UNIT II MONEY MARKET MEANING Money market is a market for short-term loans or financial assets.

s. It is a market for the lending and borrowing of short-term funds. As the name implies, it does not actually deal in cash or money. But it actually deals with near substitutes for money or near money like trade bills, promissory notes and government papers drawn for a short period not exceeding one year. hese short-term instruments can be converted into cash readily without any loss and at low transaction cost. DEFINITION According to !rowther, " he money market is the collective name given to the various firms and institutions that deal in the various grades of near money.# he $BI defines the money market as, "a market for short-term financial assets that are close substitutes for money, facilitates the exchange of money for new financial claims in the primary market as also for financial claims, already issued, in the secondary market#. MONEY MARKET VS. CAPITAL MARKET In this context, it is imperative that one should know the distinction between a money market and a capital market. he distinction is briefly shown in the following table% Money Market !apital Market

&. It is a market for short-term loanable funds It is a market for long-term funds exceeding a for a period of not exceeding one year. period of one year. '. his market supplies funds of financing his market supplies funds for financing the current business operations, working capital fixed capital re(uirements of trade and re(uirements of industries and short period commerce as well as the long-term re(uirements of the )overnment. re(uirements of the )overnment. *. he instruments that are dealt in a money his market deals in instruments like shares, market are bills of exchange, treasury bills, debentures, )overnment bonds etc. commercial papers, certificate of deposit etc. +. ,ach single money market instrument is of ,ach single capital market instrument is of large amount. A reasury Bill is of minimum small amount. ,ach share value is $s.&0. for one lakh. ,ach !ertificate of -eposit or ,ach debenture value is $s.&00. !ommercial .aper is for a minimum of $s.'/ lakhs. /. he central bank and commercial banks are -evelopment banks and insurance companies the ma1or institutions in money market. play a dominant role in the capital market. 2. Money market instruments generally do not !apital market instruments generally have have secondary markets. secondary market.

&

3. ransactions mostly take place over-theransactions take place at a formal place, vi4., phone and there is no formal place. stock exchange. 5. ransactions have to be conducted without ransactions have to be conducted only the help of brokers. through authori4ed dealers. FEATURES OF A MONEY MARKET he following are the general features of a money market. &. It is a market purely for short-term funds or financial assets called near money. '. It deals with financial assets having a maturity period upto one year only. *. It deals with only those assets which can be converted into cash readily without loss and with minimum transaction cost. +. )enerally transactions take place through phone, i.e., oral communication. $elevant documents and written communications can be exchanged subse(uently. here is no formal place like stock exchange as in the case of a capital market. /. ransactions have to be conducted without the help of brokers. 2. It is not a single homogenous market. It comprises of several submarkets, each speciali4ing in a particular type of financing, e.g., !all money market, Acceptance market, Bill market and so on. 3. he components of a money market are the !entral bank, commercial banks, nonbanking financial companies, discount houses and acceptance houses. !ommercial banks generally play a dominant role in this market. he following are the important ob1ectives of a money market. &. '. *. +. o provide a parking place to employ short-term surplus funds. o provide room for overcoming short-term deficits. o enable the central bank to influence and regulate li(uidity in the economy through its intervention in this market. o provide a reasonable access to users of short-term funds to meet their re(uirements (uickly, ade(uately and at reasonable costs.

OBJECTIVES

CHARACTERISTIC FEATURES OF A DEVELOPED MONEY MARKET In order to fulfill the above ob1ectives, the money market should be fully developed and efficient. In every country of the world, some type of money market exists. 6ome of them are highly developed while others are not well developed. .rof. 6.7. 6en has described certain essential features of a developed money market. hey are as follows% (i) Highl !"g#$i%&' (#$)i$g * *+&, he commercial banks are the nerve centre of the whole money market. hey are the principal suppliers of short-term funds. heir policies regarding loans and advances have greater

'

impact on the entire money market. he commercial banks serve as vital link between the central bank and the various segments of the money market. !onse(uently, a well developed money market and a highly organi4ed banking system co-exist. In an underdeveloped money market, the commercial banking system is not fully developed. (ii) P"&*&$-& !. # C&$+"#l B#$) he !entral Bank acts as the banker8s bank. It keeps their cash reserves and provides them financial accommodation in difficulties by discounting their eligible securities. In other words, it enables the commercial banks and other institutions to convert their assets into cash in times of financial crisis. hrough its open market operations, the central bank absorbs surplus cash during off-seasons and provides additional li(uidity in the busy seasons. hus, the central bank is the leader, guide and controller of the money market. In an underdeveloped money market, the central bank is in its infancy and not in a position to influence and control the money market. (iii) A/#il#(ili+ !. P"!0&" C"&'i+ I$*+"1,&$+* It is necessary for the existence of a developed money market a continuous availability of readily acceptable negotiable securities such as bills of exchange, treasury bills etc. in the market. here should be a number of dealers in the money market to transact in these securities. Availability of negotiable securities and the presence of dealers and brokers in large numbers to transact in these securities are needed for the existence of a developed money market. here is absence of ade(uate and proper credit instruments as well as dealers to deal in these instruments in an underdeveloped money market. (i/) E2i*+&$-& !. S1(3,#")&+* he number of sub-markets determines the development of a money market. he larger the number of sub-markets, the broader and more developed will be the structure of money market. he several sub-markets together make a coherent money market. In an underdeveloped money market, the various sub-markets, particularly the bill market, are absent. ,ven if sub-markets exist, there is no co-ordination between them. !onse(uently, different money rates prevail in the sub-markets and they remain unconnected with one another. (/) A,0l& R&*!1"-&* here must be availability of sufficient funds to finance transactions in the sub-markets. hese funds may come from within the country and also from foreign countries. he 9ondon, 7ew :ork and .aris money market attract funds from all over the world. he underdeveloped money markets are starved of funds. (/i) E2i*+&$-& !. S&-!$'#" ,#")&+ here should be an active secondary market in these instruments. (/ii) D&,#$' #$' S100l !. F1$'* here should be a large demand and supply of short-term funds. It presupposes the existence of a large domestic and foreign trade. Besides, it should have ade(uate amount of li(uidity in the form of large amounts maturing within a short period. O+h&" F#-+!"*

Besides the above, other factors also contribute to the development of a money market. $apid industrial development leading to the emergency of stock exchanges, large volume of international trade leading to the system of bills of exchange, political stability, favourable conditions for foreign investment, price stabili4ation etc. are the other factors that facilitate the development of money market in the country. 9ondon Money Market is a highly developed money market because it satisfies all re(uirements of a developed money market. If any one or more of these factors are absent, then the money market is called an underdeveloped one. IMPORTANCE OF MONEY MARKET A developed money market plays an important role in the financial system of a country by supplying short-term funds ade(uately and (uickly to trade and industry. he money market is an integral part of a country8s economy. herefore, a developed money market is highly indispensable for the rapid development of the economy. A developed money market helps the smooth functioning of the financial system in any economy in the following ways. (i) D&/&l!0,&$+ !. T"#'& #$' I$'1*+" Money market is an important source of financing trade and industry. he money market, through discounting operations and commercial papers, finances the short-term working capital re(uirements of trade and industry and facilitates the development of industry and trade both ; national and international. (ii) D&/&l!0,&$+ !. C#0i+#l M#")&+ he short-term rates of interest and the conditions that prevail in the money market influence the long-term interest as well as the resource mobili4ation in capital market. <ence, the development of capital market depends upon the existence of developed money market. (iii) S,!!+h F1$-+i!$i$g !. C!,,&"-i#l B#$)* he money market provides the commercial banks with facilities for temporarily employing their surplus funds in easily reali4able assets. he banks can get back the funds (uickly, in times of need, by resorting to the money market. he commercial banks gain immensely by economi4ing their cash balances in hand and at same time meeting the demand for large withdrawal of their depositors. It also enables commercial banks to meet their statutory re(uirements of !ash $eserve $atio =!$$> and 6tatutory 9i(uidity $atio =69$> by utili4ing the money market mechanism. (i/) E..&-+i/& C&$+"#l B#$) C!$+"!l A developed money market helps the effective functioning of a central bank. It facilitates effective implementation of the monetary policy of a central bank. he central bank, through the money market, pumps new money into the economy in slump and siphons it off in boom. he central banks, thus regulates the flow of money so as to promote economic growth with stability. (/) F!",1l#+i!$ !. S1i+#(l& M!$&+#" P!li!onditions prevailing in a money market serve as a true indicator of the monetary state of an economy. <ence, it serves as a guide to the )overnment in formulating and revising the

