus enacted the APMC Act
(Agricultural Produce Market Committees Act) for a
transparent marketing conditions in primary
assembling markets and also help in cleaning, grading
and packaging of agricultural produce.
Some of the Commodity Spot Exchanges
National Spot Exchange
NCDEX Spot Exchange
National APMC
Indian Bullion Spot Exchange
Reliance Spot Exchange

Trading members/brokers
Commodity Buyers
Commodity Sellers
Spot Exchanges (Farmers, primary
(Farmers, primary
producers, importers,
producers, importers, C
exporters, companies,
exporters, companies,
cooperatives,
cooperatives, government)
government)
Clearing Members
Warehouse Receipts Clearing Bank Warehouse Receipts

Warehouse Receipts
Once the owner of commodity brings the commodity to the
warehouse, the licensed samplers, weighers and graders test the
quality of the goods.
The warehouse receipt mentions the following:
Is the receipt Negotiable/Non-negotiable
The quantity of the commodity stored
The quality of the commodity stored
The value of the commodity stored on the date of storage
Warehouse charges associated with storage, insurance,
fumigation expenses
NAME AND ADDRESS OF THE WAREHOUSE
TYPE: NEGOTIABLE / NON-NEGOTIABLE
SERIAL No.________________
Name and Address of the Depositor_______________________________
Name of the Quantity Quality Name and License

commodity number of
warehouse
Market rate of the commodity on deposit date_____________________
Value of the commodity on deposit date_____________________
Location of warehouse where commodity deposited_________________
Storage and miscelleanous charges_______________________________
Storage Period ___________________________

Dematerialisation/Rematerialisation of WR
Owners of the commodity wanting to trade through the demat
mode has to open a commodity demat account with depository
participants.
The depository gives a unique INTERNATIONAL COMMODITY
IDENTIFICATION NUMBER (ICIN)
ICIN gives the following details:
Warehouse details
Commodity
Commodity grade
Validity date
Expiry date
Validity date and Expiry date have to be understood clearly.
Validity date indicates the date upto which THE QUALITY OF

COMMODITY WILL NOT DETERIORATE UNDER THE PRESENT
STORAGE CONDITION.
Expiry date refers to the MAXIMUM TIME period up to which

the commodity can be stored
Once the order is executed, ICIN details gets credited to the
buyer account and cash gets debited from the buyer to the
seller.
The clearing house makes sure that the transaction goes

through correctly
The buyer intending to take the delivery sends a request for

rematerisation to his depository participant by filling up REMAT
REQUEST FORM (RRF)
Once the order is executed, ICIN details gets credited to the
buyer account and cash gets debited from the buyer to the
seller.
The clearing house makes sure that the transaction goes

through correctly
The buyer intending to take the delivery sends a request for

rematerisation to his depository participant by filling up REMAT
REQUEST FORM (RRF)
Benefits of Warehousing Facilities and
Warehousing Receipts
Commodity producers/farmers:
With warehouse receipts farmers/primary producers can do the
price averaging by selling their produce over a period of time
rather than in a single lot. The farmers can get short term
financing
Commodity consumers/companies:
Many innovative financing arrangements can be made. A
tripartite agreement is signed between commodity producer,
banks/financial institutions and companies (actual users).
The bank extends a loan against the WR to the farmer, the
farmer in turn endorses the WR to the company (user) and the
company repays the loan of the farmer with the Bank
Benefits of Warehousing Facilities and
Warehousing Receipts
Banks and Financial Institutions:
Banks normally take mortgage of property, land, gold or third
party guarantee to provide loan to priority sector lending.
Since these collaterals are not easy to liquidate WR are a better
alternative.
Government:
An organised warehouse sector reduces wastage in the
agriculture sector. This is a major advantage for the Government
as they have to conserve important natural resources.
FARMERS SEEKING
HIGHER PRICES, BANKS SEEKING
ACCURATE WEIGHT EASILY LIQUIDATED
AND BANK CREDIT COLLATERAL
Robust
warehouse
receipt
system
GOVERNMENT
COMPANIES
SEEKING TO FREE
SEEKING
ITSELF FROM
SCIENTIFIC
MANAGING
STORAGE
WAREHOUSES
KINDS OF CONTRACTS IN THE COMMODITY MARKET
COMMODITY CONTRACTS
SPOT/CASH DERIVATIVES
FORWARDS FUTURES OPTIONS EFPs COMMODITY

BONDS
EFPs = Exchange of futures for physical

NTSD TSD
NTSD = Non transferable specific
delivery contracts
TSD = Transferable specific delivery

contracts
SPOT TRADING OF COMMODITIES
Spot trading is done through spot exchanges (known as ready
delivery market). There are three types of trades:
Cash Trades
Spot trades
Weekly trades
Cash Trades: In this system the seller has to have a Warehouse
Receipt before he can sell. Once the order is executed the seller
has to deliver the WR and the buyer has to pay the amount
BEFORE THE CLOSE OF BANKING HOURS. No netting off is
allowed in this system
Spot Trades:
Spot trades are similar to Cash trades except that the delivery is
allowed to happen at T+2. Spot trades cannot be netted off
Weekly Trades:
These trades are spot trades at T + 5. Weekly trades cannot be

netted-off
Forward Contracts on Commodities
A forward contract is defined as an agreement between two
parties on a date T to exchange a given quantity and quality of
goods for a price that is determined at the times the contract is
signed.
Example:
A potato farmer entered into a contract on August 15, 20X1 to
deliver 500 kg of potato to a wholesaler on 19 November, 20X1
at a price of Rs 7.25 per kg.
In this contract the seller has gone short and the wholesaler has
gone long. On the date of the delivery what is their payoff ?
Pay-off Diagram
8.00
6.00
4.00
2.00
Buyer
-
Seller
5.25 6.25 7.25 8.25 9.25 10.25 11.25 12.25 13.25
(2.00)
(4.00)
(6.00)
(8.00)
Forward Contracts on Commodities
In the Indian context a forward contract is known as a SPECIFIC
DELIVERY CONTRACT.
As per the Indian law any contract that involves giving/taking
delivery of goods and making/receiving payment over a period
exceeding 11 days falls under the category of specific delivery
contract.
These contracts are broken down into two types:
TSD Transferrable specific delivery
NTSD Non transferrable specific delivery
Margin Types and Margin Rules
Initial Margin:
While placing an order, traders deposit margin money known as
INITIAL MARGIN as required by the exchange.
Normally the exchanges world over use the SPAN (STANDARD
PORTFOLIO ANALYSIS OF RISK) method to calculate the Value at
Risk (VAR). The SPAN is the registered trademark of the Chicago
Mercantile Exchange (CME)
Commodity exchanges may levy different initial margin level for
different maturity months for a given commodity.
VAR CALCULATION
ANNUALISED
VAR OF ASSET = VALUES OF THE ASSET x VOLATILITY OF
THE ASSET
ADJUSTED FOR A
GIVEN TIME
HORIZON
X STANDARD
NORMAL VALUE
FOR A GIVEN
CONFIDENCE
INTERVAL
So from the Excel sheet example:
Each of the buyer and the seller would have to deposit an

amount of 3.98% of the transaction value if the settlement is
within 7 days.
If the settlement is within 30 days the initial margin will be

8.25% and so on
Mark-to-Market Margin:
Mark-to-Market margin is the margin that the buyer and seller
of the of the futures contract has to deposit on a DAILY basis
depending on the settlement price every day !!!!
Example:
On Nov 19, 20X1, Party A(long futures) and Party B (short
futures) took positions on 5 contracts on Caramom maturing on
Dec. 15, 20X1, the closing price of the contract is 688.70 !!!
Margin Receipt/Payment
Date Settlement A(long Position) B ( short position)

price
19, Nov 20X1 699 (699-688.70) X 10 X 5 = -515
+515
29, Nov 20X1 705 (705-699) X 10 X 5 = -300
300
21, Nov 20X1 690.80 (690.80-705) X 10 X 5 = +710
-710
On 21, Nov Party B squares up its position by taking long futures contract. Part C takes
counterparty short position. The trade was executed at 695.20 per 10 kg. Party C
deposits an initial margin of Rs 2298( 695.20 X 10 X 5 X 6.61%)
Party Bs squaring off loss is 220 (690.80-695.20) X10X5 is adjusted against the initial
margin that B had with the broker
22, Nov 20X1 700 (700-690.80) X 10 X 5 = -460
460
23 Nov 20X1 707 (707-700) x 10 X 5 = 350 -350
Additional margin:
Additional Margin is levied by the exchange on the buyer and
seller if the exchange find extremely high volatility.
Special margins:
Exchanges periodically announce these margins if the
commodity is very volatile
Tender period and delivery period margin

