CAPITAL MARKET IN INDIA

INTRODUCTION

Capital market structure of India is complex. Also, it

makes up the significant part of a financial market. Let
us look at the basic definition of the Capital
Market. It is a place for long-term financial assets
which have long or indefinite maturity. The capital
market provides long-term debt and equity finance for
the government and the corporate sector.
Capital market divides into the Primary market
and secondary market
 Primary Market: Primary market is one type of
capital market where various companies issues their
shares and bonds first time to raise funds from the
public, it is called Initial Public Offering (IPO).
 Secondary Market: A secondary market is a form
of capital market where issued securities are bought
and sold.
Secondary Market has got two wings namely Cash
Market and Derivative Market.
Capital Market Regulator
SEBI (Securities and Exchange Board of India) is a
regulator of Indian Capital Market. It was established
in 1988. The basic function of SEBI is to protect the
interest of investors.
SEBI is also the Regulator for Commodity Market.
Prior to this Forward Market Commission (FMC) was
the regulator of the commodity market.
Exchanges of Capital Market in India
Exchange provides an electronic and transparent
platform to buy and sell the shares. Stock exchange
also provides the facility for issue and redemption of
securities.
In India, there is two national Exchange of stock
market. They are the NES and the BSE. Further, there
are two national exchanges for commodity, MCX &
NCDEX.
A Brief History of Indian Exchanges
The history of Exchanges of Indian Capital Market is
way back to the 1800s. The following are the
milestones in the Indian capital market
The 1800s
 1854: Dalal Street got a permanent location.
 1875: BSE has established as “The Native Shares and
Stock Brokers Association”
The 1900s
 1956: In 1956 BSE became the first stock exchange to
be recognized under the Securities Contract Act.
 1993: In 1993 NSE has recognized as a stock exchange.
The 2000s
 2000: In the year 2000 internet trading has started at
NSE.
 2000: Derivative Trading (Index Futures) has started
at NSE.
 2001: Derivative Trading has started at BSE.

Classification and Growth of Indian Capital Market

ADVERTISEMENTS:
The Indian capital market is the market for long term
loanable funds as distinct from money market which
deals in short-term funds.
ADVERTISEMENTS:
It refers to the facilities and institutional
arrangements for borrowing and lending ‘term funds’,
medium term and long term funds. In principal capital
market loans are used by industries mainly for fixed
investment. It does not deal in capital goods, but is
concerned with raising money capital or purpose of
investment.

Classification:
The capital market in India includes the following
institutions (i.e., supply of funds tor capital markets
comes largely from these); (i) Commercial Banks; (ii)
Insurance Companies (LIC and GIC); (iii) Specialised
financial institutions like IFCI, IDBI, ICICI, SIDCS, SFCS,
UTI etc.; (iv) Provident Fund Societies; (v) Merchant
Banking Agencies; (vi) Credit Guarantee Corporations.
Individuals who invest directly on their own in
securities are also suppliers of fund to the capital
market.
Thus, like all the markets the capital market is also
composed of those who demand funds (borrowers)
and those who supply funds (lenders). An ideal capital
market at tempts to provide adequate capital at
reasonable rate of return for any business, or
industrial proposition which offers a prospective high
yield to make borrowing worthwhile.
ADVERTISEMENTS:
The Indian capital market is divided into gilt-edged
market and the industrial securities market. The gilt-
edged market refers to the market for government and
semi-government securities, backed by the RBI. The
securities traded in this market are stable in value and
are much sought after by banks and other institutions.
The industrial securities market refers to the market
for shares and debentures of old and new companies.
This market is further divided into the new issues
market and old capital market meaning the stock
exchange.
The new issue market refers to the raising of new
capital in the form of shares and debentures, whereas
the old capital market deals with securities already
issued by companies.
The capital market is also divided in primary capital
market and secondary capital market. The primary
market refers to the new issue market, which relates
to the issue of shares, preference shares, and
debentures of non-government public limited
companies and also to the realising of fresh capital by
government companies, and the issue of public sector
bonds.
The secondary market on the other hand is the market
for old and already issued securities. The secondary
capital market is composed of industrial security
market or the stock exchange in which industrial
securities are bought and sold and the gilt- edged
market in which the government and semi-
government securities are traded.