monetary policy then and there depending upon the monetary conditions prevailing in the market. (/i) N!$3i$.l#+i!$#" S!1"-& !. Fi$#$-& +! G!/&"$,&$+ A developed money market helps the )overnment to raise short-term funds through the treasury bills floated in the market. In the absence of a developed money market, the )overnment would be forced to print and issue more money or borrow from the central bank. Both ways would lead to an increase in prices and the conse(uent inflationary trend in the economy. COMPOSITION OF MONEY MARKET As stated earlier, the money market is not a single homogeneous market. It consists of a number of sub-markets which collectively constitute the money market. here should be competition within each sub-market as well as between different sub-markets. he following are the main sub-markets of a money market. =i> =ii> =iii> =iv> !all money market !ommercial bills market or discount market Acceptance market reasury bill market

CALL MONEY MARKET he call money market refers to the market for extremely short period loans, say one day to fourteen days. hese loans are repayable on demand at the option of either the lender or the borrower. As stated earlier, these loans are given to brokers and dealers in stock exchange. 6imilarly, banks with ?surplus funds8 lend to other banks with ?deficit funds8 in the call money market. hus, it provides an e(uilibrating mechanism for evening out short-term surpluses and deficits. Moreover, commercial banks can (uickly borrow from the call market to meet their statutory li(uidity re(uirements. hey can also maximi4e their profits easily by investing their surplus funds in the call market during the period when call rates are high and volatile. COMMERCIAL BILLS MARKET OR DISCOUNT MARKET A commercial bill is one which arises out of a genuine trade transaction, i.e., credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the amount due. he buyer accepts it immediately agreeing to pay the amount mentioned therein after a certain specified date. hus, a bill of exchange contains a written order from the creditor to the debtor, to pay a certain sum to a certain person, after a certain period. A bill of exchange is a ?self-li(uidating8 paper and negotiable. It is drawn always for a short period ranging between * months and 2 months. D&.i$i+i!$ 6ection / of 7egotiable Instruments Act defines a bill of exchange as follows% "An instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of a certain person or to pay the bearer of the instrument#. T 0&* !. Bill* /

Many types of bills are in circulation in a bill market. follows% =i> =ii> =iii> =iv> =v> =vi> -emand and usance bills. !lean bills and documentary bills Inland and foreign bills ,xport bills and import bills Indigenous bills Accommodation bills and supply bills.

hey can be broadly classified as

O0&"#+i!$* i$ Bill M#")&+ @rom the operations point of view, the bill market can be classified into two, vi4. =i> =ii> -iscount market Acceptance market

Di*-!1$+ M#")&+ -iscount market refers to the market where short-term genuine trade bills are discounted by financial intermediaries like commercial banks. Ahen credit sales are effected, the seller draws a bill on the buyer who accepts it promising to pay the specified sum at the specified period. he seller has to wait until the maturity of the bill for getting payment. But, the presence of a bill market enables him to get payment immediately. he seller can ensure payment immediately by discounting the bill with some financial intermediary by paying a small amount of money called ?-iscount rate8. Bn the date of maturity, the intermediary claims the amount of the bill from the person who has accepted the bill. A--&0+#$-& M#")&+ he acceptance market refers to the market where short-term genuine trade bills are accepted by financial intermediaries. All trade bills cannot be discounted easily because the parties to the bills may not be financially sound. In case such bills are accepted by financial intermediaries like banks, the bills earn a good name and reputation and such bills can be readily discounted anywhere. In 9ondon, there are specialist firms called acceptance houses which accept bills drawn by traders and impart greater marketability to such bills. <owever, their importance has declined in recent times. In India, there are no acceptance houses. he commercial banks undertake the acceptance business to some extent. TREASURY BILL MARKET Cust like commercial bills which represent commercial debt, treasury bills represent shortterm borrowings of the )overnment. reasury bill market refers to the market where treasury bills are bought and sold. reasury bills are very popular and en1oy a higher degree of li(uidity since they are issued by )overnment. M&#$i$g #$' F&#+1"&* A treasury bill is nothing but a promissory note issued by the )overnment under discount for a specified period stated therein. he )overnment promises to pay the specified amount mentioned therein to bearer of the instrument on the due date. he period does not exceed a 2

period of one year. It is purely a finance bill since it does not arise out of any trade transaction. It does not re(uire any ?grading8 or ?endorsement8 or ?acceptance8 since it is a claim against the )overnment. reasury bills are issued only by the $BI on behalf of the )overnment. reasury bills are issued for meeting temporary government deficits. he treasury bill rate or the rate of discount is fixed by the $BI from time to time. It is the lowest one in the entire structure of interest rates in the country because of short-term maturity and high degree of li(uidity and security. T 0&* !. T"&#*1" Bill* In India, there are two types of treasury bills, vi4., =i> ordinary or regular and =ii> ?ad hoc8 known as ?ad hocs8. Brdinary treasury bills are issued to the public and other financial institutions for meeting the short-term financial re(uirements of the !entral )overnment. hese bills are freely marketable and they can be bought and sold at any time and they have secondary market also. Bn the other hand, ?ad hocs8 are always issued in favour of the $BI only. hey are not sold through tender or auction. hey are purchased by the $BI and the $BI is authori4ed to issue currency notes against them. hey are not marketable in India. <owever, the holders of these bills can always sell them back to the $BI. Ad hocs serve the )overnment in the following ways% =i> hey replenish cash balances of the !entral )overnment. Cust like 6tate )overnments get advance =ways and means advances> from the $BI, the central government can raise finance through these ad hocs. hey also provide an investment medium for investing the temporary surpluses of 6tate )overnments, 6emi-government departments and foreign central banks. Bn the basis of periodicity, treasury bills may be classified into three. =i> =ii> =iii> D& days treasury bills &5' days treasury bills *2+ days treasury bills hey are%

=ii>

7inety-one days treasury bills are issued at a fixed discount rate of +E as well as through auctions. *2+ days treasury bills do not carry any fixed rate. he discount rate on these bills are (uoted in auction by the participants and accepted by the authorities. 6uch a rate is called cut-off rate. In the same way, the rate is fixed for D& days treasury bills sold through auction. =& day treasury bills =tap basis> can be rediscounted with the $BI at any time after &+ days of their purchase. Before &+ days, a penal rate is charged. MONEY MARKET INSTRUMENTS A variety of instruments are available in a developed money market. In India, till &D52, only a few instruments were available. hey were% =i> =ii> =iii> reasury bills in the treasury market. Money at call and short notice in the call loan market. !ommercial bills and promissory notes in the bill market.

