Module-I

Indian financial system

The Indian financial system can be broadly classified into,
Formal (organised) financial system
Informal (unorganised) financial system.
The formal financial system comprises of
Ministry of Finance, RBI, SEBI and other regulatory bodies, financial institutions, financial
markets, financial instruments and financial services.
The informal financial system consists of
individual money lenders, groups of persons operating as funds or associations, partnership
firms consisting of local brokers, pawn brokers, and non-banking financial intermediaries
such as finance, investment and chit fund companies, financial institutions, financial markets,
financial instruments and financial services.
Financial System
It is a set of institutions instruments and markets which fosters saving and channels
them to their most efficient use.-(H.R. Machiraju)
In the worlds of Van Horne, financial system allocates savings efficiently in an
economy to ultimate users either for investment in real assets or for consumption.
A financial system or financial sector functions as an intermediary and facilitates the
flow of funds from the areas of surplus to the areas of deficit. A Financial System is a
composition of various institutions, markets, regulations and laws, practices, money manager,
analysts, transactions and claims and liabilities.
The financial system is the network of institutions and individuals who deal in
financial claims to various instruments. Financial System of any country consists of financial
markets, financial intermediation and financial instruments or financial products.

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Structure of Indian Financial System

Components/ Constituents of Indian Financial system

The following are the four main components of Indian Financial system
1. Financial institutions
2. Financial Markets
3. Financial Instruments/Assets/Securities
4. Financial Services.
[[

1. Financial institutions:
Financial institutions are the intermediaries who facilitate smooth functioning of the
financial system by making investors and borrowers meet. They mobilize savings of the
surplus units and allocate them in productive activities promising a better rate of return.
Financial institutions also provide services to entities seeking advice on various issues
ranging from restructuring to diversification plans.
2. Financial Markets:
Finance is a prerequisite for modern business and financial institutions play a vital
role in economic system. It's through financial markets the financial system of an economy
works.

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The main functions of financial markets are:

1. to facilitate creation and allocation of credit and liquidity;
2. to serve as intermediaries for mobilization of savings;
3. to assist process of balanced economic growth;
4. to provide financial convenience
3. Financial Instruments
Another important constituent of financial system is financial instruments. They
represent a claim against the future income and wealth of others. It will be a claim against a
person or an institution, for the payment of the some of the money at a specified future date.
4. Financial Services:
Efficiency of emerging financial system largely depends upon the quality and variety
of financial services provided by financial intermediaries. The term financial services can be
defined as "activities, benefits and satisfaction connected with sale of money that offers to
users and customers, financial related value".
Following Developments took place in the Indian financial system:
1.
2.
3.
4.
5.
6.

Nationalisation of financial institutions

Establishment of Development Banks
Establishment of institution for housing finance
Establishment of Stock Holding Corporation of India (SHCIL)
Establishment of mutual funds and venture capital institutions
New Economic Policy of 1991

Functions/important and role of financial system

1. It links the savers and investors. It helps in mobilizing and allocating the savings
efficiently and effectively. It plays a crucial role in economic development through
saving-investment process. This savings investment process is called capital
formation.
2. It helps to monitor corporate performance.
3. It provides a mechanism for managing uncertainty and controlling risk.
4.

It provides a mechanism for the transfer of resources across geographical boundaries

5. It offers portfolio adjustment facilities (provided by financial markets and financial

intermediaries).
6. It helps in lowering the transaction costs and increase returns. This will motivate
people to save more.
7. It promotes the process of capital formation.
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8. It helps in promoting the process of financial deepening and broadening. Financial

deepening means increasing financial assets as a percentage of GDP and financial
broadening means building an increasing number and variety of participants and
instruments.

Money Market
A segment of the financial market in which financial instruments with high liquidity
and very short maturities are traded. The money market is used by participants as a means for
borrowing and lending in the short term, from several days to just under a year. Money
market securities consist of negotiable certificates of deposit (CDs), bankers acceptances,
U.S. Treasury bills, commercial paper, municipal notes, federal funds and repurchase
agreements
A money market is a market for borrowing and lending of short-term funds. It deals in
funds and financial instruments having a maturity period of one day to one year. It is a
mechanism through which short-term funds are loaned or borrowed and through which a
large part of financial transactions of a particular country or of the world are cleared.
Money market is a segment of financial market. It is a market for short term funds. It
deals with all transactions in short term securities. These transactions have a maturity period
of one year or less. Examples are bills of exchange, treasury bills etc.
According to Crowther, Money market is a collective name given to various firms
and institutions that deal in the various grades of near money.
It includes all organizations and institutions that deal in short term financial
instruments.
Characteristics of Money Market
1.
2.
3.
4.
5.
6.
7.
8.