These have to be deposited by the seller and the buyer
Delivery and Settlement Procedures
Option to take delivery/ deliver the underlying commodity is
based on Delivery Logic. Delivery logic can be of the following
type:
At sellers option
At buyers option
At both buyers as well as sellers option
Compulsary delivery
AMOUNT TO BE DELIVERED BASED ON DIFFERENT DELIVERY LOGIC
Volume yet Buyers Sellers Amount to be delivered based on different
to be would like to would like delivery logic
sqaured up take delivery to deliver
Buyers Sellers Both option
option option
875 kg 0 300 0 300 0
Corresponding cash settlement

875x1105 = 575 X 1105= 875 x 1105 =
966875 635375 966875
Buyers Sellers Both option
option option
875 800 100 800 100 100
75 X 1105 = 775 X 1105 775 x 1105 =

82875 = 856375 856375
Settlement Process
On delivery pay-in date short futures holders give the WR to the
clearing house
The clearing house in turn transfers the WR to the long futures
position holders on delivery-pay-out date.
Pay-in date for the FUNDS is the date on which the long futures
position holders pay money to the clearing bank
Pay-out date for the FUNDS is the date on which the clearing
bank transfers money to the short position futures holders.
These dates vary from commodity to commodity
The price to be paid is called DDR or FSP
DDR (Due Date Rate)/FSP (Final Settlement Price)
The DDR/FSP is nothing else but the spot rate prevailing on the
expiry date/or average of spot rates just before expiry date.
As spot rates can vary from place to place in a given day,
exchanges clearly indicate the mechanism for DDR/FSP
calculation.
The DDR/FSP calculations can vary from commodity to
commodity as some of the commodities that are internationally
traded, international price may be considered !!!!
Commodity DDR calculation methodology
Aluminium DDR/FSP is international spot prices of Aluminium in USD

converted to INR based on the INR/USD exchange rate
notified by RBI
Crude Palm Oil DDR/FSP is calculated from the spot prices collected from
a panel of pre-identified entities. Based on these prices,
daily average spot prices is calculated. DDR is the simple
average of 3 days average daily spot prices
Kapas DDR/FSP is calculated from the spot prices prevailing from

all delivery centres (kadi, vikramgham, kakhtar, limdi,
surandra nagar, bawla) Based on these spot prices daily
average spot price is calculated. DDR/FSP is the simple
average of the last 5 days average daily spot price
GOLD DDR/FSP is calculated by taking simple average of last 3
days spot prices at Ahmedabad
Exchange of Futures for Physicals (EFPs)
In EFPs two parties exchange their physical positions and futures
position at the same time
Example:
In the month of August 20x1 a manufacturer of silver items is
scouting for sellers which can supply 1000 kg of silver in month
of September 20X1. Similarly an Indian importer of silver bars
has stocked substantial amount of silver by August 20X1 and it
intends to sell its inventory on Sept 20X1.
On August 10 both parties reach an agreement to trade 1000 kg
of silver to be delivered on Sept 28, 20X1. The agreement will
specify the price, quality, quantity , delivery date, venue of
delivery etc.
Exchange of Futures for Physicals (EFPs)
After this agreement has been reached both parties will contact
a commodity exchange that permits EFP contracts. Brokers
representing both importer and the gift manufacturer send the
EPF request to the Exchange along with the futures price.
On August 10 the importer of silver will take a LONG POSITION
while the gift manufacturer who needs the physical silver will
take the SHORT position.
IT IS IMPORTANT TO NOTE THAT IN SUCH TRANSACTIONS THE

EXCHANGE DOES NOT GURANTEE THE PHYSICAL DELIVERY AS
THAT CONTRACT IS A PRIVATE CONTRACT !!!
TRANSACTIONS AT AUG 10, 20X1
Silver importer Agrees to sell physical silver to be delivered Sept 29,
20x1 at the negotiated price
Takes a long futures position on silver on Sept 20X1
Gift Takes a short futures on silver on Sept 20X1

Manufacturer Agrees to buy physical silver on Sept. 28, 20X1 at the
negotiated price
TRANSACTION AT SEPT 28, 20X1

Silver importer Delivers physical silver
Transfers the long futures contract to gift manufacturer
Gift Buys the physical silver
manufacturer Transfers the short future contract to the silver importer
Commodity Swaps
Commodity Swaps
Unlike futures and options , commodity swaps are OTC
contracts.
Commodity swaps can be entered for any underlying
commodity, any quantity, any quality, any delivery schedule
as agreed to by the two parties.
Banks and Financial institutions take a counterparty position
in commodity swaps and over the years commodity swap
contracts are becoming more standardised.
As the contracts are OTC contracts the counterparty risk is
very high
Example of a Commodity Swap
During sowing season in the month of august the farmer feels that during the
harvest in December the price of wheat would go down
He approaches a Financial Institution which is ready to enter into a swap
agreement, where the bank agrees to give him a fixed price, but the farmer has
to take the responsibility for the floating price
The bank is thus the buyer of the swap and the farmer is the seller. The farmer is
getting a fixed rate but giving the bank a floating rate
The contract is to be executed on Dec 24, 20X1.
The fixed price : Rs 6500/= per MT
Quantity to be delivered 350 MT
Come Dec 24, and the price of the wheat could be
1. 6350/= per MT in which case the Bank pays the farmer Rs 150 and the farmer
sells his produce for Rs 6350/=
2. If the price is 6700/= per MT the farmer pays the bank Rs 200/= per MT and
sells his produce for Rs 6700/=
Does the bank keep the exposure of the contract ?
No as soon as it enter into a buy contract it looks for a sell contract !!!
Suppose a company that sells wheat flower is looking for wheat at a fixed rate
because it has analysed that the price of wheat may go up.
It enters into a contract with the Bank that it will buy the wheat at Rs 6350/= per
MT on a settlement date of January 20X2 while the Bank agrees to sell at the
floating rate on that settlement date.
The contract is settled on the due date excatly like the previous example !!!
FINANCIAL BRANDED WHEAT
FARMERS
INSTITUTION FLOUR MAKER
BUYER OF SWAP
SELLER OF SWAP
FIXED RATE PAYER
FIXED RATE RECEIVER
FLOATING RATE
FLOATING RATE
PAYER
Commodity Bonds
Commodity Bonds
Commodity Bonds are bonds whose coupons are attached to the price of a
commodity.
Cotton Bonds with bond coupons pegged to cotton prices were issued by the
Confederate States of America during 1860s
Many Commodity Bonds have been issued since then primarily with commodity
base of oil, gold, silver and crude oil.
Commodity Bonds
Commodity Bonds are either options or forwards
Example: An investor invests in a commodity bond issued by a Gold mining
company by paying USD 5000 per bond having a 7 year maturity.
The bond can be structured in two ways:
Forward method
Each year the investor receive cash equivalent of 1 ounce of gold as coupon
payment and at the maturity get back USD 5000
Each year the investor receive cash equivalent of 1 ounce of gold as coupon
payment and get back cash equivalent 6 ounces of gold as maturity payment
Commodity Bonds
Option method
Receive USD 6000 at maturity without any coupon payment
Receive 1 ounce of physical gold as coupon payment every year and 5 ounces of
gold at maturity
Receive Rs 2500 at maturity and option to buy 2 ounces of gold every year at
USD 200 per ounce
Indian Commodity Markets
an Introduction
History of Commodity Exchanges in India
In early days there were many commodity exchanges with the first
exchange that started in 1875 by Bombay Cotton Trade Association Ltd.
An independent association called Bombay Cotton Trade Association

was started in 1893
177
By 1939 there were more than 300 commodity
exchanges in India !!!
In 1900 Futures market was established for oil seeds
like groundnut, castor etc by Gujurati Vyapari Mandali
The wheat futures market at Hapur started
functioning from 1913
Calcutta Hessian Exchange Ltd. Started in 1919
East India Jute Association started in 1927, it offered
futures contracts in raw Jute.
The Hessian Exchange and East India Jute Association
merged in 1945 to form East India Jute & Hessian Ltd
178
Futures trading in Gold and silver started in Bombay (today, Mumbai)

in 1920
The India Pepper and Spice Trade Association (IPSTA) was started in
cochin in 1957
179
In 1952 the Government of India established the Forward Contracts