7ow, in addition to the above, the following new instruments are available% =i> =ii> =iii> =iv> !ommercial paper !ertificate of deposit Inter-bank participation certificates $epo instruments

COMMERCIAL PAPER A commercial paper is an unsecured promissory note issued with a fixed maturity by a company approved by $BI, negotiable by endorsement and delivery, issued in bearer form and issued at such discount on the face value as may be determined by the issuing company. P#"+i-i0#$+* I**1&"* All private sector company, public sector units, non-banking company etc. I$/&*+!"* Individuals, banks, corporates and also 7$Is. Fsually banks, large corporate bodies and public sector units with investible funds participate in !. market. F&#+1"&* !. C!,,&"-i#l P#0&" &. !ommercial paper is a short-term money market instrument comprising usance promissory note with a fixed maturity. '. It is a certificate evidencing an unsecured corporate debt of short-term maturity. *. !ommercial paper is issued at a discount to face value basis but it can also be issued in interest-bearing form. +. he issuer promises to pay the buyer some fixed amount on some future period but pledges no assets, only his li(uidity and established earning power, to guarantee that promise.

/. !ommercial paper can be issued directly by a company to investors or through banksGmerchant bankers. CERTIFICATE OF DEPOSIT (CD) !ertificate of -eposits are short-term deposit instruments issued by banks and financial institutions to raise large sums of money. !-s are issued in the form and Fsance .romissory 7otes. hey are negotiable and are in marketable form bearing specific face value and maturity. he !-s are transferable from one party to another. -ue to their negotiable nature, they are also known as 7egotiable !ertificate of -eposit . I**1&"* he issuers of !ertificate of -eposits are commercial banks, financial institutions etc. S1(*-"i(&"*

!-s are available for subscription by individuals, corporations, trusts, Associations and 7$Is. F&#+1"&* !. C&"+i.i-#+& !. D&0!*i+ &. -ocument of title to time deposit. '. Fnsecured negotiable pronotes. *. @reely transferable by endorsement and delivery. +. Issued at discount to face value. /. $epayable on a fixed date without grace days. 2. 6ub1ect to stamp duty like the usance promissory notes. INTER3BANK PARTICIPATION CERTIFICATE he governor of the $eserve Bank of India while dealing with credit policy measures in Bctober &D55, had informed the bank !hiefs about a proposal to authori4e banks to fund their short-term needs from within the system through issuance of inter-bank .articipations. his announcement by the $BI was in line with the recommendations made by the Aorking )roup on the Money Market. Inter-bank .articipation !ertificate provides them an additional instrument for even out short-term li(uidity within the perimeter of the banking system, particularly at times when there are imbalances affecting the maturity mix of assets in banker8s books. REPO INSTRUMENTS $epo stands for $epurchase. Fnder $epo transaction, the borrower parts with securities to the lender with an agreement to repurchase them at the end of the fixed period at a specified price. At the end of the period, the borrower will repurchase the securities at the predetermined price. he difference between the purchase price and the original price is the cost for the borrower. his cost of borrowing is called "$epo $ate# which is little cheaper than pure borrowing. A transaction is called a $epo when viewed from the perspective of the seller of the securities and $everse $epo when described from the point of view of the suppliers of funds. hus whether a given agreement is term a $epo or $everse $epo depends largely on which party initiated the transaction. $epo transactions are conducted in the money market to manipulate short-term interest rate and manage li(uidity levels. In India, $epos are normally conducted for a period of * days. he eligible securities for the purpose are decided by $BI. hese securities are usually )overnment promissory notes, reasury bills and public sector bonds. Ahen the $BI announces a fixed rate $epo, for certain number of days G period it conveys its intention to market at the desirable level of short-term interest rate. Ahen $BI conducts ?repos8, the short-term interest rate in the money market may not go below the $BI repo rate. If the interest is lower in other markets such as foreign exchange market, reasury bills market, holders of funds may go for $epos with $BI. hus $epo transactions ensure stability in short-term interest rates in the money market. In case, the $BI wants to in1ect fresh funds in the market, it will conduct ?$everse $epo8 transactions with primary dealers against )overnment securities.

UNIT III CAPITAL MARKET NE4 ISSUE MARKET he industrial securities market in India consists of 7ew Issue Market and 6tock ,xchange. he new issue market deals with new securities which were not previously available to the investing public, i.e., the securities that are offered to the investing public for the first time. he market, therefore, makes available a new block of securities for public subscription. In other words, new issue market deals with raising of fresh capital by companies either for cash or for consideration other than cash. he new issue market encompasses all institutions dealing in fresh claim. hese claims may be in the form of e(uity shares, preference shares, debentures, rights issues, deposits etc. All financial institutions which contribute, underwrite and directly subscribe to the securities are part of new issue market. STOCK E5CHANGE he stock exchange is a market for old securities i.e., those which have been already issued and listed on a stock exchange. hese securities are purchased and sold continuously among investors without the involvement of companies. 6tock exchange provides not only free transferability of shares but also makes continuous evaluation of securities traded in the market. DISTINCTION BET4EEN NE4 ISSUE MARKET AND STOCK E5CHANGE he distinction between the new issue market and the stock exchange can be made on three grounds. =i> =ii> =iii> @unctional difference. Brganisational difference. 7ature of contribution to industrial finance.

(i) F1$-+i!$#l Di..&"&$-& he new issue market deals with new securities which are issued for the first time for public subscription. he stock exchange provides a ready market for buying and selling of old securities. (ii) O"g#$i*#+i!$#l Di..&"&$-& he stock exchanges have physical existence and are located in particular geographical areas. he stock exchange is a place where dealers of security meet regularly at appointed time announced by the market. It is a well established organi4ation with rules and regulations for a smooth conduct of the business. he members are supplied with information about companies and daily changes in price of stocks. he new issue market en1oys neither any tangible form nor any administrative organi4ational set-up nor is sub1ect to any centrali4ed control and administration for the execution of the business. It renders service to the lenders and borrowers of funds at the time of any particular operation and the services are taken up entirely by banks, brokers and underwriters. (iii) N#+1"& !. C!$+"i(1+i!$ +! I$'1*+"i#l Fi$#$-&

&0

he new issue market provides the issuing company with funds for starting new enterprise or for either expansion or diversification of an existing one by making, a direct link between companies which re(uire funds and the investing public. 6o, the contribution of new issue market is direct. he role of stock exchange in providing capital is indirect as it provides marketability to the shares. FUNCTIONS OF NE4 ISSUE MARKET he main function of a new issue market is to facilitate transfer of resources from savers to the users. he savers are individuals, commercial banks, insurance companies etc. he users are public limited companies and the government. he new issue market plays an important role of mobili4ing the funds from the savers and transferring them to borrowers for production purposes, an important re(uisite of economic growth. It is not only a platform for raising finance to establish new enterprises but also for expansionGdiversificationGmoderni4ation of existing units. Bn this basis, the new issue market can be classified as% &. Market where firms go to the public for the first time through initial public offering =I.B>. '. Market where firms which are already trading raise additional capital through seasoned e(uity offering =6,B>. he main functions of a new issue market can be divided into a triple service functions% &. Brigination '. Fnderwriting *. -istribution O"igi$#+i!$ Brigination refers to the work of investigation, analysis and processing of new pro1ect proposals. Brigination starts before an issue is actually floated in the market. here are two aspects in this function. i. ii. =a> A careful study of the technical, economic and financial viability to ensure soundness of the pro1ect. his is a preliminary investigation undertaken by the sponsors of the issue. Advisory services which improve the (uality of capital issues and ensure its success. he advisory services include% ype of Issue. his refers to the kind of securities to be issued whether e(uity share, preference share, debenture or convertible debenture. ime of floating an issue.