It is basically an over the phone market.

It is a wholesale market for short term debt instruments.
It is not a single market but a collection of markets for several instruments.
It facilitates effective implementation of monetary policy of a central bank of a
country.
It is a market for short term financial assets that are close substitutes of money.
Transactions are made without the help of brokers.
It establishes the link between the RBI and banks.
The players in the money market are RBI, commercial banks, and companies.

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Functions of Money Market Money

1. Facilitating adjustment of liquidity position of commercial banks, business
undertakings and other non-banking financial institutions.
2. Enabling the central bank to influence and regulate liquidity in the economy through
its intervention in the market.
3. Providing a reasonable access to users of short term funds to meet their requirements
quickly at reasonable costs.
4. Providing short term funds to govt. institutions.
5. Enabling businessmen to invest their temporary surplus funds for short period.
6. Facilitating flow of funds to the most important uses.
Money market instruments
Important money market instruments are
1.
2.
3.
4.
5.
6.
7.
8.
9.

Call/Notice Money
Inter-Bank Term Money
Treasury Bills
Term Money
Certificate of Deposit
Commercial Papers
REPO
MMMF
ADR/GDR

1. Call / Notice-Money
Call/Notice money is the money borrowed or lent on demand for a very short period.
When money is borrowed or lent for a day, it is known as Call (Overnight) Money.
Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on
a day and repaid on the next working day, (irrespective of the number of intervening
holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14
days, it is "Notice Money".
2. Inter-Bank Term Money
Inter-bank market for deposits of maturity beyond 14 days is referred to as the term
money market. The entry restrictions are the same as those for Call/Notice Money except
that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.

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3. Treasury Bills.
Treasury Bills are short term (up to one year) borrowing instruments of the union
government. It is an IOU (I owe you- Debt instrument) of the Government. It is a promise by
the Government to pay a stated sum after expiry of the stated period from the date of issue
(14/91/182/364 days i.e. less than one year).
They are issued at a discount to the face value, and on maturity the face value is paid
to the holder. The rate of discount and the corresponding issue price are determined at each
auction.
Types of T-Bills
1. Ordinary or Regular T-Bills
2.Ad hoc T-Bills (91-Day T-Bills, 14-Day T-Bills, 182-Day T-Bills, 364-Day T-Bills
4. Certificate of Deposits
Certificates of Deposit (CDs) is a negotiable money market instrument and issued in
dematerialised form or as a Promissory Note, for funds deposited at a bank or other eligible
financial institution for a specified time period. Guidelines for issue of CDs are presently
governed by various directives issued by the Reserve Bank of India, as amended from time to
time.
5. Commercial Paper
CP is an unsecured promissory note privately placed with investors at a discount rate
to face value determined by market forces. CP is freely negotiable by endorsement and
delivery.
6. Repurchase Agreements (REPO)
REPO is basically a contract entered into by two parties (parties include RBI, a bank
or NBFC. In this contract, a holder of Govt. securities sells the securities to a lender and
agrees to repurchase them at an agreed future date at an agreed price. At the end of the period
the borrower repurchases the securities at the predetermined price. The difference between
the purchase price and the original price is the cost for the borrower. This cost of borrowing
is called repo rate.

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7. Money Market Mutual Funds (MMMFs)

Money Market Mutual Funds mobilise money from the general public. The money
collected will be invested in money market instruments. The investors get a higher return.
They are more liquid as compared to other investment alternatives. The MMMFs were
originated in the US in 1972. In India the first MMMF was set up by Kothari Pioneer in
1997.But this did not succeed.
8. American depository receipt and Global depository receipt
ADRs are instruments in the nature of depository receipt and certificate. These
instruments are negotiable and represent publicly traded, local currency equity shares issued
by non - American company. For example, an NRI can invest in Indian Companys shares
without bothering dollar conversion and other exchange formalities.
If the facilities extended globally, these instruments are called GDR. ADR are listed
in American Stock exchanges and GDR are listed in other than American Stock exchanges,
say Landon, Luxembourg, Tokyo etc.,
Components / Composition of Money Market (Structure of Money Market)
Money market consists of a number of sub markets. All submarkets collectively
constitute the money market. Each sub market deals in a particular financial instrument. The
main components or constituents or sub markets of a money markets are as follows :
1. Call money market
2. Commercial bill market
3. Treasury bill markets
4. Certificates of deposits market
5. Commercial paper market
6. Acceptance market
7. Collateral loan market

