Financial Markets: Money Markets, Capital Markets, Government Securities Market Commerce YouTube Lecture Handouts Part 2

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Financial Markets: Money Markets, Capital Markets, Government Securities Market | Commerce

Certificate of Deposits (CD)

  • A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities.
  • The dealer sells the underlying security to investors and,
    • by agreement between the two parties,
    • buys them back shortly afterwards, usually the following day, at a slightly higher price.
  • The repo market is an important source of funds for large financial institutions in the non-depository banking sector, which has grown to rival the traditional depository banking sector in size.
  • Large institutional investors such as money market mutual funds lend money to financial institutions such as investment banks, either in exchange for (or secured by) collateral, such as Treasury bonds and mortgage-backed securities held by the borrower financial institutions.

Forward Rate Agreements (FRA՚s)

  • Forward Rate Agreements are similar to forward contracts
  • where one party agrees to borrow or lend a certain amount of money
  • At a fixed rate
  • On a pre-specified future date.
  • For example, two parties can enter into an agreement to borrow ₹ 50,000 after 60 days for a period of 90 days, at say 10 % .
  • A financial contract between two parties
  • To exchange interest payments for a ‘notional principal’ amount
  • on settlement date,
  • For a specified period from start date to maturity date.
  • The settlement rate is the agreed bench-mark/reference rate prevailing on the settlement date.

Interest Rate Swaps

  • A type of a derivative contract
  • Through which two counterparties agree
  • To exchange one stream of future interest payments for another, based on a specified principal amount.
  • In most cases, interest rate swaps include the exchange of a fixed interest rate for a floating rate.
  • Generally, the two parties in an interest rate swap are trading a fixed-rate and variable-interest rate.
  • For example, one company may have a bond that pays the London Interbank offered Rate (LIBOR) , while the other party holds a bond that provides a fixed payment of 10 % .

Capital Market

Capital Market

Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments.

Capital Market

Primary Market

  • New stock or bond issues are sold to investors via underwriting.
  • Governments issue only bonds, whereas companies often issue both equity and bonds.
  • The main entities purchasing the bonds or stock include pension funds, hedge funds, sovereign wealth funds, and less commonly wealthy individuals and investment banks trading on their own behalf
  • Funds borrowed from money markets are typically used for general operating expenses, to provide liquid assets for brief periods

Secondary Market

  • Existing securities are sold and bought among investors or traders, usually on an exchange, over-the-counter, or elsewhere.
  • It consists of a series of channels through which the savings of the community are made available for industrial and commercial enterprises and public authorities.
  • Deals with the exchange of prevailing or previously-issued securities among investors e. g. , Equity shares, preference shares, debentures and bonds
  • The purpose is to invest in additional physical capital goods, which will be used to help increase its income.

Government Securities Market

  • The government securities market is at the core of financial markets in most countries.
  • It deals with tradeable debt instruments issued by the Government for meeting its financing requirements.
  • These are debt instruments issued by the government to borrow money. The two key categories are treasury bills – short-term instruments which mature in 91 days, 182 days, or 364 days, and dated securities – long-term instruments, which mature anywhere between 5 years and 40 years.
  • The Primary Market consists of the issuers of the securities.
  • For example, Central and Sate Government and buyers include Commercial Banks, Primary Dealers, Financial Institutions, Insurance Companies & Co-operative Banks.
  • RBI also has a scheme of non-competitive bidding for small investors.

Types of Government Securities

  • Treasury bills (T-bills) Treasury bills or T-bills are issued only by the central government of India.
  • Cash Management Bills (CMBs) Cash Management Bills (CMBs) are relatively new to the Indian financial market.
  • Dated G-Secs.
  • State Development Loans (SDLs)
  • In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities to raise funds from the market at market determined rate using auction mechanism which are called the State Development Loans (SDLs) . Minimum Amount of issue/sale: ₹ 10,000.
  • G-Secs carry practically no risk of default and, hence, are called risk-free gilt-edged instruments.
  • The RBI conducts auctions of G-secs (Government-dated securities with original maturity of one year or more) where institutional investors can place competitive bids for them, and retail investors can apply for allotment.
  • Retail investors can also technically invest in G-secs through RBI trading platform. However, awareness is low and liquidity is poor because the market trades in wholesale lots of, say, ₹ 5 crore and not in retail lots.

MCQs

Q. ________refers to borrowing/lending of funds for period exceeding 14 days.

Answer: ‘Term Money’

Q. G-Secs carry practically no risk of default and, hence, are called ________ instruments.

Answer: Risk-free gilt-edged

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