=b> Magnitude of issue. =c> =d> .ricing of an issue ; whether shares are to be issued at par or at premium. =e> Methods of issue. =f> echni(ue of selling the securities. he function of origination is done by merchant bankers who may be commercial banks, all India financial institutions or private firms. Initially, this service was provided by speciali4ed &&

division of commercial banks. At present, financial institutions and private firms also perform this service. hough this service is highly important, the success of the issue depends, to a large extent, on the efficiency of the market. he organi4ation itself does not guarantee the success of the issue. Fnderwriting, a speciali4ed service, is re(uired in this regard. U$'&"6"i+i$g Fnderwriting is an agreement whereby the underwriter promises to subscribe to a specified number of shares or debentures or a specified amount of stock in the event of public not subscribing to the issue. If the issue is fully subscribed, then there is no liability for the underwriter. If a part of share issues remain unsold, the underwriter will buy the shares. hus, underwriting is a guarantee for the marketability of shares. M&+h!'* !. U$'&"6"i+i$g An underwriting agreement may take any of the following three forms% (i) S+#$'i$g (&hi$' +h& I**1& Fnder this method, the underwriter guarantees the sale of a specified number shares within a specified period. If the public do not subscribe to the specified amount of issue, the underwriter buys the balance in the issue. (ii) O1+"igh+ P1"-h#*& he underwriter, in this method, makes outright purchase of shares and resells them to the investors. (iii) C!$*!"+i1, M&+h!' Fnderwriting is 1ointly done by a group of underwriters in this method. form a syndicate for this purpose. his method is adopted for large issues. Di*+"i(1+i!$ -istribution is the function of sale of securities to ultimate investors. his service is performed by brokers and agents who maintain a regular and direct contact with the ultimate investors. METHODS OF FLOATING NE4 ISSUES he various methods which are used in the floatation of securities in the new issue market are% &. .ublic issue '. Bffer for sale *. .lacement +. $ights issue P1(li- I**1&* Fnder this method, the issuing company directly offers to the general publicGinstitutions a fixed number of shares at a stated price through a document called prospectus. his is the most he underwriters

&'

common method followed by 1oint-stock companies to raise capital through the issue of securities. he prospectus must state the following% &. 7ame of the company '. Address of the registered office of the company *. ,xisting and proposed activities +. 9ocation of the industry /. 7ames of directors 2. Authorised and proposed issue capital to the public 3. -ates of opening and closing the subscription list 5. Minimum subscription D. 7ames of brokersGunderwritersGbankersGmanagers and registrars to the issue &0. A statement by the company that it will apply to stock exchange for (uotations of its shares. According to the !ompanies Act, &D/2, every application form must be accompanied by a prospectus. 7ow, it is no longer necessary to furnish a copy of the prospectus along with every application form as per the !ompanies Amendment Act, &D55. 7ow, an abridged prospectus is being annexed to every share application form. O..&" .!" S#l& he method of offer of sale consists in outright sale of securities through the intermediary of Issue <ouses or share brokers. In other words, the shares are not offered to the public directly. his method consists of two stages. he first stage is a direct sale by the issuing company to the Issue <ouse and brokers at an agreed price. In the second stage, the intermediaries resell the above securities to the ultimate investors. he Issue <ouses or stock brokers purchase the securities at a negotiated price and resell at a higher price. he difference in the purchase and sale price is called turn or spread. It is otherwise called Bought But -eals =BB->. 9et us take a simple example, H, a small company has a turnover of $s.' crore a year. It re(uires additional funding of $s.5 crore to expand its capacity. he merchant banker sees potential business for the company. <e asks the promoters of the company to sell 5 lakh shares of its capital to it. he company gets $s.5 crore to expand its business. he merchant bankerGissue house is not holding 50E of the company8s entire capital, in &' month8s time. h company expanded its operations marketed its products successfully and earned sufficient profit. 7ow, the issue house decides to offload the 50E capital to the public at a premium of $s.*0 per share. In a period of &5 months the merchant bankGissue house has earned a profit. Pl#-&,&$+ Fnder this method, the issue houses or brokers buy the securities outright with the intention of placing them with their clients afterwards. <ere, the brokers act as almost wholesalers selling them in retail to the public. he brokers would make profit in the process of reselling to the public. he issues houses or brokers maintain their own list of clients and

&*

through customer contact sell the securities. underwriting agreement. Righ+* I**1&

here is no need for a formal prospectus as well as

$ights issue is a method of raising funds in the market by an existing company. A right means an option to buy certain securities at a certain privileged price within a certain specified period. 6hares, so offered to the existing shareholders are called rights shares. $ights shares are offered to the existing shareholders in a particular proportion to their existing share ownership. he ratio in which the new shares or debentures are offered to the existing share capital would depend upon the re(uirement of capital. he rights themselves are transferable and saleable in the market. 6ection 5& of the !ompanies Act deals with rights issue. According to this section, where a company increases its subscribed capital by the issue of new shares either after two years of its formation or after one year of its first issue of share whichever is earlier, these have to be first offered to the existing shareholders with the right to reserve them in favour of a nominee. A company issuing rights is re(uired to send a circular to all existing shareholders. he circular should provide information on how additional funds would be used and their effect on the earning capacity of the company. he company should normally give a time limit of atleast one month to two months to shareholders to exercise their right. If the rights are not fully taken up, the balance is to be e(uitably distributed among the applicants for additional shares. Any balance still left over may be disposed off in the market in a way which is most beneficial to the company. SECONDARY MARKET he market were existing securities are traded is referred to as the secondary market or stock market. In a stock market, purchases and sales of securities whether of )overnment or 6emi-government bodies or other public bodies and also shares and debentures issued by 1ointstock companies are effected. he securities of government are traded in the stock market as a separate component, called gift-edged market. )overnment securities are traded outside the trading wing in the form of over-the-counter sales or purchases. Another component of the stock market deals with trading in shares and debentures of limited companies. STOCK E5CHANGES 6tock exchanges are the important ingredient of the capital market. hey are the citadel of capital and fortress of finance. hey are the theatres of trading in securities as such they assist and control the buying and selling of securities. hus, according to <usband and -ockeray, "securities or stock exchanges are privately organi4ed markets which are used to facilitate trading in securities.# <owever, at present, stock exchanges need not necessarily be privately organi4ed ones. As per the 6ecurities !ontracts $egulation Act, &D/2, a stock exchange has been defined as follows% "It is an association, orgnaisation or body of individuals whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities.# In brief, stock exchanges constitute a market where securities issued by the !entral and 6tate governments, public bodies and 1oint-stock companies are traded. &+