Growth of Indian Capital Market:

Indian Capital Market before Independence:

Indian capital market was hardly existent in the pre-
independence times. Agriculture was the mainstay of
economy but there was hardly any long term lending
to agricultural sector. Similarly the growth of
industrial securities market was very much hampered
since there were very few companies and the number
of securities traded in the stock exchanges was even
smaller.
Indian capital market was dominated by gilt-edged
market for government and semi-government
securities. Individual investors were very few in
numbers and that too were limited to the affluent
classes in the urban and rural areas. Last but not the
least, there were no specialised intermediaries and
agencies to mobilise the savings of the public and
channelise them to investment.
Indian Capital Market after Independence:
Since independence, the Indian capital market has
made widespread growth in all the areas as reflected
by increased volume of savings and investments. In
1951, the number of joint stock companies (which is a
very important indicator of the growth of capital
market) was 28,500 both public limited and private
limited companies with a paid up capital of Rs. 775
crore, which in 1990 stood at 50,000 companies with a
paid up capital of Rs. 20,000 crore. The rate of growth
of investment has been phenomenal in recent years, in
keeping with the accelerated tempo of development of
the Indian economy under the impetus of the five year
plans.

Factors Influencing Capital Market:

The firm trend in the market is basically affected by
two important factors: (i) operations of the
institutional investors in the market; and (ii) the
excellent results flowing in from the corporate sector.
New Financial Intermediaries in Capital Market:
ADVERTISEMENTS:
Since 1988 financial sector in India has been
undergoing a process of structural transformation.
Some important new financial intermediaries
introduced in Indian capital market are:
Merchant Banking:
Merchant bankers are financial intermediaries
between entrepreneurs and investors. Merchant banks
may be subsidiaries of commercial banks or may have
been set up by private financial service companies or
may have been set up by firms and individuals
engaged in financial up by firms and individuals
engaged in financial advisory business. Merchant
banks in India manage and underwrite new issues,
undertake syndication of credit, advice corporate
clients on fund raising and other financial aspects.
Since 1993, merchant banking has been statutorily
brought under the regulatory framework of the
Securities Exchange Board of India (SEBI) to ensure
greater transparency in the operation of merchant
bankers and make them accountable. The RBI
supervises those merchant banks which were
subsidiaries, or are affiliates of commercial banks.
Leasing and Hire-Purchase Companies:
Leasing has proved a popular financing method for
acquiring plant and machinery specially or small and
medium sized enterprises. The growth of leasing
companies has been due to advantages of speed,
informality and flexibility to suit individual needs.
The Narasimhan Committee has recognised the
importance of leasing and hire-purchase companies in
financial intermediation process and has
recommended that: (i) a minimum capital
requirement should be stipulated; (ii) prudential
norms and guidelines in respect of conduct of business
should be laid down; and (iii) supervision should be
based on periodic returns by a unified supervisory
authority.
Mutual Funds:
It refers to the pooling of savings by a number of
investors-small, medium and large. The corpus of fund
thus collected becomes sizeable which is managed by
a team of investment specialists backed by critical
evaluation and supportive data.
A mutual fund makes up for the lack of investor’s
knowledge and awareness. It attempts to optimise
high return, high safety and high liquidity trade off for
maximum of investor’s benefit. It thus aims at
providing easy accessibility of media including stock
market in country to one and all, especially small
investors in rural and urban areas.
Mutual funds are most important among the newer
capital market institutions. Several public sector banks
and financial institutions set up mutual funds on a tax
exempt basis virtually on same footing as the Unit
Trust of India (UTI) and have been able to attract
strong investor support and have shown significant
progress.
Government has now decided to throw open the field
to private sector and joint sector mutual funds. At
present Securities and Exchange Board of India (SEBI)
has authority to lay down guidelines and to supervise
and regulate working of mutual funds.
The guidelines issued by the SEBI in January 1991, are
related in advertisements and disclosure and