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1. Call money market /Notice Money Market/ Inter-Bank Money Market

The market for extremely short-period is referred as call money market. Under call
money market, funds are transacted on overnight basis.
The participants are mostly banks. Therefore it is also called Inter-Bank Money Market.
Under notice money market funds are transacted for 2 days and 14 days period. The lender
issues a notice to the borrower 2 to 3 days before the funds are to be paid. On receipt of
notice, borrowers have to repay the funds.
In this market the rate at which funds are borrowed and lent is called the call money rate.
The call money rate is determined by demand and supply of short term funds.
In call money market the main participants are commercial banks, co-operative banks
and primary dealers. They participate as borrowers and lenders. Discount and Finance House
of India (DFHI), Non-banking financial institutions like LIC, GIC, UTI, NABARD etc. are
allowed to participate in call money market as lenders.
Call money markets are located in big commercial centres like Mumbai, Kolkata,
Chennai, Delhi etc. Call money market is the indicator of liquidity position of money market.
RBI intervenes in call money market as there is close link between the call money market and
other segments of money market.
Objective of Call Money Market
To provide a parking place to employ short term surplus funds.
To provide room for overcoming short term deficits.
To enable the central bank to influence and regulate liquidity in the economy through its
intervention in this market.
To provide a reasonable access to users of short-term funds to meet their requirement
quickly, adequately at reasonable cost.
Importance of call Money Market

Development of trade & industry.

Development of capital market.
Smooth functioning of commercial banks.
Effective central bank control.
Formulation of suitable monetary policy.
Non-inflationary source of finance to government.
To provide help to the industry and trade.

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2. Commercial bill market

Commercial bill market refers to the market where treasury bills are bought and
sold.

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. The buyer accepts it immediately agreeing to pay amount mentioned therein
after a certain specified date. Thus, 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 creation period. A bill
of exchange is a self-liquidating paper and negotiable/; it is drawn always for a short period
ranging between 3 months and 6 months.
Trade bills are called commercial bills when they are accepted by commercial banks.
If the bill is payable at a future date and the seller needs money during the currency of the
bill, he may approach his bank to discount the bill.
Commercial bill is a short term, negotiable, and self-liquidating instrument with low
risk. It enhances he liability to make payment in a fixed date when goods are bought on
credit. According to the Indian Negotiable Instruments Act, 1881, bill or exchange is a
written instrument containing an unconditional order, signed by the maker, directing to pay a
certain amount of money only to a particular person, or to the bearer of the instrument
Features of Commercial Bills
1. These are negotiable instruments.
2. These are generally issued for 30 days to 120 days. Thus these are short term credit
instruments.
3. These are self-liquidating instruments with low risk.
4. These can be discounted with a bank. When a bill is discounted with a bank, the holder
gets immediate cash. This means bank provides credit to the customers. The credit is
repayable on maturity of the bill. In case of need for funds, the bank can rediscount the
bill in the money market and get ready money.
5. These are used for settling payments in the domestic as well as foreign trade.
6. The creditor who draws the bill is called drawer and the debtor who accepts the bill is
called drawee.
3. Treasury bill markets
Treasury bill market refers to the market where treasury bills are bought and sold.

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This market deals in Treasury Bills of short term duration issued by RBI on behalf of
Government of India. At present three types of treasury bills are issued through auctions,
namely 91 day, 182 day and364day treasury bills. State government does not issue any
treasury bills. Interest is determined by market forces. Treasury bills are available for a
minimum amount of Rs. 25,000 and in multiples of Rs. 25,000. Periodic auctions are held for
their Issue.
T-bills are highly liquid, readily available; there is absence of risk of default. In India
T-bills have narrow market and are undeveloped. Commercial Banks, Primary Dealers,
Mutual Funds, Corporates, Financial Institutions, Provident or Pension Funds and Insurance
Companies can participate in T-bills market.
T-bills are short-term securities that mature in one year or less from their issue date.
They are issued with three-month, six-month and one-year maturities. T-bills are purchased
for a price that is less than their par (face) value; when they mature, the government pays the
holder the full par value. Effectively, your interest is the difference between the purchase
price

of

the

security

and

what

you

get

at

maturity.