FUNCTIONS 7 SERVICES OF STOCK E5CHANGES he stock market occupies a pivotal position in the financial system. It performs several economic functions and renders invaluable services to the investors, companies, and to the economy as a whole. hey may be summari4ed as follows% (i) Li81i'i+ #$' M#")&+#(ili+ !. S&-1"i+i&* 6tock exchanges provide li(uidity to securities since securities can be converted into cash at any time according to the discretion of the investor by selling them at the listed prices. hey facilitate buying and selling, of securities at listed prices by providing continuous marketability to the investors in respect of securities they hold or intend to hold. his they create a ready outlet for dealing in securities. (ii) S#.&+ !. F1$'* 6tock exchanges ensure safety of funds intended because they have to function under strict rules and regulations and the bye-laws are meant to ensure safety of investible funds. Bvertrading, illegitimate speculation etc. are prevented through carefully designed set of rules. his would strengthen the investor8s confidence and promote larger investment. (iii) S100l !. L!$g3+&", F1$'* he securities traded in the stock market are negotiable and transferable in character and as such they can be transferred with minimum of formalities from one hand to another. 6o, when a security is transferred, one investor is substituted by another, but the company is assured of 9ong-term availability of funds. (i/) Fl!6 !. C#0i+#l +! P"!.i+#(l& V&$+1"&* he profitability and popularity of companies are reflected in stock prices. he prices (uoted indicate the relative productivity and performance of companies. @unds tend to be attracted towards securities of profitable companies and this facilitates the flow of capital into profitable channels. In the words of <usband and -ockeray, "6tock exchanges function like a traffic signal, indicating a green light when certain fields offer the necessary inducement to attract capital and bla4ing a red light when the outlook for new investment is not attractive.# (/) M!+i/#+i!$ .!" I,0"!/&' P&".!",#$-& he performance of a company is reflected on the prices (uoted in the stock market. hese prices are more visible in the eyes of the public. 6tock market provides room for this price (uotation for those securities listed by it. his public exposure makes a company conscious of its status in the market and it acts as a motivation to improve its performance further. (/i) P"!,!+i!$ !. I$/&*+,&$+ 6tock exchanges mobili4e the savings of the public and promote investment through capital formation. But for these stock exchanges, surplus funds available with individuals and institutions would not have gone for productive and remunerative ventures. (/ii) R&.l&-+i!$ !. B1*i$&** C -l& he changing business conditions in the economy are immediately reflected on the stock exchanges. Booms and depressions can be identified through the dealings on the stock &/

exchanges and suitable monetary and fiscal policies can be taken by the government. hus, a stock market portrays the prevailing economic situation instantly to all concerned that suitable actions can be taken. (/iii) M#")&+i$g !. N&6 I**1&* If the new issues are listed, they are readily acceptable to the public, since listing presupposes their evaluation by concerned stock exchange authorities. .ublic response to such new issues would be relatively high. hus, a stock market helps in the marketing of new issues also. (i2) Mi*-&ll#$&!1* S&"/i-&* 6tock exchange supplies securities of different kinds with different maturities and yields. It enables the investors to diversify their risks by a wider portfolio of investment. It also inculcates saving habits among the community and paves the way for capital formulation. It guides the investors in choosing securities by supplying the daily (uotation of listed securities and by disclosing the trends of dealings on the stock exchange. It enables companies and the )overnment to raise resources by providing a ready market for their securities. LISTING OF SECURITIES 9isting of securities means that the securities are admitted for trading on a recogni4ed stock exchange. ransactions in the securities of any company cannot be conducted on stock exchanges unless they are listed by them. <ence, listing is the very basis of stock exchange operations. It is the green signal given to selected securities to get the trading privileges of the stock exchange concerned. 6ecurities become eligible for trading only through listing. 9isting is compulsory for those companies which intend to offer sharesGdebentures to the public for subscription by means of issuing a prospectus. Moreover, the 6,BI insists on listing for granting permission to a new issue by a public limited company. Again, financial institutions do insist on listing for underwriting new issues. hus, listing becomes an unavoidable one today. he companies which have got their sharesGdebentures listed in one or more recogni4ed stock exchanges must submit themselves to the various regulatory measures of the stock exchange concerned as well as the 6,BI. hey must maintain necessary books, documents etc. and disclose any information which the stock exchange may call for. he listed shares are generally divided into two categories namely% =i> )roup A shares =6pecified shares or cleared securities> and =ii> )roup B shares =7on-specified shares or noncleared securities>. REGISTRATION OF STOCK BROKERS A broker is none other than a commission agent who transacts business in securities on behalf of his clients who are non-members of a stock exchange. hus, a non-member can purchase and sell securities only through a broker who is a member of the stock exchange. o deal in securities on recogni4ed stock exchanges, the broker should register his name as a broker with the 6,BI. A stock broker must possess the following (ualifications to register as a broker% &. <e must be an Indian citi4en with '& years of age. '. <e should neither be a bankrupt nor compounded with creditors.

&2

*. <e should not have been convicted for any offence, fraud etc. +. <e should not have engaged in any other business other than that of a broker in securities. /. <e should not be a defaulter of any stock exchange. 2. <e should have completed &'th standard examination. Apart from individuals, corporate and institutional members can also become brokers. Brokers will be selected by the selection committee of the stock exchange on the basis of their (ualifications, experience, financial status, their performance in the written test, interview etc. METHODS OF TRADING IN STOCK E5CHANGE he stock exchange operations at floor level are highly technical in nature. 7onmembers are not permitted to enter into the stock market. <ence, various stages have to be completed in executing a transaction at a stock exchange. he steps involved in the method of trading have been given below% 9. Ch!i-& !. # B"!)&" he prospective investor who wants to buy shares or the investor who wants to sell his shares cannot enter into the hall of the exchange and transact business. hey have to act through only member brokers. hey can also appoint their brokers for this purpose, since, bankers can become members of the stock exchange as per the present regulations. 6o, the first task in transacting business on a stock exchange is to choose a broker of repute or a banker. 6uch persons alone can ensure prompt and (uick execution of a transaction at the best possible and profitable price. :. Pl#-&,&$+ !. O"'&" he next step is the placing of order for the purchase or sale of securities with the broker. he order is usually placed by telegram, telephone, letter, fax etc. or in person. o avoid delay, it is placed generally over the phone. o reduce the cost also, it is placed in abbreviations, i.e., "Buy &00 6BI I $s.&/2#. It means that it is an order for the purchase of &00 shares of 6tate Bank of India I $s.&/2G-. ;. E2&-1+i!$ !. O"'&"* Big brokers transact their business through their authori4ed clerks. 6mall ones carry out their business personally. Brders are executed in the rading ring of a stock exchange which works from &' noon to 'p.m. on all working days from Monday to @riday and a special one hour session on 6aturday. rading outside trading hours are called ?Jerb dealings8. <. P"&0#"#+i!$ !. C!$+"#-+ N!+&* Fsually, the authori4ed clerks enter the particulars of the business transacted during a particular day in the ?Jacga 6auda Books, from the rough notebooks at the close of that working day. @rom Jacha 6auda Books, they are transferred to ?.ucca 6auda Books8 which are maintained separately for the ready delivery contracts and forward delivery contracts. hen the brokerG authori4ed clerk prepares a contract note. A contract note is a written agreement between the broker and his client for the transactions executed. It contains the details of the contract made for the purchase G sale of securities, the brokerage chargeable, name of the company, number of