Regulation Act, 1952:
Three types of commodity have been established
Regulated List Commodities in which futures trading were allowed
Prohibited List Commodities in which futures trading were not permitted
Free List Commodities not part of the above categories belonged to this list
180
Government Intervention in the Comodity Exchanges in India:

1919 Bombay passed Bombay Contract Control (War Provision) Act
1939, Bombay Options in Cotton Prohibition Act
1943, Defence of India Act (it prohibited trading in Food grains, spices,
oilseeds and sugar
1966 the Government of India brought in a comprehensive ban on
futures trading in all kinds of contracts.
181
History of Committees on Commodity Derivative Market
Shroff Committee (1950) A D Shroff committee recommended the setting up of the

Forward Contracts (Regulation) Act, 1952 and also the
Forward Market Commission in 1953
Dantawala Committee The Committee highlighted the importance of forward
(1966) trading/market, yet the Government of India banned
commodity trading
Khusro Committee (1980) In 1980 this committee recommended reintroduction of
commodity derivatives trading in India
Kabra Committee (1994) This committee was formed to make the Indian
Commodities Markets compatible with International
Commodity markets
Expert Committee on Committee was headed by Shankarlal Guru, The committee
National Agriculture first formulated the National Agriculture Policy, 2000. On
Policy (2000) the basis of the recommendation of the committee Futures
trading on commodity was permitted
182
History of Committees on Commodity Derivative Market
Abhijit Sen Committee This committee examined the impact of futures trading on
(2007) agriculture commodity prices
183
Futures Markets
Commission
Commodity Exchanges
National Level
Regional Exchanges
Exchanges
Many
MCX NCDEX NMCE ICEX Exchanges
184
Primary Commodity Markets
Name Date Established, Commodity Traded
location, brief history
Multi-Commodity 2003, Mumbai, India Having started operations in
Exchange of India (MCX) November 2003, today, MCX
holds a market share of over
85%* (as on March 31, 2012
MCX had a market share of
86%) of the Indian
commodity futures market.
MCX was the third largest
commodity futures exchange
in the world, in terms of the
number of contracts traded in
CY2011
MCX offers more than 40

commodities across various
segments such as bullion,
ferrous and non-ferrous
metals, energy, and a number
of agri-commodities on its
185
platform.
Name Date Established, location, Commodity Traded
brief history
National Commodity and NCDEX is a nation-level,

Derivatives Exchange, India
2003, Mumbai, technology driven de-
(NCDEX) India mutualised on-line commodity
exchange with an independent
Board of Directors and
professional management -
both not having any vested
interest in commodity markets.
The Exchange, as on February
9, 2012 offered contracts in 34
commodities - comprising 23
agricultural commodities, 6
precious metals, 2 energy, 1
polymer and 2 other metals.
The top 5 commodities, in
terms of volume traded at the
Exchange, were Soya oil, Gaur
Seed, Chana, RM seed and Guar
gum.
186
Name Date Established, Commodity Traded
location, brief history
National Multi- 2001, Gujarat It trades primarily in

Commodity Exchange the Agricultural
(NMCE) products
187
COMMODITY MARKETS OF INDIA
Ace Derivatives & Commodity Exchange
Bhatinda Om & Oil Exchange Ltd., Batinda
E-Commodities Ltd
Esugarindia.com
First Commodity Exchange of India Ltd, Kochi
Haryana Commodities Ltd., Hissar
Multi-Commodity Exchange of India
National Board of Trade Limited
National Commodity & Derivatives Exchange Limited
National Multi-Commodity Exchange of India Ltd
Rajdhani Oils and Oilseeds Exchange Ltd. , Delhi
Surendranagar Cotton oil & Oilseeds Association Ltd
The Bikaner Commodities Exchange Limited
The Bombay Commodity Exchange Ltd
The Bullion Association Limited
The Central India Commercial Exchange Ltd, Gwaliar
The Chamber of Commerce
The East India Cotton Association
The East India Jute & Hessian Exchange Ltd,
The Indian Pepper and Spice Trade Association
The Meerut Agro Commodities Exchange Co. Ltd., Meerut
The Rajkot Seeds oil & Bullion Merchants` Association Ltd
The Spices and Oilseeds Exchange Ltd.
Vijay Beopar Chamber Ltd.,Muzaffarnagar
The Universal Exchange
188
Some of the Commodities traded on the Indian exchanges
Bullion Metals Energy Oil & Oil seeds Cereals Fiber
Gold Aluminium ATF Crude Palm Oil Barley Kapas
Gold Guinea Aluminium Mini Brent Crude Oil Kapasia Khalli Wheat Cotton (29mm)
Gold M Copper Crude Oil Refined Soya Oil Maize-Feed /
Gold Petal Copper Mini Electricity Soya Bean Industrial Grade
Gold Petal Iron Ore Monthly &
(New Delhi) Lead Weekly
Platinum Lead Mini Gasoline
Silver Mild Steel Heating Oil
Silver M Ingot,Billets Imported
Silver Micro Nickel Thermal Coal
Silver 1000 Nickel Mini Natural Gas
Tin
Zinc
Zinc Mini
SPICES OTHER
Cardamom Almond
Coriander Gaur Seed
Turmeric Melted Menthol
Flakes
Mentha Oil
Potato (Agra)
Potato
(Tarkeshwar)
Sugar M
189
190
191
Type of Memberships-MCX
Trading-cum-Clearing Member (Deposit Based)
Trading-cum-Clearing Member (Non-Deposit Based)
Professional Clearing Member
Institutional Trading-cum-Clearing Member
Trading Member
198
Type of Membership-NCDEX
1. Trading cum Clearing Member (TCM)
2. Professional Clearing Members (PCM)
3. Trading Member ( TM )
4. Strategic Trading cum Clearing Member (STCM):
199
Primary need for Commodity Exchanges
Fluctuations in the commodity markets a primary dampener for the economy as a
whole
India being an economy that is primarily agriculture driven the exchange serves
as a price discovery mechanism for:
The Government
The farmers
The intermediaries
The manufacturers who use these commodities as raw material
Exporters who export these commodities
200
Primary need for Commodity Exchanges In
India
Indian economy has two distinct features:
Dependence on import for energy
Agro based real economy
201
Primary need for Commodity Exchanges In
India
The price discovery process becomes very important for the primary
stake holders:
Government
Farmers
Intermediaries
Manufacturers who consume commodities as raw material
202
Commodity Exchange Hierarchy
Government of India Department of Consumer Affairs, Food and Public
Distribution
Commodity Exchanges
Clients of the Commodity Exchange Members

203
The Forward Market Commission
Has notified commodities via section 15 FC(R) Act and
commencement of trading- these are the base commodities
Commodities for which futures trading permitted during the year
Suspended commodities
204
The Commission also has circulars that deal with:
-General
-Regulatory
-Trading Permission
205
The Commission is the authority to sign the MOUs with foreign
Commodity Exchanges
The Commission also acts as an intermediary for consumer protection
The Commission runs Market Development programs
206
Marketing of Agricultural commodities
In India the Commodity market works on the basis of
demand and supply but the Government intervention
has played a big part in the agricultural commodity
market
The government has played a positive role in
Establishing regulated markets
Constructing warehouses
Grading and standardising produce
Standardising weights
Providing agriculture prices on Radio
207
Some of the Government Agencies Involved in Agro
Commodity Markets
Central Government Bodies
Commission for agricultural costs and Prices
Food Corporation of India
Cotton Corporation of India
Jute Corporation of India
Specialised marketing boards like the rubber board
Directorate of Marketing and Inspection of the Ministry of Agriculture
Central warehousing corporation
State Government Bodies

National Agricultural Cooperative Marketing Federation of India
Network of cooperatives at the local, state and national levels
208
Physical Market Operations
State Agricultural Marketing Board (SAMB)
Mandi Boards are set up at the district level
There are approximately 28,000 mandis
Each mandi serves around 100- 1000 sq. kms
It serves as a delivery point and have commission agents called pukka
arthiya and kacha arthiya
209
State
Taxes
State Agricultural
Mandi Board (SAMB)
Mandi Staff and Buyers/Wholesale