4. Certificates of deposits market

A certificate of deposit (CD) is a time deposit with a bank. CDs are generally issued
by commercial banks but they can be bought through brokerages. They bear a specific
maturity date (from three months to five years), a specified interest rate, and can be issued in
any denomination, much like bonds.
Certificates of deposit (or CDs for short) are debt instruments issued by banks and
other financial to investors. In exchange for lending the institution money for a predetermined
length of time, the investor is paid a set rate of interest. Maturities on certificates of deposit
can range from a few weeks to several years, with the rate earned by the investor increasing
in proportion to the time his capital is tied up in the investment under most yield rate
environments.
A certificate of deposit is a promissory note issued by a bank. It is a time deposit that
restricts holders from withdrawing funds on demand. Although it is still possible to withdraw
the money, this action will often incur a penalty.
CDs are generally issued by commercial banks and are insured by the FDIC. The term
of a CD generally ranges from one month to five years.

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5. Commercial paper market

Commercial Papers were introduced in January 1990. The Commercial Papers can be
issued by listed company which has working capital of not less than Rs. 5 crores. They could
be issued in multiple of Rs. 25 lakhs. The minimum size of issue being Rs. 1 crore. At present
the maturity period of CPs ranges between 7 days to 1 year. CPs are issued at a discount to its
face value and redeemed at its face value.
Commercial paper is an unsecured, short-term loan issued by a corporation, typically
for financing accounts receivable and inventories. It is usually issued at a discount, reflecting
current market interest rates. Maturities on commercial paper are usually no longer than nine
months, with maturities of between one and two months being the average.
For the most part, commercial paper is a very safe investment because the financial
situation of a company can easily be predicted over a few months. Furthermore, typically
only companies with high credit ratings and credit worthiness issue commercial paper.
CP is an unsecured promissory note privately placed with investors at a discount rate
to face value determined by market forces. CP is freely negotiable by endorsement and
delivery

Gilt Edged Securities Market

Gilt-Edged Securities 'High-grade bonds that are issued by a government or firm. This
type of security originally boasted gilded edges, thus the name. In the case of a firm, a giltedged security is a stock or bond issued by a company that has a strong record of consistent
earnings and can be relied on to cover dividends and interest.
Gilt-edged securities are a high-grade investment with very low risk. Typically, these
are issued by blue chip companies that dependably meet dividend or interest payments
because they are well-established and financially stable.
Gilt edged bonds are considered sufficiently lowrisk that the law allows banks to invest in them. In a
ddition to being low-risk, investment-grade bonds are low
return, greatly reducing the cost on the issuer. It is a private-issued, investment

grade bond. Only blue chip

companies issue gilt edged bonds and, for that reason, they have highratings

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Their value will be affected by inflation, other types of investment available and the
remainder of time left until maturity. The optimum time to purchase Gilts is when interest
rates are high and are on the brink of falling. As interest rates fall, the value of the stock will
rise and therefore can be sold at a profit.
The gilt market is split into three classifications, according to their redemption date or
maturity, classified as:
Shorts (less than five years)
Mediums (five to fifteen years)
Longs (more than fifteen years)
Characteristics of Gilt-edged Securities Market
Gilt-edged securities market is one of the oldest markets in India. The market in these
securities is a significant part of Indian stock market. Main characteristics of government
securities market are as follows:
Supply of government securities in the market arises due to their issue by the Central,
State of Local governments and other semi-government and autonomous institutions
explained above.
Government securities are also held by Reserve Bank of India (RBI) for purpose and
sale of these securities and using as an important instrument of monetary control.
The securities issued by government organisations are government guaranteed
securities and are completely safe as regards payment of interest and repayment of
principal.
Gilt-edged securities bear a fixed rate of interest which is generally lower than interest
rate on other securities.
These securities have a fixed maturity period.
Interest on government securities is payable half-yearly.