&3

shares boughtG sold, net rate, etc. It is prepared in a prescribed form and a copy of it is also sent to the client. =. S&++l&,&$+ !. T"#$*#-+i!$* @inally, the settlement is made by means of delivering the share certificates along with the transfer deed. he transfer deed is duly signed by the transferor, i.e., the seller. It bears the stamp of the selling broker. he buyer then fills up the particulars in the transfer deed. >. L!#'i$g .!" T"#$*.&" #$' R&+1"$ !. C&"+i.i-#+&* @inally the shares have to be registered in the name of the buyer. @or this purpose, the share certificate along with duly filled transfer deed must be sent to the company. he transfer deed should bear ade(uate share transfer stamp. After verifying the bonafide of the transfer, the company has to transfer the shares in the name of buyer and send them back within ' months. he share certificate should bear a new ledger folio number, transfer number, buyer8s name etc. on the reverse side of it. his completes the legal formality for transfer of shares from the seller to the buyer. DEFECTS OF INDIAN CAPITAL MARKET he Indian stock market is suffering from many limitations. 6ome of the important ones are the following% 9. A(*&$-& !. G&$1i$& I$/&*+!"* As it is, speculative activities outplay the genuine trading activities. Kery negligible fraction of transactions represent purchases or sales by genuine investors. Most of the transactions are carry forward transactions with a speculative motive of deriving benefit from short-term price fluctuations. 6peculators are only interested in taking a bet on the stock and profiting from its price swings. <ence the market is not sub1ect to free interplay of demand and supply for securities. It is reported that approximately $s.*,000 crore is traded between the Bombay 6tock ,xchange and the 7ational 6tock ,xchange every day. Investors buying and selling existing holdings contribute a very small portion of this. Almost 5/ percent is contributed by speculators. :. P"&*&$-& !. P"i-& Riggi$g here is a tendency among companies issuing securities to artificially push up the prices before the issue of securities. his is generally done by buying and selling securities by a few group of persons among themselves and thereby pushing the prices up. here is a strong bull movement in the market. ;. P"&/#l&$-& !. I$*i'&" T"#'i$g Insider trading has been accepted as a routine practice in India. Insiders are those who have access to unpublished price-sensitive information by virtue of their position in the company and who use such information in their best advantage. 6ince it is an undesirable activity, the 6,BI has introduced many regulations to curb insider trading. All of them remain in paper only and it is said that controlling insider trading is similar to controlling black money.

&5

<. L#-) !. Li81i'i+ hough there are approximately 3500 listed companies in India, the shares of only a few companies are actively traded in the market and they are li(uid. It is reported that of the total turnover on the B6, and the 76,, over 20 percent is concentrated in 1ust &0 stocks. <ence, investors of many companies are on the horns of a dilemma on account of lack of li(uidity. A vast ma1ority of the shares are li(uid and hence investors of such companies shares have to burn their hand. =. S-#"-i+ !. Fl!#+i$g S&-1"i+i&* o add fuel to the fire, there is scarcity of floating securities in the market. It is due to the fact that institutional investors who collectively own nearly 3/E of the e(uity capital in the private sector, retain their holdings with themselves without offering them for trading. Bn the other hand, individual investors too are not exposed to wider portfolio investment. hey have sticky portfolio habits. <ence, the market is highly volatile and it is sub1ect to easy price manipulations. >. L#-) !. T"#$*0#"&$hrough many regulations have been introduced to in1ect transparency to the operations of stock market, they are not successful. Many brokers are violating the regulations with a view to cheating innocent investing community. Ahile the day8s opening, high, low and closing prices are reported, no information is available to investors regarding the volume of transactions carried out at the highest and lowest prices. he time taken to execute a transaction is also not reported. ?. P!!" R&*0!$*& !. I$'i#$ H!1*&h!l'* At present there is lack of confidence of genuine investors in the stock market. An analysis of the portfolio of Indian households reveals the poor response to the securities of companies. @. High V!l#+ili+ !. S+!-) M#")&+ @or instance, the volatile variation in the B6, sensex is displayed in the following able% T#(l& <.<A BSE S&$*&2 D#+# D#+& I$'&2 &0-0&-05 '&.'02.5 '0-&&-05 5+/&.0 '2-&'-05 D*'5.D &3-0+-0D &&.0'*.0 '0-0+-&0 &3.+00.25 0*-02-&& &5+D+.&5

his high rate of volatility is not conductive for the smooth functioning of the stock market. B. C1,(&"*!,& P"!-&'1"&* !. S&++l&,&$+ rade transactions have to be settled by physical delivery of securities accompanied by transfer deeds. It means that securities have to move from the seller to the seller8s broker and from the buyer8s broker to the buyer. It makes the settlement dilatory. Again the buyer has to lodge the securities for transfer. his process takes two or three months. he irksome settlement procedures result in fre(uent delays in payment for the shares as well.

&D

9C. P"!(l&,* !. O'' L!+* )enerally, the listed securities are included under )roup A or )roup B categories as stated earlier. he other tradable securities which are not listed are called ?odd lots8 and they come under the category of )roup !. his group also contains permitted securities which are listed on other exchanges and not on the particular stock exchange concerned. 99. D!,i$#$-& !. Fi$#$-i#l I$*+i+1+i!$* @ew financial institutions like the F I, 9I!, and )I! dominate the Indian stock market scene. <ence, the Indian stock market is significantly influenced by the actions of these few institutions. It actually reduces the level of competition in the stock market which is not a healthy trend for the growth of any stock market. 9:. L#-) !. P"!.&**i!$#li*, Bn the one hand, one can find highly competent and professional brokers playing an active and positive role in the market. Bn the other hand, many brokers are found to be lacking in high professional standards. Brokers with inade(uate financial support and little skill or experience enter into big contracts. herefore, defaults become (uite common. Jerb trading is also (uite common. 9;. U$h&#l+h C!,0&+i+i!$ !. M&"-h#$+ B#$)&"* At present, there are about D00 merchant bankers rendering their services in the capital market. he increase in the number of merchant bankers has led to unhealthy competition and dilution of the (uality of issues. Merchant bankers tend to show a definite bias towards the issuing company instead of protecting the interest of investors. hey help the unscrupulous promoters to raise funds dubious pro1ects at un1ustifiable premium. he ultimate sufferers are the investors. 9<. O+h&" D&.&-+* he investor8s apathy to stock exchanges is clearly visible due to their loss of confidence. here are many reasons for this. here is considerable delay in refunding application money, issuing of allotment letters, posting of share certificates etc. It makes more that 2 months to effect transfer of shares. Bad deliveries, loss of certificates etc., are (uite common. 7o immediate action is generally taken on investor8s complaints. o make matters worse, the Investor8s Association in India is still a weak body. UNIT IV MUTUAL FUNDS DEFINITION he 6ecurities and ,xchange Board of India =Mutual @unds> $egulations, &DD* defines a mutual fund as "a fund established in the form of a trust by a sponsor, to raise monies by the trustees through the sale of units to the public, under one or more schemes, for investing in securities in accordance with these regulations.# According to Aeston C. @red and Brigham, ,ugene, @., Fnit rusts are "!orporations which accept dollars from savers and then use these dollars to buy stocks, long-term debt instruments issued by business or government unitsL these corporations pool funds and thus reduce risk by diversification.#