Sellers licensed dealers/mill owners
(producers/farmers)
intermediaries
210
MSP (Minimum Support Price)
Commission for Agricultural Costs and Prices recommends the prices after due
consideration of wide spectrum of data:
Cost of cultivation/production
Trends of input use
Production and productivity of the crop
Emerging supply-demand situation
Indian council of agricultural research provides a lot of data for this
process
211
Inefficiencies at the Mandi Level
The Indian farmer get merely 25%-30% of the price paid by the end-
consumer for agricultural produce as compared to the US farmer
getting 65%-70% of the price !!!!
India has a wastage level of 35-40% in agricultural/ vegetables/fruits -

DUE TO IMPROPER STORAGE SPACE
212
Some innovative solutions
E-Chaupal by ITC
213
214
Kisan Knowledge toll free.
215
216
Personalized Multi-modal and Multi

Lingual Agro Commodity Pricing System
for The Indian Kisan
Rajesh Hegde
Dept of EE IIT Kanpur
rhegde@iitk.ac.in
217
218
PRIVATE COMPANIES BEING
ISSUED LICENCES TO
OPERATE IN
MANDIS.
219
Cargill in India
Cargills operations in India started in 1987. We employ more than 2,000
employees working in offices and plants across the country and have a
network of warehouses and depots.
We offer a range of products and services:
We process, refine and market imported and indigenous vegetable oils
Serving food industry customers with vegetable oils, fats, blends and
bakery shortenings
Serving household consumers with a portfolio of fortified and healthy
branded edible oils
We offer high quality food ingredients to serve food manufacturers and food
service industry
We originate, process, store, trade and market a wide range of agricultural
commodities such as grains, oilseeds, sugar and cotton
We offer premix, compound feed and therapeutic care products to nourish
animals
We provide risk management and financial solutions
We offer freight solutions and serve our industrial customers with energy
commodities and metal products
220
Indian Debt Market
Fixed Income Markets in
India
What is a Fixed Income Security
A Fixed Income security is a plain vanilla BOND that is issued by a

borrower to repay to the investor the amount borrowed plus interest
over a specified period of time.
COUPON + CAPITAL
COUPONS
PURCHASE PRICE
Type of Bonds
Based on coupon:
1. Annual coupon bonds
This bond pays a coupon on an annual basis
2. Bi-annual coupon bonds

This bond pays a coupon on a bi-annual basis
3. Cumulative Coupon Paying Bonds

This bond accumulates the interest and pays the interest on a cumulative
basis
Type of Bonds
4. Floating Rate Coupons Paying Bonds
These Bonds pay coupon based on a REFERENCE RATE and to that reference
rate they add a margin
Popular reference rates are
LIBOR (LONDON INTERBANK)
MIBOR(MUMBAI INTERBANK BID RATE)
MIBID (MUMBAI INTERBANK OFFER RATE)
YIELD ON BENCHMARK GOVERNMENT SECURITIES
5. Zero Coupon Bonds
These bonds do not pay any coupon but are sold at a discount depending on
the prevailing interest rates when the bonds are issued
Type of Bonds
Based on Conversion
1. Vanilla convertible bonds
These bonds are bonds that will get converted at a pre-determined rate without
any complicated conditions. The conversion is at the option of the owner
2. Exchangeable Bonds
These bonds are bonds that can get converted into shares of entities other than an
issuer company
3. Contingency Convertible Bonds
These bonds are those that are converted on the happening of a particular event
i.e. if the price reaches above/below a certain level compared to the conversion
price level
Type of Bonds
4. Mandatory convertible Bonds
These Bonds do not give the holder an option but have a mandatory
conversion clause. These securities are of a limited duration
5. Foreign Exchange convertible Bonds
These Bonds are very popular among Indian companies. They are Bonds are
issued in a currency other than the currency of the country of the issuer.
The investor in these bonds face exchange risk
Type of Bonds
Based of Redemption
Callable Bonds: These bonds are that allow the issuer to call them
back at a pre-determined price and at a pre-determined time. The
issue terms specify the time and the price very clearly
Since the issuer will invariably call these bonds when the enterprise has
the funds to repay and the market interest rate is much lower than the
coupon rate paid on the bond. Thus callable bonds carry a higher
coupon compared to the non-callable bonds
Type of Bonds
Putable Bonds (Bonds with a put option)
These bonds are exactly the opposite of the callable bonds, the Bonds
are putable (sold back to the company) at the discretion of the investor.
Thus if the investor finds that he can get a higher coupon amount on a
comparable Bond the investor will exercise the option. These Bonds are
always sold at a premium.
Type of Bonds
Perpetual Bonds:
These Bonds are the type that pay a coupon for life, they do not have a
specified maturity date. They pay a coupon to perpetuity
The Indian Government Debt
Debt Market
Corporate Debt Government Debt
G-Sec
T-Bills
State
Development
Loans
SOME CCIL STATISTICS FROM
THE ANNUAL BOOK 2016
INTEREST RATE SWAPS - VOLUMES
History of Treasury Bills in India
Type of T-Bill Introduced Discontinued
91 days T-Bill on weekly Before 1950s Mid-1950s
auction
91 days Ad-hoc T-Bills Mid 1950s April 1997
91 days T-Bill on Tap Mid 1950s March, 1997
182 days T-Bill on weekly November 1986 April, 1992
auction
14 days T-Bill on weekly April, 1997 May, 2001
auction
364 days T-Bills on April 1992
fortnightly auction
91 days T-Bill on weekly January, 1993
auction
182 days T-Bill on weekly Re-introduced in June May 2001
auction 1999
182 days T-Bill on weekly Re-introduced in April,
auction 2005
Features of a typical dated Government Security
Example: 8.12%GS2021 would mean:

Coupon 8.12% paid on face value
Name of issuer Government of India
Date of Issue April 6, 2011
Maturity April 6, 2021
Coupon Payment dates Half yearly
Minimum amount of 10,000
issue/sale
Different kind of Fixed Income securities
DATED GOVERNMNENT SECURITIES
Fixed Rate Bonds: These are Bonds where the coupon rate is fixed. Most government bonds are
issued at fixed rate bonds.
Floating Rate Bonds: Floating rate Bonds are securities which do not have a fixed coupon rate. The
coupon is re-set at pre-announced intervals (say every six-months or one year) by adding a spread
over a base rate. In case of Government of India floating rate Bonds, the base rate is the weighted
average cut-off yield of the last three 364-day Treasury Bill auctions preceding the coupon re-set
date.
Zero Coupon Bonds: These are Bonds that do not pay any coupon
Capital Indexed Bonds: These Bonds are bonds where the principal is
co-related to a certain inflation index e.g. the WPI
Bonds with call/put options: These Bonds allow the issuer to buy back
the bond (call option) or the buyer to sell the Bond(put option) e.g.
6.72%GS2012 was issued on July18, 2002 for a maturity of 10 years.
The optionality on the Bond could be exercised after 5 years.
Special securities: In addition to the dated securities issued by the

government of India under the market borrowing program, the
government of India also issues from time to time special securities
from time to time to entities like Oil Marketing companies, Fertiliser
companies etc
STRIPS
The STRIPS are instruments in which each cash fl ow of the fixed
coupon security is converted into a separate tradable zero coupon
bond and traded. These cash fl ows are traded separately as
independent securities in the secondary market.
The STRIPS in government securities will ensure the availability of
sovereign zero coupon bonds, which will facilitate the development of
a market-determined zero coupon yield curve (ZCYC).
The STRIPS will also provide institutional investors with an additional
instrument for their asset-liability management
STRIPS (Separate trading of Registered Interest and Principal of

Securities) The Government has submitted a working committee report
on the issuance of STRIP securities which has yet to be implemented
Treasury Bills:Treasury bills or T-bills, which are money market

instruments, are short term debt instruments issued by the
Government of India and are presently issued in three tenors, namely,
91 day, 182 day and 364 day. Treasury bills are zero coupon securities
and pay no interest. They are issued at a discount and redeemed at the
face value at maturity.
Cash Management Bills (CMBs) are instrument that are
issued by RBI to meet the temporary mismatches in the
cash flow of the Government. The CMBs have the
generic character of T-bills but are issued for maturities
less than 91 days. Like T-bills, they are also issued at a
discount and redeemed at face value at maturity
SDLs (State Development Loans):