Capital Market
Capital market is the part of a financial system concerned with raising capital by
dealing in shares, bonds, and other long-term investments.
Capital market may be defined as a market for borrowing and lending of long term
capital funds required by business enterprises.
The markets where investment instruments like bonds and equities are Capital
markets are financial markets for the buying and selling of long-term debt or equitybacked securities

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Capital markets channel savings and investment between suppliers of capital such as
retail investors and institutional investors, and users of capital like businesses, government
and individuals.
Capital markets are vital to the functioning of an economy, since capital is a critical
component for generating economic output. Capital markets include primary markets, where
new stock and bond issues are sold to investors, and secondary markets, which trade existing
securities.
Capital markets have numerous participants including individual investors,
institutional investors such as pension funds and mutual funds, municipalities and
governments, companies and organizations and banks and financial institutions. Suppliers of
capital generally want the maximum possible return at the lowest possible risk, while users of
capital

want

to

raise

capital

at

the

lowest

possible

cost.

Different types of financial instruments that are traded in the capital markets are
Equity instruments
Credit market instruments
Insurance instruments
Foreign exchange instruments
Hybrid instruments
Derivative instruments
Debenture & Bonds
Company Fixed Deposit
Capital market reforms
The Indian capital market has witnessed major reforms in the decade of 1990s and
thereafter. It is on the verge of the growth. Thus, the Government of India and SEBI has
taken a number of measures in order to improve the working of the Indian stock exchanges
and to make it more progressive and vibrant.
The 1990s have witnessed the emergence of the securities market as a major source of
finance for trade and industry in India.

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Reforms in Capital Market

1) Establishment of SEBI India
The Securities and Exchange Board of India (SEBI) was established in 1988. It got a
legal status in 1992. SEBI was primarily set up to regulate the activities of the merchant
banks, to control the operations of mutual funds, to work as a promoter of the stock exchange
activities and to act as a regulatory authority of new issue activities of companies.
The SEBI was set up with the fundamental objective, "to protect the interest of
investors in securities market and for matters connected therewith or incidental thereto."
The main functions of SEBI are:

To regulate the business of the stock market and other securities market.
To promote and regulate the self-regulatory organizations.
To prohibit fraudulent and unfair trade practices in securities market.
To promote awareness among investors and training of intermediaries about safety of
market.
To prohibit insider trading in securities market.
To regulate huge acquisition of shares and takeover of companies.
2) Establishment of Creditors Rating Agencies:
Three creditors rating agencies viz. The Credit Rating Information Services of
India Limited (CRISIL - 1988), the Investment Information and Credit Rating Agency
of India Limited (ICRA - 1991) and Credit Analysis and Research Limited (CARE)
were set up in order to assess the financial health of different financial institutions and
agencies related to the stock market activities. It is a guide for the investors also in evaluating
the risk of their investments.
3) Increasing of Merchant Banking Activities :
Many Indian and foreign commercial banks have set up their merchant banking
divisions in the last few years. These divisions provide financial services such as
underwriting facilities, issue organizing, consultancy services, etc. It has proved as a helping
hand to factors related to the capital market.
4) Candid Performance of Indian Economy :
In the last few years, Indian economy is growing at a good speed. It has attracted a
huge inflow of Foreign Institutional Investments (FII). The massive entry of FIIs in the

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Indian capital market has given good appreciation for the Indian investors in recent times.
Similarly many new companies are emerging on the horizon of the Indian capital market to
raise capital for their expansions.
5) Rising Electronic Transactions :
Due to technological development in the last few years. The physical transaction with
more paper work is reduced. Now paperless transactions are increasing at a rapid rate. It
saves money, time and energy of investors. Thus it has made investing safer and hassle free
encouraging more people to join the capital market.
6) Growing Mutual Fund Industry:
The growing of mutual funds in India has certainly helped the capital market to grow.
Public sector banks, foreign banks, financial institutions and joint mutual funds between the
Indian and foreign firms have launched many new funds. A big diversification in terms of
schemes, maturity, etc. has taken place in mutual funds in India. It has given a wide choice
for the common investors to enter the capital market.
7) Growing Stock Exchanges:
The numbers of various Stock Exchanges in India are increasing. Initially the BSE
was the main exchange, but now after the setting up of the NSE , stock exchanges have
spread across the country. Recently a new Inter-connected Stock Exchange of India has
joined the existing stock exchanges.
8) Investors Protection:
Under the preview of the SEBI the Central Government of India has set up the
Investors Education and Protection Fund (IEPF) in2001. It works in educating and guiding
investors. It tries to protect the interest of the small investors from frauds and malpractices in
the capital market.
9) Growth of Derivative Transactions:
Since June 2000, the NSE has introduced the derivatives trading in the equities. In
November 2001 it also introduced the future and options transactions. These innovative
products have given variety for the investment leading to the expansion of the capitalmarket.