reporting requirements etc. The investors have to be
informed about the status of their investments in
equity, debentures, government securities etc.
The Narasimhan Committee has made the following
recommendations regarding mutual funds: (i) creation
of an appropriate regulatory framework to promote
sound, orderly and competitive growth of mutual fund
business: (ii) creation of proper legal framework to
govern the establishments and operation of mutual
funds (the UTI is governed by a special statute), and
(iii) equality of treatment between various mutual
funds including the UTI in the area of tax concessions.
Global Depository Receipts (GDR):
Since 1992, the Government of India has allowed
foreign investment in the Indian securities through the
issue of Global Depository Receipts (GDRs) and
Foreign Currency Convertible Bonds (FCCBs). Initially
the Euro-issue proceeds were to be utilised for
approved end uses within a period of one year from
the date of issue.
Since there was continued accumulation of foreign
exchange reserves with RBI and there were long
gestation periods of new investment the government
required the issuing companies to retain the Euro-
issue proceeds abroad and repatriate only as and
when expenditure for the approved end uses were
incurred.
Venture Capital Companies (VCC):
The aim of venture capital companies is to give
financial support to new ideas and to introduction and
adaptation of new technologies. They are of a great
importance to technocrat entrepreneurs who have
technical competence and expertise but lack venture
capital.
Financial institutions generally insist on greater
contribution to the investment financing, in which
technocrat entrepreneurs can depend on venture
capital companies. Venture capital financing involves
high risk.
According to the Narasimhan Committee the
guidelines for setting up of venture capital companies
are too restrictive and unrealistic and have impeded
their growth. The committee has recommended a
review and amendment of guidelines.
Knowing the high risk involved in venture capital
financing, the committee has recommended a
reduction in tax on capital gains made by these
companies and equality of tax treatment between
venture capital companies and mutual funds.
Other New Financial Intermediaries:
Besides the above given institutions, the government
has established a number of new financial
intermediaries to serve the increasing financial needs
of commerce and industry is the area of venture
Capital, credit rating and leasing etc.
(1) Technology Development and Information
Company of India (TDICI) Ltd., a technology venture
finance company, which sanctions project finance to
new technology venture since 1989.
(ii) Risk Capital and Technology Finance Corporation
(RCTFC) Ltd., which provides risk capital to new
entrepreneurs and offers technology finance to
technology-oriented ventures since 1988.
(iii) Infrastructure Leasing and Financial Services
(IL&FS) Ltd., set up in 1988 focuses on leasing of
equipment for infrastructure development.
(iv) The credit rating agencies namely credit rating
information services of India (CRISIS) Ltd., setup in
1988; Investment and Credit Rating Agency (ICRA)
setup in 1991, and Credit Analysis and Research
(CARE) Ltd., setup in 1993 provide credit rating
services to the corporate sector.
Credit rating promotes investors interests by
providing them information on assessed comparative
risk of investment in the listed securities of different
companies. It also helps companies to raise funds
more easily and at relatively cheaper rate if their
credit rating is high.
(v) Stock Holding Corporation of India (SHCIL) Ltd.,
setup in 1988, with the objective of introducing a book
entry system for transfer of shares and other type of
scrips thereby avoiding the voluminous paper work
involved and thus reducing delays in transfers.

Role and Importance of Capital Market

Financial market deals about the raising of finance by

various institutions through the issue of various securities.
Every business concern requires two types of finance.
They are Short-term or working capital requirements
and long-term or fixed capital requirements. The short-
term or working capital requirements are raised or
borrowed in the money market through the issue of
different securities such as bills, promissory notes, etc.
Government raises the short-term funds through the issue
of treasury bills. Banks play a vital role in providing
short-term funds. The long-term funds or fixed capital are
raised by companies by the issue of shares, debentures
and bonds in the capital market. The long-term funds or
fixed capital are raised by companies by the issue of
shares, debentures and bonds in the capital market. Lets
look at some of the importance of capital market in
economy.