State Governments also raise loans from the market. SDLs
are dated securities issued through an auction similar to the
auctions conducted for dated securities issued by the
Central Government.
Interest is serviced at half-yearly intervals and the principal
is repaid on the maturity date. Like dated securities issued
by the Central Government, SDLs issued by the State
Governments qualify for SLR.
Advantages of Investing in
Government Securities
1. Government Securities provide a guaranteed
return in the form of coupons
2. Government securities offer the maximum
safety as they carry the Sovereigns
commitment for payment of interest and
repayment of principal.
3. They can be held in book entry, i.e.,
dematerialized/ scripless form, thus, obviating
the need for safekeeping.
4. Government securities are available in a wide
range of maturities from 91 days to as long as
30 years to suit the duration of a bank's
liabilities.
5. Government securities can be sold easily in the
secondary market to meet cash requirements.
6. Government securities can also be used as collateral
to borrow funds in the repo market
7. The settlement system for trading in Government
securities, which is based on Delivery versus
Payment (DvP), is a very simple, safe and efficient
system of settlement. The DvP mechanism ensures
transfer of securities by the seller of securities
simultaneously with transfer of funds from the
buyer of the securities, thereby mitigating the
settlement risk.
8. Government security prices are readily
available due to a liquid and active secondary
market and a transparent price dissemination
mechanism
9. Banks, insurance companies and other large
investors, smaller investors like Co-operative
banks, Regional Rural Banks, Provident Funds
are also required to hold Government
securities
Who is Required to Invest in
these Securities
Section 24 of the Banking Regulation Act 1949,
(as applicable to co-operative societies) provides
that every primary (urban) cooperative bank
shall maintain liquid assets, which at the close of
business on any day, should not be less than 25
percent of its demand and time liabilities in India
(in addition to the minimum cash reserve
requirement). Such liquid assets shall be in the
form of cash, gold or unencumbered
Government and other approved securities. This
is commonly referred to as the Statutory
Liquidity Ratio (SLR) requirement.
All primary (urban) co-operative banks (UCBs)
are presently required to invest a certain
minimum level of their SLR holdings in the form
of Government and other approved securities as
indicated below:
Scheduled UCBs have to hold 25 per cent of their

SLR requirement in Government and other
approved securities.
Non-scheduled UCBs with Demand and Time
Liabilities (DTL) more than Rs. 25 crore have to
hold 15 per cent of their SLR requirement in
Government and other approved securities.
Non-scheduled UCBs with DTL less than Rs. 25

crore have to hold 10 per cent of their SLR
requirements in Government and other
approved securities.
As per Section 24 of the Banking Regulation Act
1949, the State Co-operative Banks (SCBs) and
the District Central Co-operative Banks (DCCBs)
are required to maintain in cash, gold or
unencumbered approved securities, valued at a
price not exceeding the current market price,
an amount which shall not, at the close of
business on any day, be less than 25 per cent of
its demand and time liabilities as part of the
SLR requirement. DCCBs are allowed to meet
their SLR requirement by maintaining cash
balances with their respective State Co-
operative Bank.
Since April 2002, all the RRBs are required to
maintain their entire Statutory Liquidity Ratio
(SLR) holdings in Government and other
approved securities. The current SLR
requirement for the RRBs is 24 percent of their
Demand and Time Liabilities (DTL).
Presently, RRBs have been exempted from the

'mark to market' norms in respect of their SLR-
securities. Accordingly, RRBs have been given
freedom to classify their entire investment
portfolio of SLR-securities under 'Held to
Maturity' and value them at book value.
The non-Government provident funds, superannuation
funds and gratuity funds are required by the Central
Government, effective from January 24, 2005, to invest
40 per cent of their incremental accretions in Central
and State Government securities, and/or units of gilt
funds regulated by the Securities and Exchange Board
of India (SEBI) and any other negotiable security fully
and unconditionally guaranteed by the Central/State
Governments.
Major Market participants
Major Market Participants
Central Government
Reserve Bank of India
Primary Dealers: Market intermediaries authorised by the Reserve Bank of
India
State Government, Municipalities and local bodies

Public sector units
Corporate Treasuries
Public sector Financial units
Insurance Companies
Banks
Mutuals Funds
FII
Provident Funds
Charitable Institution
Trading Platforms available
Negotiate Dealing System:
In 2002 RBI introduced the first Electronic Bond Trading
in India.
The following are available for trading:
Call money
Repos in eligible securities are available
The deals that are done using the telephone have to
report the deal on the NDS system within 15 minutes of
the settlement
NDS-OM trading system:
This system was developed primarily for the bidding for G-Sec auctions
and for trading and reporting in the secondary market transactions.
This system is screen based anonymous order matching system that is
Integrated with NDS. This system started in August 1, 2005
This system allows trading in all Government dated securities, T-Bills,
State Government securities on a T+1 basis
NDS-OM:
This system is now being used being used by all entities
that are required to invest government securities like
Banks, NBFCs, Provident Funds, Pension Funds,
Insurance Companies, Co-operative Banks etc.
It also provides for WI(When issued) transactions i.e.
it allows forward market for government securities
This system is directly connected to the CCILs clearing

and settlement system
Latest Initiatives
The latest RBI Annual report (August 14, 2012) points out to two new
developments in trading:
New Web based system for NDS and MDS-OM
Extension of the short sales period from five days to Three months
Central Government
Securities-Bonds
Initiatives by RBI
Introduced the system of Primary Dealers
Introduction of the Subsidiary General Ledger
Introduction of the Liquidity Adjustment Facility
Expansion of the Repo Market
Emergence of self-regulatory bodies like:
Primary Dealers Association of India
Fixed Income Money Markets and Derivatives Association
of India
Initiatives by RBI
Operationalisation of the NDS which is an automatic
electronic trading system
Establishment of the CCIL (Clearing Corporation of
India)
Introduction of the G-Secs in the stock exchanges
Introduction of the Real Time Gross Settlement
System (RTGS)
Adoption of the modified Delivery-versus-Payment
mode of settlement
Announcement of the Indicative auction calendar
Initiatives by RBI
Introduction of NDS-OM (since 2005) which is an
anonymous order matching electronic platform
Establishment of the CSGL (Constitutent Subsidiary
General Ledger) system which was initially available to
select category of participants (primarily deposit
taking entities) has now been extended to
Systematically Important Non-deposit taking NBFCs
Short sale and WI (When issued) trading introduced
in 2006
Trading parameters on the RDM segment
Face Value 100
Permitted Lot Size 10
Tick Size Re 0.01
Operating Range +/- 5%
Mkt. Type D (RETDEBT)
Book Type RD
Primary Issuance Process
The Primary Issuance process is by AUCTION
There are two types of Auctions:
Yield based auction
Price based auction

Yield Based auction
This type of auction is used when a NEW government security is being
issued. The Yield of the security is determined by the auction process
itself.
The cut-off yield is arrived at after arranging the bids in the ascending
order
Example of a Yield based Auction
Yield based auction details (fictituous, only an example)

Maturity Date March 25, 2023
Coupon It is determined in the auction
Auction date March 23, 2013
Settlement date March 24, 2013
Notified Amount 1000 crores
Example of a Yield based Auction
Bid No. Bid Yield Amount of Cumulative
the bid Amount
1 8.19% 300 300
2 8.20% 200 500
3 8.20% 250 750
4 8.21% 150 900
5 8.22% 100 1000
6 8.22% 100 1100
7 8.23% 150 1250
8 8.24% 100 1350
In the above situation the auction will determine the yield to be 8.22%
and bidder 5 and 6 will get 50 crore each while the other bidders will get
the amount they bid for. The bidders 7 and 8 will be rejected
Price Based Auction
This kind of auction takes place when the government of India re-issues
securities issued earlier.
Bidders quote in terms of price per Rs 100 of face value of the security.
The Bids are arranged in the descending order of the price bid and the
successful bidders are those that have bid at or above the cut-off price.
Example of a Price Bid
Maturity Date September 5, 2023
Coupon 8.24%
Auction Date September 4, 2013
Settlement date September 5, 2013
Notified Amount 1000 crore
Example of a Price Bid
Bid No. Price Bid Amount of Cumulative Implicit
the bid Amount Yield
1 100.31 300 300 8.1912%
2 100.26 200 500 8.1987%
3 100.25 250 750 8.2002%
4 100.21 150 900 8.2062%
5 100.20 100 1000 8.2077%
6 100.20 100 1100 8.2077%
7 100.16 150 1250 8.2136%
8 100.15 100 1350 8.2151%
In the above case the bidders 7 & 8 will get rejected as their bids go beyond the cut-
off point. While bidders 5&6 will get allocation on a pro-rata basis
Method of allocation
Depending on the method of allocation to successful bidders the
auction process can be of two type:
Uniform price based: In this system all the successful bidders
have to pay for the allotted quantity of the securities at an
UNIFORM RATE irrespective of the rate quoted by them
Multiple Price based: In this system the respective successful
bidders are required to pay the rate which they quoted in the
auction
Thus in the second example of the auction if the process foloowed was
UNIFORM PRICE then each of the bidders would have to pay Rs 100.20 while if
the process was MULTIPLE PRICE each bidder would pay the price they quoted
Competitive and Non-competitive bidding
Competitive bidding is for seasoned players like Banks, Other financial