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10) Insurance Sector Reforms:

Indian insurance sector has also witnessed massive reforms in last few years. The
Insurance Regulatory and Development Authority (IRDA) were set up in 2000. It paved the
entry of the private insurance firms in India. As many insurance companies invest their
money in the capital market, it has expanded.
11) Commodity Trading:
Along with the trading of ordinary securities, the trading in commodities is also
recently encouraged. The Multi Commodity Exchange (MCX) is set up. The volume of such
transactions is growing at a splendid rate. Apart from these reforms the setting up of Clearing
Corporation of India Limited (CCIL), Venture Funds, etc., have resulted into the tremendous
growth of Indian capital market.
12) Other development
Dematerialization of Shares
Corporatization of exchange memberships
Banning of Badla / ALBM
Introduction of Derivative products - Index / Stock Futures & Options
Reforms/Changes in the margining system
STP (straight through processing)- electronic contracts
Margin Lending and Securities Lending

Nature of capital market

The nature of capital market is brought out by the following facts

It Has Two Segments ( Primary and Secondary)

It Deals In Long-Term Securities
It Performs Trade-off Function
It Creates Dispersion In Business Ownership
It Helps In Capital Formation
It Helps In Creating Liquidity

Functions of a capital market

Mobilization of Savings & acceleration of Capital Formation

Promotion of Industrial Growth
Raising of long term Capital
Ready & Continuous Markets
Proper Channelization of Funds
Provision of a variety of Services
Disseminate information efficiently
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Enable quick valuation of financial instruments both equity and debt

Provide insurance against market risk or price risk
Enable wider participation
Provide operational efficiency through(Simplified transaction procedure, Lowering
settlement timings and Lowering transaction costs)
Develop integration among (Real sector and financial sector, Equity and debt
instruments, Long term and short term funds,Private sector and government sector
and, Domestic funds and external funds)
Direct the flow of funds into efficient channels through (Investment, Disinvestment,
Reinvestment)
Types of capital market
There are two types of capital market
1. Primary market
2. Secondary market
I. Primary Market
It is that market in which shares, debentures and other securities are sold for the first
time for collecting long-term capital.
This market is concerned with new issues. Therefore, the primary market is also
called NEW ISSUE MARKET.
In this market, the flow of funds is from savers to borrowers (industries), hence, it
helps directly in the capital formation of the country. The money collected from this market is
generally used by the companies to modernize the plant, machinery and buildings, for
extending business, and for setting up new business unit.
Features of Primary Market
It is related with new issues
it has no particular place
Market for new long term equity capital
The process of selling new issues to investors is called underwriting
It has various methods of float capital: following are the methods of raising capital in
the primary market: i) public issue ii) offer for sale iii) private placement iv) right
issue v) electronic-initial public offer
it comes before secondary market

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Functions
Right issue
Book building (Process of generating, capturing and recording investor demand for
shares during an IPO and securities in order to support efficient price discovery)
Private placement (Private placement is the opposite of a public issue, in which
securities are made available for sale on the open market.)
Stock exchange
Methods of raising capital in the primary market
1.
2.
3.
4.
5.
6.
7.

Public issue
Offer for sale
Private placement
Right issue
Electronic-initial public offer
Preferential Issue
Green Shoe Option

1. Public issue or Initial public offering (IPO)

The issuing company directly offers to the general public/institutions a fixed number
of securities at a stated price or price band through a document called prospectus. This is the
most common method followed by companies to raise capital through issue of the securities
2. Offer for sale
It consists in outright sale of securities through the intermediary of issue houses or
share brokers. It consists of two stages: the first stage is a direct sale by the issuing company
to the issue house and brokers at an agreed price. In the second stage, the intermediaries resell
the above securities to the ultimate investors. The issue houses purchase the securities at a
negotiated price and resell at a higher price. The difference in the purchase and sale price is
called turn or spread.
3. Private placement
It involves sale of securities to a limited number of sophisticated investors such as
financial institutions, mutual funds, venture capital funds, banks, and so on. It refers to sale of
equity or equity related instruments of an unlisted company or sale of debentures of a listed
or unlisted company
4. Right issue
When a listed company proposes to issue securities to its existing shareholders, whose names
appear in the register of members on record date, in the proportion to their existing holding,
through an offer document, such issues are called Right Issue. This mode of raising capital
is the best suited when the dilution of controlling interest is not intended.