'0

IMPORTANCE he mutual fund industry has grown at a phenomenal rate in the recent past. Bne can witness a revolution in the mutual fund industry in view of its importance to the investors in general and the country8s economy at large. he following are some of the important advantages of mutual funds% (i) Ch#$$&li*i$g S#/i$g* .!" I$/&*+,&$+ Mutual funds act as a vehicle in galvanising the savings of the people by offering various schemes suitable to the various classes of customers for the development of the economy as a whole. A number of schemes are being offered by M@s so as to meet the varied re(uirements of the masses, and thus, savings are directed towards capital investments directly. In the absence of M@s, these savings would have remained idle. hus, the whole economy benefits due to the costefficient and optimum use and allocation of scarce financial and real resources in the economy for its speedy development. Again, M@6 prefer less risky investments. (ii) O..&"i$g 4i'& P!"+.!li! I$/&*+,&$+* 6mall and medium investors used to burin their fingers in stock exchange operations with a relatively modest outlay. If they invest in a select few shares, some may even sink without a trace never to rise again. 7ow, these investors can en1oy the wide portfolio of the investment held by the mutual fund. he fund diversifies its risks by investing on a large varieties of shares and bonds which cannot be done by small and medium investors. his is in accordance with the maxim ?7ot to lay all eggs in one basket8. hese funds have large amounts at their disposal, and so, they carry a clout in respect of stock exchange transactions. hey are in a position to have a balanced portfolio which is free from risks. hus, M@s provide instantaneous portfolio diversification. (iii) P"!/i'& B&++&" Yi&l'* he pooling of funds from a large number of customers enables the fund to have large funds at its disposal. -ue to these large funds, mutual funds are able to buy cheaper and sell dearer than the small and medium investors. hus, they are able to command better market rates and lower rates of brokerage. 6o, they provide better yields to their customers. hey also en1oy the economies of large scale and can reduce the cost of capital market participation. he transaction costs of large investments are definitely lower than that of small investments. In fact, all the profits of a mutual fund are passed on to the investors by way of dividends and capital appreciation. he expenses pertaining to a particular scheme alone are charged to the respective scheme. Most of the mutual funds so far floated have given a dividend at the rate ranging between &'E p.a. and &3E p.a. It is fairly a good yield. It is an ideal vehicle for those who look for long-term capital appreciation. (i/) R&$'&"i$g E20&"+i*&' I$/&*+,&$+ S&"/i-& #+ L!6 C!*+ he management of the @und is generally assigned to professionals who are well trained and have ade(uate experience in the field of investment. he investment decision of these professionals are always backed by informed 1udgement and experience. hus, investors are assured of (uality services in their best interest. -ue to the complex nature of the securities market, a single investor cannot to all these works by himself or he cannot go to a professional manager who manages individual portfolios. In such a case, he may charge hefty management fee. he intermediation fee is the lowest being & percent in the case of a mutual fund. '&

(/) P"!/i'i$g R&*&#"-h S&"/i-& A mutual fund is able to command vast resources and hence it is possible for it to have an in-depth study and carry out research on corporate securities. ,ach fund maintains a large research tem which constantly analyses the companies and the industries and recommends the fund to buy or sell a particular share. hus, investments are made purely on the basis of a thorough research. 6ince research involves a lot of time, efforts and expenditure, and individual investor cannot take up this work. By investing in a mutual fund, the investor gets the benefit of the research done by the @und. (/i) O..&"i$g T#2 B&$&.i+* !ertain funds offer tax benefits to its customers. hus, apart from dividends, interest and capital appreciation, investors also stand to get the benefit of tax concession. @or instance, under 6ection 509 of the Income ax Act, a sum of $s.&0,000 received as dividend =$s.&*000 to F I> from a M@ is deductible from the gross total income. Fnder section 55A, '0E of the amount invested is allowed to be deducted from the tax payable. Fnder the Aealth Act, investments in M@ are exempted up to $s./ lakhs. he mutual funds themselves are totally exempt from tax on all income on their investments. But all other companies have to pay taxes and they can declare dividends only from the profits after tax. But, mutual funds do not deduct tax at source them dividends. his is really a boon to investors. (/ii) I$+"!'1-i$g Fl&2i(l& I$/&*+,&$+ S-h&'1l& 6ome mutual funds have permitted the investors to exchange their units from one scheme to another and this flexibility is a great boon to investors. Income units can be exchanged for growth units depending upon the performance of the funds. Bne cannot derive such a flexibility in any other investments. (/iii) P"!/i'i$g G"&#+&" A..!"'#(ili+ #$' Li81i'i+ ,ven a very small investor can afford to invest in Mutual @unds. hey provide an attractive and cost-effective alternative to direct purchase of shares. In the absence of M@s, small investors cannot think of participating I a number of investments with such a meager sum. Again, there is greater li(uidity. Fnits can be sold to the @und at any time at the 7et Asset Kalue and thus (uick access to li(uid cash is assured. Besides, branches of the sponsoring bank is always ready to provide loan facility against the unit certificates. (i2) Si,0li.i&' R&-!"' K&&0i$g An investor with 1ust an investment in /00 shares or so in * or + companies has to keep proper records of dividend payments, bonus, issues, price movements, purchase or sale instruction, brokerage and other related items. It is tedious and it consumes a lot of time. Bne may even forget to record the rights issue and may have to forfeit the same. hus, record keeping is the biggest problem for small and medium investors. 7ow, a mutual fund offers a single investment source facility, i.e., a single buy order of &00 units from a mutual fund is e(uivalent to investment in more than &00 companies. he investors has to keep a record of only one deal with the Mutual @und. ,ven if he does not keep a record, the Mf sends statements very often to the investor. hus, by investing in M@s, the record keeping work is also passed on to the @und.

''

(2) S100!"+i$g C#0i+#l M#")&+ Mutual funds play a vital role in supporting the development of capital markets. he mutual funds make the capital market active by means of providing a sustainable domestic source of demand for capital market instruments. In other words, the savings of the people are directed towards investments in capital markets through these mutual funds. hus, funds serve as a conduit for disintermediating banks deposits into stocks, shares and bonds. Mutual @unds also provide a valuable li(uidity to the capital market, and thus, the market is made very active and stable. Ahen foreign investors and speculators exit and re-enter the markets en masse, mutual funds, keep the market stable and li(uid. In the absence of mutual funds, the prices of shares would be sub1ect to wide price fluctuation due to the exit and re-entry of speculators into the capital market en masse. hus, it is rendering an excellent support to the capital market and helping in the process of institutionali4ation of the market. (2i) P"!,!+i$g I$'1*+"i#l D&/&l!0,&$+ he economic development of any nation depends upon its industrial advancement and agricultural development. All industrial units have to raise their funds by resorting to the capital market by the issue of shares and debentures. he mutual funds not only create a demand for these capital market instruments but also supply a large source of funds to the markets, and thus, the industries are assured of their capital re(uirements. In fact, the entry the mutual funds has enhanced the demands for India8s stocks and bonds. hus, mutual funds provide financial resources to the industries at market rates. (2ii) A-+i$g #* S1(*+i+1+& .!" I$i+i#l P1(li- O..&"i$g* (IPO*) In most cases, investors are not able to get allotment in I.Bs of companies because they are often oversubscribed many time. Moreover, they have to apply for a minimum of /00 shares which is very difficult particularly for small investors. But, in mutual funds, allotment is more or less guaranteed. Mutual @unds are also guaranteed a certain percentage of I.Bs by companies, hus, by participating in M@s, investors are able to get the satisfaction of participating in hundreds of varieties of companies. (2iii) R&'1-i$g +h& M#")&+i$g C!*+ !. N&6 I**1&* he mutual funds help to reduce the marketing cost of the new issues. he promoters used to allot a ma1or share of the initial public offering to the mutual funds and thus they are saved from the marketing cost of such issues. (2i/) K&&0i$g +h& M!$& M#")&+ A-+i/& An individual investor cannot have any access to money market instruments since the minimum amount of investment is out of his reach. Bn the other hand, mutual funds keep the money market active by investing money on the money market instruments. In fact, the availability of more money market instruments itself is a good sign for a developed money market which is essential for the successful functioning of the !entral Bank in a country. hus, mutual funds provide stability to share prices, safety to investors and resources to prospective entrepreneurs. RISKS