institutions, primary dealers, mutual funds. In this kind of bidding the
players are allowed to put-in multiple bids and they get allotment
depending whether their price/yield is within the cut-off. The minimum
amount is Rs 10,000
Competitive and Non-competitive bidding
The Government in a move to encourage retail participation in the

bidding process has started non-competitive bidding in which 5% of the
auction amount is allotted to the non-competitive bidders at
WEIGHTED AVERAGE PRICE/YIELD of the successful bidders in the
competitive bidding. The non-competitive bidders do no need to quote
any PRICE/YIELD in the bidding process. Co-operative Banks also can
participate in the non-competitive process
Open Market Operations
OMO
Open Market operations are conducted by Reserve
Bank by way of sale or purchase of Government
securities with an objective to adjust the rupee liquidity
conditions in the market on a durable basis.
When the RBI observes that the liquidity in the market
is high it will issue government securities and suck out
the liquidity and when it observes that the liquidity is
very low it will buy back government securities and
inject liquidity in the market
Liquidity Adjustment Facility
Liquidity Adjustment facility
The RBI comes to the rescue of the Scheduled Commercial Banks and
Primary Dealers in case they have a liquidity crunch.
RBI will loan funds to them (against government securities) or get funds
from them through the REPO and reverse REPO mechanism.
MONEY MARKET
INSTRUMENTS
REPO and REVERSE REPO
REPO (Ready forward contract) is an instrument for
borrowing funds by selling securities with an
agreement to repurchase the said securities on a
mutually agreed future date at an agreed price which
includes interest
REVERSE REPO on the other hand is a transaction of the
lending of funds against buying of securities with an
agreement to resell the said securities on a mutually
agreed date at a mutually agreed future price that
includes interest
COPORATE REPO and REVERSE REPO
To enhance the debt market depth, RBI has appointed
designated Banks, PD, NBFCs, Mutual Funds, Housing
Finance companies to undertake repo operations in
corporate debt market.
These operations are exactly similar to the RBI

operations, only the AAA corporate debt market are
the instruments that are underlying securities
Commercial Paper
Commercial Paper
This is an instrument available to be issued by Corporates, Primary
Dealers and the all-India Financial Institutions.
This is an unsecured money market instrument issued in the form of a
promissory note
The instrument has a duration of minimum of 7 days and maximum of
one year
Risk involved in Investing In
Risks Involved
Market Risk- This risk arises out of changes in the interest rate
Re-investment risk: The coupon payments that an entity gets has to

be re-invested, they may not be re-invested at the rate at which the
original security had investment
Risks Involved
Liquidity Risk: This is the risk the buyer has to face
when he tries to sell the bond, the buyer will find the
market of the bond he has purchased to be illiquid over
a period of time. If the buyer has purchased a ten year
bond and after six years (the bond now has four years
to maturity) he will find that the market is very illiquid
for a bond that will mature in four years.
T-Bills
T-Bills are short term instruments issued for 91-day, 182-day and 364-
day.
They do not carry any coupons, they are sold at a discount and
redeemed at face value. Thus a 182-day T-Bill with the face value of
Rs 100 could be sold for 98.75.
T-Bills are sold in multiples of Rs. 25,000

T-Bills
Auction of T-Bills has primarily been on the multiple price auction
method at present
The auctions quantity of the T-Bills is announced at the beginning of

the year in consultation with the Government of India
Yield of the T-Bill is calculated with the formula:

((100-Price)*365)/(Price * No of days of maturity)
Treasury Bills: Treasury bills (T-bills) are money market instruments, i.e., short-term debt instruments
issued by the Government of India, and are issued in three tenors91 days, 182 days, and 364 days. The
T-bills are zero coupon securities and pay no interest. They are issued at a discount and are redeemed at
face value on maturity.
Cash Management Bills: Cash management bills (CMBs)3 have the generic characteristics of T-bills but are
issued for a maturity period less than 91 days. Like the T-bills, they are also issued at a discount, and are
redeemed at face value on maturity. The tenure, notifi ed amount, and date of issue of the CMBs depend
on the temporary cash requirement of the government. The announcement of their auction is made by
the RBI through a Press Release that would be issued one day prior to the date of auction. The settlement
of the auction is on a T+1 basis.
Dated Government Securities: Dated government securities are long-term securities that carry a fi xed or
fl oating coupon (interest rate), which is paid on the face value, payable at fi xed time periods (usually
half-yearly). The tenor of dated securities can be up to 30 years.
State Development Loans: State governments also raise loans from the market. State Development Loans
(SDLs) are dated securities issued through an auction similar to the auctions conducted for the dated
securities issued by the central government. Interest is serviced at half-yearly intervals, and the principal
is repaid on the maturity date. Like the dated securities issued by the central government, the SDLs
issued by the state governments qualify for SLR. They are also eligible as collaterals for borrowing
through market repo as well as borrowing by eligible entities from the RBI under the Liquidity Adjustment
Facility (LAF).
Fixed Rate Bonds: These are bonds on which the coupon rate is fi xed for the entire life of the bond.
Most government bonds are issued as fi xed rate bonds.
Floating Rate Bonds: Floating rate bonds are securities that do not have a fi xed coupon rate. The
coupon is re-set at pre-announced intervals (say, every 6 months, or 1 year) by adding a spread over
a base rate. In the case of most fl oating rate bonds issued by the Government of India so far, the base
rate is the weighted average cut-off yield of the last three 364-day Treasury Bill auctions preceding
the coupon re-set date, and the spread is decided through the auction. Floating rate bonds were fi rst
issued in India in September 1995.
Zero Coupon Bonds: Zero coupon bonds are bonds with no coupon payments. Like T-Bills, they are
issued at a discount to the face value. The Government of India issued such securities in the 90s; it
has not issued zero coupon bonds after that.
Capital Indexed Bonds: These are bonds, the principal of which is linked to an accepted index
of infl ation with a view to protecting the holder from infl ation. Capital indexed bonds, with the
principal hedged against infl ation, were fi rst issued in December 1997. These bonds matured in
2002. The government is currently working on a fresh issuance of Infl ation Indexed Bonds wherein
the payment of both the coupon as well as the principal on the bonds would be linked to an
Infl ation Index (Wholesale Price Index). In the proposed structure, the principal will be indexed and
the coupon will be calculated on the indexed principal. In order to provide the holders protection
against actual infl ation, the fi nal WPI will be used for indexation.
Bonds with Call/Put Options: Bonds can also be issued with features of optionality, wherein the
issuer can have the option to buy back (call option) or the investor can have the option to sell the
bond (put option) to the issuer during the currency of the bond.
Special Securities: In addition to T-Bills and dated securities issued by the Government of India
under the market borrowing program, the government also issues special securities, from time
to time, to entities such as oil marketing companies, fertilizer companies, the Food Corporation
of India, and so on as compensation to these companies in lieu of cash subsidies.
Separate Trading of Registered Interest and Principal of Securities (STRIPS): Steps are
being taken to introduce new types of instruments such as the STRIPS (Separate Trading of Registered
Interest and Principal of Securities). Accordingly, guidelines for the stripping and the reconstitution of
government securities have been issued. The STRIPS are instruments in which each cash fl ow of the
fi xed coupon security is converted into a separate tradable zero coupon bond and traded
Chronology of key debt market milestones
Framework for
Registered Real
FPIs Estate and
Government Amendment in
Introduction of
mandatory SEBI (Public Offer
SEBI unveils allowed to Infrastructure
risk invest in Investment
provisions related dissemination, and Listing of Mutual funds permitted
NSE, BSE and management credit- Investment
to issuances of by Securitised Debt to set up an IDF
FIMMDA framework enhanced Trusts NBFCs get to
corporate bonds - Issuer, of key operationalise Instruments) for the bonds up to undertake NBFCs to
single rating information corporate Regulations, 2008, Guidelines for debt a limit forward undertake ready
SEBI instead of relating to bond trade and SEBI (Issue
Reporting made
Issue and segment of of $5 billion contracts forward contracts
dual for default, reporting and Listing of Listing of stock in corporate debt
mandatory for in corporate
public/rights creation of platforms Debt Securities) Structured exchanges securities
inter-scheme debt
issue, removal of charge Regulations, 2008 Products/Maket
least rating and rating etc notified transfers of
Linked
criteria, removal corporate
Debentures Stock
of structural bonds by
RBI restrictions
Conventions
prevalent in
mutual funds exchanges
allowed to
Centralised
database
Draft
framework
Bonds issued
by
(maturity, put/call the G- Simplified on multilaterals
Corporate Bonds Regulated create a for corporate
options) Amendments sec market listing issuance of such as
and entities debt segment bonds
to regarding agreement rupee- World Bank
Securitisation asked to for trading announced to
listing shut period, for debt linked Group
Advisory settle OTC help
agreements lot size securities Mandatory bonds (IBRD, IFC),
Committee set trades in market
to ensure and day- usage of Record date to be abroad ADB and
up debt participants
electronic count interest rate not more than 15 introduced
to make AfDB in India
transfer convention days prior to instruments
introduced made
of interest recommendations of actual/ book closure for including CPs FIIs included in
for eligible
and on developing actual by all prospective & CDs through list of strategic
corporate underlying for
redemption the corporate issuers privately placed clearing investors in
bonds repo
bond and issues of corporation infrastructure
securitisation corporate bonds debt funds
markets
Years 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Reporting
Announcements made Short-term Issuers permitted
Recommendations platform Interest rate Introduction ofweb-
on launch of exchange- debt to consolidate
of High Level Expert for all futures on based system for
based interest rate futures, securities and re-issue
Committee for the secondary 91-day access to NDS
separation of equity Infrastructure permitted corporate debt
development of market T-bills auction and
the corporate bond option from convertible transactions permitted debt funds NDS-OM to for corporate Credit enhancement
and securitisation bonds to boost trading, in CPs and CDs under the facilitate direct repo reset allowed in
EPFO New pattern of
markets accepted market-based system operationalised NBFC and AMC participation by securitisation
allowed to investments in
for classifying by FIMMDA routes retail and transactions for
Non- invest up to equity, and
instruments based on announced mid-segment both banks and
competitive NBFCs permitted 55%in new Incremental FPI
complexity, TDX investors NBFCs
bidding for Introduction to set up Credit default debt instruments investments
exemption for
SDLs of guidelines infrastructure swaps for securities such as REITs allowed only in
listed and demand
introduced permitting debt funds unlisted rated issued by and InvITs corporate bonds
Clarification instruments Cash-settled
repo in corporate bodies notified with a minimum
on issues of SDLs made interest rate
corporate bonds ermitted corporate residual
regulatory eligible futures
bonds Credit default maturity of three
jurisdiction of securities on 10-year
swaps on Announcement years, and
the RBI and under Interest rate futures G-sec
corporate on Real Estate restrictions
SEBI provided the liquidity (IRFs) reintroduced introduced
bonds and Infrastructure announced on
adjustment with modifications STRIPS introduced Investment Trusts liquid and
facility introduced
Inflation indexed money-market
repos in G-secs
bonds introduced mutual fund
schemes
Debt Market
It has been more than a decade since the High Level Expert Committee
chaired by the late Dr R H Patil released the first defining report on
developing Indias corporate bond market.
Since then, such markets in emerging economies have tripled in terms
of bonds outstanding. Recent data released by RBI shows that the
bond market has merely doubled in the last 6 decades and is primarily
driven by financial sector entities primarily from the public sector.
But in terms of the more important yardstick of market penetration
which is the amount outstanding to GDP Indias corporate bond
market has grown just 6.43 percentage points in those five fiscals from
10.31% to 16.74%.
Debt Market
The example of Malaysia is germane and instructive here. The
government there drew out a 10-year roadmap for its capital market in
2001, implemented programmes, and in 2009, opened it up even
further by setting up the countrys first national financial guarantee
institution, the Danajamin Nasional Berhad.
The upshot? Penetration of the corporate bond market in Malaysia is