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5. Electronic-initial public offer

In E-IPO the companies are now allowed to issue capital to the public through the on-line
system of the stock exchanges. For making such on-line issues, the companies should comply
with the provisions contained in Chapter 11A of SEBI (Disclosure and Investor Protection)
Guidelines, 2000
6. Preferential Issue
An issue of equity by a listed company to selected investors at a price which may or may not
be related to the prevailing market price is referred to as preferential allotment in the Indian
capital market. In India preferential allotment is given mainly to promoters or friendly
investors to ward off the threat of takeover.
7. Green Shoe Option
It denotes an option of allocating shares in excess of the shares included in the public issue.
SEBI guidelines allow the issuing company to accept over subscriptions, subject to a ceiling,
say 15% of the offer made to public. It is extensively used in international IPOs to stabilized
the post-listing price of new issued shares.
II. Secondary Market
The secondary market is that market in which the buying and selling of the previously
issued securities is done. The transactions of the secondary market are generally done through
the medium of stock exchange.
The chief purpose of the secondary market is to create liquidity in securities. If an
individual has bought some security and he now wants to sell it, he can do so through the
medium of stock exchange to sell or purchase through the medium of stock exchange requires
the services of the broker presently, there are 24 stock exchange in India.
Features of Secondary Market

It Creates Liquidity
It Comes After Primary Market
It Has A Particular Place
It Encourages New Investments
Aids In Financing The Industry
Ensures Safe & Fair Dealing( Media Broadcasting)

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Public issue Global market

Indian companies are permitted to raise foreign currency resources through two main
sources:
a) Issue of foreign currency convertible bonds more commonly known as 'Euro' issues
b) Issue of ordinary shares through depository receipts namely
'Global Depository Receipts (GDRs)
American Depository Receipts (ADRs)'
.
1.

Global depository receipts (GDR)

A global

depository

receipt (GDR),

also

known

as international

depository

receipt (IDR), is a certificate issued by a depository bank, which purchases shares of foreign
companies and deposits it on the account. They are the global equivalent of the original American
depository receipts (ADR) on which they are based. GDRs represent ownership of an underlying
number of shares of a foreign company and are commonly used to invest in companies from
developing or emerging markets by investors in developed markets.
Global Depository Receipts (GDRs) may be defined as a global finance vehicle that
allows an issuer to raise capital simultaneously in two or markets through a global offering.
GDRs may be used in public or private markets inside or outside US. GDR, a negotiable
certificate usually represents company's traded equity/debt. The underlying shares correspond to the
GDRs in a fixed ratio say 1 GDR=10 shares.
GDRs are securities available in one or more markets outside the companys home country.
GDR represents one or more (or fewer) shares in a company. The shares are held by the custody of
the depositary bank in the home country. A GDR investor holds the same rights as the shareholders
of ordinary shares, but typically without voting rights. Sometimes voting rights can be the executed
by the depositary bank on behalf of the GDR holders.
Prices of global depositary receipt are based on the values of related shares, but they are
traded and settled independently of the underlying share. Typically, 1 GDR is equal to 10
underlying shares, but any ratio can be used. It is a negotiable instrument which is denominated in
some freely convertible currency. GDRs enable a company, the issuer, to access investors in capital
markets outside of its home country.

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Several international banks issue GDRs, such as JPMorgan Chase, Citigroup, Deutsche Bank, The
Bank of New York Mellon. GDRs are often listed in the Frankfurt Stock Exchange, Luxembourg
Stock Exchange, and the London Stock Exchange, where they are traded on the International Order
Book (IOB).
Characteristics
1.
2.
3.
4.