Importance of Capital Market

1. It is only with the help of capital market, long-term
funds are raised by the business community.
2. It provides opportunity for the public to invest their
savings in attractive securities which provide a higher
return.
3. A well developed capital market is capable of attracting
funds even from foreign country. Thus, foreign capital
flows into the country through foreign investments.
4. Capital market provides an opportunity for the
investing public to know the trend of different securities
and the conditions prevailing in the economy.
5. It enables the country to achieve economic growth as
capital formation is promoted through the capital market.
6. Existing companies, because of their performance will
be able to expand their industries and also go in
for diversification of business due to the capital market.
7. Capital market is the barometer of the economy by
which you are able to study the economic conditions of
the country and it enables the government to take suitable
action.
8. Through the Press and different media, the public are
informed about the prices of different securities.
This enables the public to take necessary investment
decisions.
9. Capital market provides opportunities for different
institutions such as commercial banks, mutual funds,
investment trust; etc., to earn a good return on the
investing funds. They employ financial experts who are
able to predict the changes in the market and accordingly
undertake suitable portfolio investments.

Features OF CAPITAL MARKET

1. Link between Savers and Investment

Opportunities:
Capital market is a crucial link between saving and
investment process. The capital market transfers
money from savers to entrepreneurial borrowers.
2. Deals in Long Term Investment:
Capital market provides funds for long and medium
term. It does not deal with channelising saving for
less than one year.
3. Utilises Intermediaries:
ADVERTISEMENTS:
Capital market makes use of different intermediaries
such as brokers, underwriters, depositories etc.
These intermediaries act as working organs of
capital market and are very important elements of
capital market.
4. Determinant of Capital Formation:
The activities of capital market determine the rate of
capital formation in an economy. Capital market
offers attractive opportunities to those who have
surplus funds so that they invest more and more in
capital market and are encouraged to save more for
profitable opportunities.
5. Government Rules and Regulations:
The capital market operates freely but under the
guidance of government policies. These markets
function within the framework of government rules
and regulations, e.g., stock exchange works under
the regulations of SEBI which is a government body.
An ideal capital market is one:
1. Where finance is available at reasonable cost.
2. Which facilitates economic growth.
3. Where market operations are free, fair,
competitive and transparent.
4. Must provide sufficient information to investors.
5. Must allocate capital productively

Capital market has a crucial significance to capital

formation. For a speedy economic development
adequate capital formation is necessary. The significance
of capital market in economic development is explained
below:-
1. Mobilization Of Savings And Acceleration Of Capital
Formation :-
In developing countries like India the importance of
capital market is self evident. In this market, various
types of securities helps to mobilize savings from various
sectors of population. The twin features of reasonable
return and liquidity in stock exchange are definite
incentives to the people to invest in securities. This
accelerates the capital formation in the country.
2. Raising Long - Term Capital :-
The existence of a stock exchange enables companies to
raise permanent capital. The investors cannot commit
their funds for a permanent period but companies
require funds permanently. The stock exchange resolves
this dash of interests by offering an opportunity to
investors to buy or sell their securities, while permanent
capital with the company remains unaffected.
3. Promotion Of Industrial Growth :-
The stock exchange is a central market through which
resources are transferred to the industrial sector of the
economy. The existence of such an institution
encourages people to invest in productive channels. Thus
it stimulates industrial growth and economic
development of the country by mobilizing funds for
investment in the corporate securities.
4. Ready And Continuous Market :-
The stock exchange provides a central convenient place
where buyers and sellers can easily purchase and sell
securities. Easy marketability makes investment in
securities more liquid as compared to other assets.