more than two-and-a-half times Indias at 43.85% of GDP today.
Important steps from the government ..
A uniform KYC (know your customer) norm proposed, with inter-usability of
KYC records across the entire financial sector and a single demat account so
that consumers can access and transact all financial assets through this one
account.
International settlement of Indian debt securities proposed and the Indian
depository receipt scheme completely revamped.
American depository receipt/ global depository receipt regime liberalised to
allow issuance of depository receipts on all permissible securities.
It was proposed that financial sector regulators take early steps for a vibrant,
deep and liquid corporate bond market and deepen the currency derivatives
market by eliminating unnecessary restrictions.
The finance minister mooted extension of a liberalised facility of 5%
withholding tax to all bonds issued by Indian
Important steps from the government ..
corporates abroad, extending validity of the scheme to June 30, 2017.
(Currently, the tax rate varies across bonds and could be higher as well).
A modified real estate investment trust-type structure proposed for
infrastructure projects to be announced as infrastructure investment trusts,
with a similar tax-efficient pass through status, for public-private partnership
and other infrastructure projects.
Move to increase the holding period for long-term capital gains tax for fixed-
income funds from 12 months to 36 months has tax implications for
investors in debt mutual fund schemes. The applicable tax rate on long-term
capital gains will now be 20% on the nominal long-term capital gains
indexed for inflation.
INCREASING INVESTOR DEMAND
TRANSITIONING FROM BANK LOANS TO BONDS
DEVELOPING FACILITATIVE INFRASTRUCTURE

Increasing investor demand
India has a gross domestic savings rate of 33% of GDP, among the highest in the
world. Close to 40% of the total savings are financial savings, of which 47% are in fixed
deposits. It is interesting to note that the fixed-income nature of bank deposits
appeals to Indian investor psyche.
But bonds, despite being fixed-income instruments, do not have the same appeal.
Therefore, we believe investment products such as mutual funds, insurance and
pension funds have the best chance of mobilising financial savings to corporate
bonds in India.
Transitioning from bank loans to bonds
Bank financing is by far the most preferred mode of funding in India
today. Corporate bonds outstanding to bank loans
(corporate) was 26.5% as on December 31, 2015. Various factors such
as difference in pricing, accounting/valuation treatment for an asset,
time lag permitted for recognition of event of delayed
payment/default etc., have contributed to the arbitrage that exists at
present between loans and the capital market
The measures that can be taken in this regard are:
Provide impetus to securitisation market by encouraging insurance
companies and provident funds to invest in long-term mortgage-
backed securities; persuading banks to securitise their housing and
infrastructure portfolios; and, enhancing market for innovations such
as commercial mortgage-backed securitisation transactions, toll road
Remove loan-bond arbitrage by measures such as allowing banks to
classify (and reclassify) bond and loan assets into held-to-maturity or
available-for-sale buckets based on their declared intention rather
than automatically based on legal documentation
Limit the amount of bank loan that can be taken by specific category of
borrowers -- say for instance, large borrowers
Measures taken/proposed to develop bond markets
Review of framework for large exposures: The RBI has floated a discussion paper on enhancing credit supply for large
borrowers through a market-based
mechanism. The guidelinescould reduce concentration of bank exposure to large borrowers and help expand the bond
market.
Managing primary issuances: Primary market issuances have suffered because of high cost of issuances and narrow
investor base. To address this, SEBI plans to introduce an electronic auction
platform for primary debt offers, to develop an enabling ecosystem for the private placement market in corporate bonds.
Information repository: A complete information repository for corporate bonds covering both primary and secondary
market segments will be developed jointly by the RBI and SEBI.
Innovative instruments such as masala bonds: The RBI had issued guidelines in September 2015 for masala bonds
denominated in rupees where the credit risk and currency risk lie with the investor and has recently reduced the tenure
to 3 years from 5 (similar to government securities) to make them more attractive.
Promoting derivatives market for hedging: One factor constraining bond market expansion has been the absence of a
well-functioning derivatives market that could absorb risks emanating from interest- rate fluctuations and default
possibilities. Taking cognisance of this issue, the RBI has issued guidelines for interest rate futures and credit default
swaps.
Settlement: The government has been considering a proposal to join Euroclear, the worlds largest securities settlement
system. This would allow investors such as sovereign wealth funds to settle Indian government/ corporate bonds on the
system, which has beena long- standing demand.
Easing investment norms: Investment norms for insurance companies, banks and pension funds in India are heavily
skewed towards government and public sector bonds (only 15% of funds can be invested in corporate bonds below AA
rating). Easing of such norms and increased retail participation will increase liquidity
Regulations EPFO PFRDA Life insurance Pension General Mutual FPI Banks
and group insurance funds
business
Limits on 35-45% Up to 45% for Not exceeding Not Not Nolimit $51 billion, NA
corporate bonds government 50% exceeding exceeding70% or
investments employees; no 60% Rs 244,323
restriction crore
under NPS for
all
Additional Minimum Minimum Minimum Minimum Issuer Minimum Minimum tenure