'*

Mutual @unds are not free from risks. It is so because basically the mutual funds also invest their funds in the stock market on shares which are volatile in nature and are not risk free. <ence, the following risks are inherent in their dealings% (i) M#")&+ Ri*)* In general, there are certain risks associated with every kind of investment of shares. hey are called market risks. hese market risks can be reduced, but cannot be completely eliminated even by a good investment management. he prices of shares are sub1ect to wide price fluctuations depending upon market conditions over which nobody has a control. Moreover, every economy has to pass through a cycle ; Boom, $ecession, 6lump and $ecovery. he phase of the business cycle affects the market conditions to a larger extent. (ii) S-h&,& Ri*)* here are certain risks inherent in the scheme itself. It all depends upon the nature of the scheme. @or instance, in a pure growth scheme, risks are greater. It is obvious because if one expects more returns as in the case of a growth scheme, one has to take more risks. (iii) I$/&*+,&$+ Ri*)* Ahether the Mutual @und makes money in shares or loses depends upon the investment expertise of the Asset Management !ompany =AM!>. If the investment advice goes wrong, the @und has to suffer a lot. he investment expertise of various funds are different and it is reflected on the returns which they offer to investors. (i/) B1*i$&** Ri*)* he corpus of a mutual fund might have been invested in a company8s shares. If the business of that company suffers any setback, it cannot declare any dividend. It may even go to the extent of winding up its business. hrough the mutual fund can withstand such a risk, its income paying capacity is affected. (/) P!li+i-#l Ri*)* 6uccessive )overnments bring with them new economic ideologies and policies. It is often said that many economic decisions are politically motivated. !hanges in )overnment bring in the risk of uncertainty which every player in the financial service industry has to face. 6o, mutual funds are no exception to it. CLASSIFICATION OF FUNDS In the investment market, one can find variety of investors with different needs, ob1ectives and risk-taking capacities. @or instance, a young businessman would like to get more capital appreciation for his funds and he would be prepared to take greater risks than a person who is 1ust on the verge of his retiring age. 6o, it is very difficult to offer one fund to satisfy all the re(uirements of investors. Cust as one shoe is not suitable for all legs, one fund is not to meet the vast re(uirements of all investors. herefore, many types of funds are available to the investor. It is completely left to the discretion of the investor to choose any one of them depending upon his re(uirement and his risk-taking capacity. O$ +h& B#*i* !. E2&-1+i!$ #$' O0&"#+i!$ (A) Cl!*& &$'&' F1$'*

'+

Fnder this scheme, the corpus of the fund and its duration are prefixed. In other words, the corpus of the fund and the number of units are determined in advance. Bnce the subscription reaches the predetermined level, the entry of investors is closed. After the expiry of the fixed period, the entire corpus is disinvested and the proceeds are distributed to the various unit holders in proportion to their holding. hus, the fund ceases to be a fund, after the final distribution. (B) O0&$3&$'&' F1$'* It is 1ust the opposite of close-ended funds. Fnder this scheme, the si4e of the fund and 7or the period of the fund is not predetermined. he investors are free to buy and sell any number of units at any point of time. @or instance, the unit scheme =&D2+> of the Fnit rust of India is an open ended one, both in terms of period and target amount. Anybody can buy this unit at any time and sell it also at any time at his discretion. INCOME FUNDS As the name suggests, this @und aims at generating and distributing regular income to the members on a periodical basis. It concentrates more on the distribution of regular income and it also sees that the average return is higher than that of the income from bank deposits. GRO4TH FUNDS Fnlike the Income @unds, )rowth @unds concentrate mainly on long-run gains, i.e., capital appreciation. hey do not offer regular income and they aim at capital appreciation in the long run. <ence, they have been described as "7est ,ggs# investments. BALANCE FUNDS his is otherwise called "income-cum-growth# fund. It is nothing but a combination of both income and growth funds. It aims at distributing regular income as well as capital appreciation. his is achieved by balancing the investments between the high growth e(uity shares and also the fixed income earning securities. SPECIALISED FUNDS Besides the above, a large number of speciali4ed funds are in existence abroad. hey offer special schemes so as to meet the specific needs of specific categories of people like pensioners, widows etc. here are also @unds for investments in securities of specified areas. @or instance, Capan @und, 6outh Jorea @und etc. In fact these funds open the door for foreign investors to invest on the domestic securities of these countries. MONEY MARKET MUTUAL FUND hese funds are basically open-ended mutual funds and as such they have all the features of the open-ended fund. But, they invest in highly li(uid and safe securities like commercial paper, banker8s acceptances, certificates of deposits, treasury bills etc. hese instruments are called money market instruments. hey take the place of shares, debentures and bonds in a capital ?money funds8 in F6A and they have been functioning since &D3'. Investors generally use it as a "parking place# or "stop gap arrangement for their cash resources till they finally decide about the proper avenue for their investment, i.e., long-term financial assets like bonds and stocks. TA5ATION FUNDS '/

A taxation fund is basically a growth-oriented fund. But, it offers tax rebates to the investors either in the domestic or foreign capital market. It is suitable to salaried people who want to en1oy tax rebates particularly during the month of @ebruary and March. In India, at present, the law relating to tax rebates is covered under 6ec. 55 of the Income ax Act, &D2&. An investors is entitled to get '0E rebate in Income tax for investments made under this fund sub1ect to a maximum investment of $s.&0,000G-. .er annum. he ax 6aving Magnum of 6BI !apital Market 9imited is the best example for the domestic type. F I8s F6 M20 million India @und, based in the F6A, is an example for the foreign type. ORGANISATION OF THE FUND he structure of mutual fund operations in India envisages a three-tier establishment namelyL =i> A sponsor institution to promote the @und, =ii> A team of trustees to oversee the operations and to provide checks for the efficient, profitable and transparent operations of the @und, and =iii> An Asset Management !ompany =AM!> to actually deal with the funds. (i) S0!$*!"i$g I$*+i+1+i!$*A he company which sets up the Mutual @und is called the sponsor. he 6,BI has laid down certain criteria to be met by the sponsor. hese criteria mainly deal with the ade(uate experience, good past track record, net worth etc. (ii) T"1*+&&*A rustees are people with long experience and good integrity in their respective fields. hey carry the crucial responsibility of safeguarding the interest of investors. @or this purpose, they monitor the operations of the different schemes. hey have wide ranging powers and they can even dismiss Asset Management !ompanies with the approval of the 6,BI. (iii) A**&+ M#$#g&,&$+ C!,0#$ (AMC)A he AM! actually manages the funds of the various schemes. he AM! employs a large number of professionals to make investments, carry out research and to do agent and investor servicing. In fact, the success of any Mutual @und depends upon the efficiency of this AM!. he AM! submits a (uarterly report on the functioning of the mutual fund to the trustees who will guide and control of the AM!. NET ASSET VALUE he repurchases price is always linked to the 7et Asset Kalue =7AK>. he 7AK is nothing but the market price of each unit of a particular scheme in relation to all the assets of the scheme. It can otherwise be called "the intrinsic value# of each unit. his is a true indicator of the performance of the fund. If the 7AK is more than the face value of the unit, it clearly indicates that the money invested on that unit has appreciated and the @und has performed well. Ill1*+"#+i!$ @or instance, @ortune Mutual @und has introduced a scheme called Millionaire 6cheme. he scheme si4e is $s.&00 crore. he value of each unit is $s.&0G-. It has invested all the funds in shares and debentures and the market value of the investment comes to $s.'00 crore. '2

7ow 7AK N '00 crore ------------ H value of each unit &00 crore N 'H&0N '0 hus, the value of each unit of $s. &0G- is worth $s.'0. <ence, the 7AK N $s.'0. his 7AK forms the basis for fixing the repurchase price and reissue price. he investor can call up the @und any time to find out the 7AK. 6ome M@s publish the 7AK weekly in two or three leading daily newspapers.

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