5. Technical Assistance :-
An important shortage faced by entrepreneurs in
developing countries is technical assistance. By offering
advisory services relating to preparation of feasibility
reports, identifying growth potential and training
entrepreneurs in project management, the financial
intermediaries in capital market play an important role.
6. Reliable Guide To Performance :-
The capital market serves as a reliable guide to the
performance and financial position of corporate, and
thereby promotes efficiency.
7. Proper Channelization Of Funds :-
The prevailing market price of a security and relative
yield are the guiding factors for the people to channelize
their funds in a particular company. This ensures
effective utilization of funds in the public interest.
8. Provision Of Variety Of Services :-
The financial institutions functioning in the capital
market provide a variety of services such as grant of long
term and medium term loans to entrepreneurs, provision
of underwriting facilities, assistance in promotion of
companies, participation in equity capital, giving expert
advice etc.
9. Development Of Backward Areas :-
Capital Markets provide funds for projects in backward
areas. This facilitates economic development of
backward areas. Long term funds are also provided for
development projects in backward and rural areas.
10. Foreign Capital :-
Capital markets makes possible to generate foreign
capital. Indian firms are able to generate capital funds
from overseas markets by way of bonds and other
securities. Government has liberalized Foreign Direct
Investment (FDI) in the country. This not only brings in
foreign capital but also foreign technology which is
important for economic development of the country.
11. Easy Liquidity :-
With the help of secondary market investors can sell off
their holdings and convert them into liquid cash.
Commercial banks also allow investors to withdraw their
deposits, as and when they are in need of funds.

equity), we need to analyze the impact based on three

critical factors: Availability of global liquidity; demand
forIndia investment and cost thereof and decreased
consumer demand affecting Indian exports. The concerted
intervention by central banks of developed countries in
injecting liquidity is expected to reducethe unwinding of
India investments held by foreign entities, but fresh
investment flows into India are in doubt. The impact of
this will be three-fold: The element of GDP growth driven
by off-shore flows (along with skills andtechnology) will
be diluted; correction in the asset prices which were
hitherto pushed by foreign investors anddemand for
domestic liquidity putting pressure on interest
rates Talking about exporting importing and
manufacturing business, India goes ahead in all of
these areas. India'sskilled talent manufactures and exports
a great array of products, which make a huge marketplace
offshore.
Agriculture Industry
- India's financial system is different from others, with
farming being its foundation. Indiaexports a huge
hunk from its agriculture stock, and various stuffs are
heartily valued in the international bazaar.A few goods
that reach out to international audience directly from
nations farms are Sugar, Tea, Spices, Wheat,Rice,
Tobacco, etc.
Textile and Apparel Industry
- Apparel industry has a unique place in India's export
import data