requirements three-year three-year investment of investment of limit 10% three years of one year for
residual residual 15% in 5% in single issuer residual bonds;
maturity; maturity; housing and housing, 10% in for debt. maturity investment in
minimum AA minimum AA infrastructure; infrastructure; In unrated unrated papers
rating from two rating from two maximum investment in papers, not allowed
agencies; can agencies; can investment of securities rated maximum except for
invest up to 5% invest up to 5% 15% in below AA and investment infrastructure
in ABS/ MBS/ in ABS/ MBS/ securities rated ABS/MBS maxi- of 10% (capped at 10%)
REITS/ InvITs REITS/ below AA and mum 25% for issuer and and investment in
InvITs ABS/ MBS, 5% total unlisted
in exposure cap securities
securities of 25%. capped at 10%
rated belowA Sectoral limit
at 25%.
Group limit at
20%.
Fiscals 2012-15 saw a sharp rise in traded volume
Rscr
900 Spread inbps
800 200
700
600 150
500
400 100
300
200 50
100
0 0
FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15
Average daily trading

Spread of SDL over G-sec for the year (RHS)
Spread of AAA bond over G-sec for the year (RHS)
Over the past three years, as traded volume and liquidity yields offered were higher than in G-secs and even AAArated
increased in SDLs, their spreads over G-secs continued to corporatebonds
narrow. Despite this, there was higher demand because the
75
Corporate bonds (Rs Total investments (Rs % investments in
cr) cr) corporate bonds
EPFO 182,128 636,039 28.63%
Corporates* 137,708 1,032,299 13.34%
Banks 267,765 2,983,576 8.97%

FPI 181,781 2,320,539 7.83%
MFs 250,054 1,194,774 20.93%
Life insurers 420,349 2,344,228 17.93%
General insurers 78,951 139,887 56.44%
Total 1,518,736 10,651,342 14.26%

Amount outstanding as on Dec 31, 2015 (Rs cr)
% of total
Sovereign 63,96,089 72%
i) G-secs 45,19,205 51%
ii) SDL 14,51,236 16%
iii) T-bills 4,25,648 5%
Corporate 24,26,294 28%
i) Corporate bonds 19,11,226 22%
ii) CP 3,08,509 4%
iii) CD 2,06,559 2%
Total 88,22,383 100%

Penetration (outstanding debt/GDP) as on Dec 31, 2015 Ratio (bonds/ G-secs)
G-secs Corp bonds

US 81% 123% 1.5
China 39% 20% 0.5
Japan 199% 16% 0.1

South Korea 53% 77% 1.5
Hong Kong 39% 29% 0.8
Singapore 46% 32% 0.7
Malaysia 53% 44% 0.8
India 40% 17% 0.4
Rating Amount (Rs cr)
category
FY11 FY12 FY13 FY14 FY15 FY16 FY16*-% of
total
AAA 1,32,075 1,89,447 2,26,311 1,89,396 2,80,348 1,85,840 54%
AA+ 18,775 28,054 54,742 36,917 60,466 41,500 12%
AA 10,851 12,587 25,351 15,360 24,345 24,271 7%
AA- 13,856 6,237 16,946 9,404 26,707 24,286 7%
A+ 8,178 2,167 3,735 5,880 12,637 9,620 3%
A 5,844 6,175 12,015 5,207 7,826 7,832 2%
A- 890 3,414 2,536 2,243 5,357 3,455 1%
BBB and 1,658 3,356 10,637 6,539 15,007 47,095 14%
Below
Total 1,92,127 2,51,437 3,52,272 2,70,946 4,32,692 3,43,898 100%
No. of Issuers Amt. mobilised (Rs cr) Growth in amount
mobilised
FY11 182 1,92,127 1%
FY12 164 2,51,437 31%
FY13 267 3,51,848 40%
FY14 245 2,70,946 -23%
FY15 344 4,32,692 60%
FY16 470 4,58,073* 6%

Amount (Rs cr) FY16*-% of
total
FY11 FY12 FY13 FY14 FY15 FY16(Q3)
Financial institutions 72,112 113,520 109,425 82,434 127,892 60,404 18%
Housing finance companies 29,801 36,367 57,850 55,106 73,938 56,502 16%
NBFCs 12,877 26,697 45,777 38,774 64,957 78,466 23%
Banks 19,481 14,974 24,495 14,388 47,881 25,484 7%
Sub-total 64%
Public sector undertakings 12,850 27,176 39,851 31,784 31,219 22,497 7%
State-level undertakings 1,981 4,184 8,584 3,686 5,207 502 0%
State financial institutions 1,425 1,575 5,394 1,482 1,733 0%
Sub-total 7%
Private non-financial sector 41,599 26,946 60,473 43,291 79,864 1,00,043 29%
Total 192,127 251,437 351,848 270,946 432,692 3,43,898 100%

Financial Markets

Enviado por

Dados do documento

Direitos autorais

Formatos disponíveis

Compartilhar este documento

Compartilhar ou incorporar documento

Opções de compartilhamento

Você considera este documento útil?

Este conteúdo é inapropriado?

Direitos autorais:

Formatos disponíveis

Financial Markets

Enviado por

Direitos autorais:

Formatos disponíveis

Financial Markets

Difference between two assets classes

Real Assets Financial Assets

Common stock or equity

Securitization: Buying mortgage loans from originators and bundling

Systemic Risk: A potential breakdown of the financial system in which

One default may set off a chain of further defaults

Banks had a mismatch between the maturity and liquidity of their

Investors relied too much on credit enhancement through structured

On-line trading facility

FDI & FII

Number of Listed securities

The age of the stock exchange

1. Market for securities : Stock exchange is a market, where securities of corporate

5. Transactions effected only through members : All the transactions in securities at

9. Specific location : Stock exchange is a particular market place where authorised

Majority of the developing nations have Ministries that have an

Coffee Board of India (indiacoffee.org)

Commodity Markets Equity Markets

Far more demanding in terms of Primarily local as majority of the

Commodity Markets Equity Markets

Commodity Markets Equity Markets

Commodity Markets Equity Markets

MSP minimum support price is No concept of MSP-minimum

Commodity Markets Equity Markets

Positional Limit (member level) 20,000 MT

Settlement Settlement ( contd..)

Tender period Delivery logic

Delivery period Funds pay-out

Buyers intention Funds pay-in

Tender days Delivery pay-out

Tender notice by seller Mode of communication

Dissemination of information on tendered Penal provision

Exemption from tender and delivery period Delivery order rate

All terms not included !!!!!!

Through out the year Seasonal

Seasonal Seasonal ( but seasons dont match)

Through out the year Through out the year

Seasonal Through out the year ??????

Through out the year Seasonal ???????

Seasonal Seasonal ( but seasons ?????????

Through out the year Through out the year ???????

IN THE WORLD TODAY YOU WILL FIND THAT THE

The commodity price has two very important elements:

Financing is a common cost to all financial markets

The commodity price is also a function of the durability of the

Forward Market Commission

CLEARING HOUSE CLEARING BANKS

Order receipt and Novation Margin Payment and

Order matching and Margin Calculation Delivery payment and

Reporting of executed Clearing limits Auctioning in case

NCDEX Spot Exchange

Indian Bullion Spot Exchange

Reliance Spot Exchange

Warehouse Receipts Clearing Bank Warehouse Receipts

Name and Address of the Depositor_______________________________

Name of the Quantity Quality Name and License

Market rate of the commodity on deposit date_____________________

Value of the commodity on deposit date_____________________

Location of warehouse where commodity deposited_________________

Storage and miscelleanous charges_______________________________

Storage Period ___________________________

Validity date indicates the date upto which THE QUALITY OF

Expiry date refers to the MAXIMUM TIME period up to which