bank. Afteragriculture, textile industry sees India possibly,

as the 2nd largest center of exportingto other country.
If reviews are to be believed, Indian textile trade creates
about 30% of the total exports! Specialist orate
thatkeeping in view the constantly increasing demand of
Indian textile and apparel industry, the position of
thissector is bound to raise.Home Furnishing goods -
Indian Jewelry - Indian jewelry region is completely
attributed to the ancient Indiansociety and civilization.
The outstanding gems and jewels that India has under its
lap, clubbed with theastonishing artwork, makes it
renowned in the international market. India trade jewelry
and gems to U.S, UAE,U.K, Hong Kong,Singapore,
Belgium, among others nations.Like any other nation, a
big part of India's economyis reliant on its exporting. The
foreign exchange
market India is growing very rapidly. The annual turnover
of the market is more than$400 billion. This transaction
does not include the inter-bank transactions. According to
the record of transactions releasedby RBI, the average
monthly turnover in the merchant segment was $40.5
billion in 2003-04 and the inter-banktransaction was
$134.2 for the same period. The average total monthly
turnover was about $174.7 billion forthe same period. The
transactions are made on spot and also on forward basis, which
include currency swapsand interest rate swaps. The Indian
foreign exchange market consists of the buyers,
sellers,market intermediaries and the monetaryauthority
of India. The main center of foreign exchange
transactions in India is Mumbai, the commercial capitalof
the country. There are several other centers for foreign
exchange transactions in the country includingKolkata,
New Delhi, Chennai, Bangalore, Pondicherry and Cochin.
In past, due to lack of communication facilitiesall these
markets were not linked. But with the development of
technologies, all the foreign exchange marketsof India
are working collectively. The foreign exchange market
India is regulated by the reserve bank of India through
the Exchange ControlDepartment. At the same
time, Foreign Exchange Dealers Association (voluntary
association) also providessome help in regulating the
market. The Authorized Dealers (Authorized by the RBI)
and the accredited brokersare eligible to participate in the
foreign Exchange market in India. When the foreign
exchange trade is going onbetween Authorized Dealers
and RBI or between the Authorized Dealers and
the Overseas banks, the brokershave no role to play.Apart
from the Authorized Dealers and brokers, there are some
others who are provided with the restrictedrights to
accept the foreign currency or travelers cheque. Among
these, there are the authorized moneychangers, travel
agents, certain hotels and government shops. The IDBI
and Exim bank are also permittedconditionally to hold
foreign currency. The whole foreign exchange market in
India is regulated by the Foreign Exchange Management
Act, 1999 orFEMA. Before this act was introduced, the
market was regulated by the FERA or Foreign Exchange
RegulationAct ,1947. After independence, FERA was
introduced as a temporary measure to regulate the inflow
of theforeign capital. But with the economic and
industrial development, the need for conservation
of foreign currencywas felt and on the recommendation
of the Public Accounts Committee, the Indian government
passed theForeign Exchange Regulation Act,1973 and
gradually, this act became famous as FEMA.

Liquidity in bank
CNX Nifty Junior (Junior Nifty) is an index comprised
of the next rung of 50 most liquid stocks afterS&P
CNX Nifty. In
fact S&P CNX Nifty and Junior Nifty may be regarded as
a basket of 100 most liquid stocks in India.Stocks in
Junior Nifty are filtered on their liquidity characterized by
their impact cost and market valuerepresented bytheir
market capitalization. The stocks comprising S&P CNX
Nifty and Junior Nifty are mutually exclusive i.e. astock
willnever appear in both indexes at the same time. Junior
Nifty may also be considered an incubator for stocks
entering Nifty.PROFESSIONALLY MANAGED The index
is professionally managed by India Index Services and
Products Limited (IISL), which is India’s
firstspecialistcompany dedicated to providing investors
in Indian equity markets with Indexes and Index
services.IISL is a joint venture between two entities who
have immensely contributed to the Indian Capital Markets
- theNationalStock Exchange of India Limited (NSE),
India’s largest stock exchange and the Credit Rating
InformationServicesof India Limited (CRISIL), India’s
leading credit rating agency. IISL also has a consulting
and licensing agreementwithStandard & Poor’s
(S&P).Index Maintenance plays a crucial role in ensuring
stability of the Index as well as in meeting its objective
of being aconsistent benchmark of the equity markets.
IISL has constituted an Index Policy Committee (IPC),
which isinvolved informulating policies and guidelines
for managing the Indexes. The committee is a blend of
academics andmarketpractitioners – comprising of
eminent persons from the Mutual Fund industry,
Economists, National StockExchange,CRISIL and S&P to
ensure that indexes are constructed on sound principles.
The committee determines macropolicies,with respect to
construction and maintenance of indexes. The selection
criteria specified by the Index PolicyCommitteefor
various indexes are transparent and published by IISL.A
separate Index Maintenance Sub-Committee comprising
of officials of NSE, CRISIL and IISL takes all
decisionsonaddition/ deletion of companies in any Index.
The Index Maintenance Sub-committee ensures that Index
reviewandmaintenance is carried out in accordance with
the policies developed by IPC and includes:• Monitoring
and completing adjustments in a timely manner on
account of corporate actions•Reviewing according to laid
down criteriaIndex Reviews are normally carried out
every quarter. At the time of review, a Replacement Pool
comprisingcompanies that meet all criteria for candidacy
to the Index are analysed.
In banking, liquidity
is the ability to meet obligations when they come due
without incurring unacceptablelosses. Managing liquidity is
a daily process requiringbankersto monitor and project cash
flows to ensureadequate liquidity is maintained.
Maintaining a balance between short-term assets
and short-term liabilities iscritical. For an individual bank,
clients' deposits are its primaryliabilities(in the sense that the
bank is meant togive back all client deposits on demand),
whereas reserves and loans are its primaryassets(in the
sense thatthese loans are owed to the bank, not by the
bank). The investment portfolio represents a smaller
portion of assets, and serves as the primary source of
liquidity. Investment securities can be liquidated to satisfy
depositwithdrawals and increased loan demand. Banks have
several additional options for generating liquidity, such
asselling loans, borrowing from other banks, borrowing
from acentral bank, such as theUS Federal Reserve bank,and
raising additional capital. In a worst case scenario,
depositors may demand their funds when the bank
isunable to generate adequate cash without incurring substantial
financial losses. In severe cases, this may resultin abank run.
Most banks are subject to legally-mandated requirements
intended to help banks avoid aliquiditycrisis.Banks can
generally maintain as much liquidity as desired because
bank deposits are insured by governmentsin most
developed countries. A lack of liquidity can be remedied
by raising deposit rates and effectivelymarketing deposit
products. However, an important measure of a
bank's value and success is the cost of
liquidity. A bank can attract significant liquid funds, but
at what cost? Lower costs generate stronger profits,more
stability, and more confidence among depositors,
investors, and regulators.Funds management involves
estimating and satisfying liquidity needs in the most cost-
effective way possibleand without unduly sacrificing
income potential. Effective analysis and management
of liquidity requiresmanagement to measure the liquidity
position of the bank on an ongoing basis and to examine
how fundingrequirements are likely to evolve under
various scenarios, including adverse conditions. The
formality and sophistication of liquidity management
depends on the size and sophistication of the bank, aswell
as the nature and complexity of its activities. Regardless
of the bank, good management informationsystems,
strong analysis of funding requirements under alternative
scenarios, diversification of funding sources,and
contingency planning are crucial elements of strong
liquidity management. The adequacy of a bank's liquidity
will vary. In the same bank, at different times, similar
liquidity positions maybe adequate or inadequate
depending on anticipated or unexpected funding needs.
Likewise, a liquidity positionadequate for one bank may
be inadequate for another. Determining a bank's liquidity
adequacy requires ananalysis of the current liquidity
position, present and anticipated asset quality, present and
future earningscapacity, historical funding requirements,
anticipated future funding needs, and options for reducing
fundingneeds or obtaining additional funds.Purchasing
aputoption and entering into ashort saletransaction are the
two most common ways for traders toprofit when the
price of an underlying asset decreases, but the payoffs are
quite different. Even though both of these instruments
appreciate in value when the price of the underlying asset
decreases, the amount of loss andpain incurred by the
holder of each position when the price of the underlying
asset
increases
is drasticallydifferent.
A short sale transaction
consists of borrowing shares from a broker and selling
them on the market in thehope that the share price will
decrease and you'll be able to buy them back at a lower
price. (If you need arefresher on this subject, see our
Short Selling Tutorial
.) As you can see from the diagram below, a trader
whohas a short position in a stock will be severely
affected by a large price increase because the losses
becomelarger as the price of the underlying asset
increases. The reason why the short seller sustains such
large lossesis that he/she does have to return the borrowed
shares to the lender at some point, and when that happens,
theshort seller is obligated to buy the asset at the market
price, which is currently higher than where the shortseller
initially sold.In contrast, the purchase of a put option
allows an investor to benefit from a decrease in the price
of theunderlying asset, while also limiting the amount of
loss he/she may sustain. The purchaser of a put option
willpay a premium to have the right, but not
the obligation, to sell a specific number of shares at an
agreed uponstrike price. If the price rises dramatically, the
purchaser of the put option can choose to do nothing and
justlose the premium that he/she invested. This limited
amount of loss is the factor that can be very appealing
tonovice traders