It is an unsecured security
It may be converted into number of shares
Interest and redemption price is public in foreign agency
It is listed and traded in the stock exchange

2. American Depository Receipts (ADR)

American Depositary Receipts are US securities representing an indirect ownership of a
non-US company. Each certificate stands for a depositary share (American Depositary Share
ADS11), which is safe kept by the depositary bank (depositary). ADRs allow American investors to
invest into non-US companies without having to worry about the complexities associated with the
cross-border transactions.
ADRs can list on any American stock exchange, most frequently on New York Stock
Exchange (NYSE), American Stock Exchange (AMEX) and are also traded in National Association
of Securities Dealers Automated Quotation System (NASDAQ) or in the over-the-counter (OTC)
market.
A negotiable certificate issued by a U.S. bank representing a specified number of shares (or
one share) in a foreign stock that is traded on a U.S. exchange. ADRs are denominated in U.S.
dollars, with the underlying security held by a U.S. financial institution overseas. ADRs help to
reduce administration and duty costs that would otherwise be levied on each transaction.
ADRs are denominated and traded in US dollars; also the dividends and other payments are
made in US dollars. Investors receive annual reports and proxy materials in English.
Types of ADR

OTC ADR (Level 1): These are not listed on any US exchange and can be traded only in the overthe-counter (OTC) market. These ADRs are not subject to very stringent regulations from the SEC.
They represent shares of foreign companies that do not qualify for a US exchange listing or choose
not to list on the exchange.
Investors can buy unsponsored OTC ADRs, which can be issued by more than one bank.
Sponsored OTC ADRs are generally confined to being issued by one sponsoring bank. They are
also more structured than unsponsored ones.

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Listed ADR (Level 2): These are typically listed on the NASDAQ or the NYSE and are subject to
stricter SEC regulations which all listed companies need to comply with.

Public Issues (Level 3): Some ADRs may be offered through a public issue by the sponsoring
bank. The foreign company can raise substantial funds from the American markets with these
ADRs. Publicly issued ADRs require the most stringent adherence to SEC rules.

Guidelines On Issue Of ADR and GDR

The Indian company issuing shares through ADR/GDR route, shall furnish to the Reserve
Bank, full details of such issue in the prescribed form, within thirty (30) days from the
date of closing of the issue.
The Indian company issuing shares against ADR/GDR shall furnish a quarterly return in
the prescribed form to the Reserve Bank within fifteen (15) days of the close of the
calendar quarter.
The issue related expenses (covering both fixed expenses like under writing commissions,
lead managers charges, legal expenses and other reimbursable expenses) shall be subject
to a ceiling of 4% in the case of GDRs and 7% in the case of ADRs. Issue expenses
beyond the said ceiling would need prior approval of the Reserve Bank.
Indian companies are permitted to retain funds raised abroad through ADRs/GDRs for
any period to meet their future forex requirements.

In terms of Foreign Currency Convertible Bonds and Ordinary Shares (Through

Depository Receipts Mechanism) Scheme, 1993, the issuer company is required to obtain
RBI approval for overseas investment/business acquisitions (where GDR proceeds are to
be utilized for overseas investment) prior to the GDR issue.
Indian companies can raise foreign currency resources abroad through the issue of ADRs/
GDRs, in accordance with the Scheme for issue of Foreign Currency Convertible Bonds
and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 and
guidelines issued by the Government of India.
A company can issue ADRs / GDRs, if it is eligible to issue shares to persons resident
outside India under the FDI Scheme. Unlisted companies, which have not yet accessed
the ADR/GDR route for raising capital in the international market, would require prior or
simultaneous listing in the domestic market, while seeking to issue such overseas
instruments. Unlisted companies, which have already issued ADRs/GDRs in the

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international market, have to list in the domestic market on making profit or within three
years of such issue of ADRs/GDRs
After the issue of ADRs/GDRs, the company has to file a return in Form DR as indicated
in the RBI Notification No. FEMA.20/ 2000-RB dated May 3, 2000, as amended from
time to time. The company is also required to file a quarterly return in Form DRQuarterly as indicated in the RBI Notification ibid.
There are no end-use restrictions on GDR/ADR issue proceeds, except for an express ban
on investment in real estate and stock markets. Erstwhile OCBs which are not eligible to
invest in India and entities prohibited to buy, sell or deal in securities by SEBI will not be
eligible to subscribe to ADRs / GDRs issued by Indian companies.
The pricing of ADR / GDR issues including sponsored ADRs / GDRs should be made at
a price determined under the provisions of the Scheme of issue of Foreign Currency
Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism)
Scheme, 1993 and guidelines issued by the Government of India and directions issued by
the Reserve Bank, from time to time.
Under the limited Two-way fungibility Scheme, a registered broker in India can purchase
shares of an Indian company on behalf of a person resident outside India for the purpose
of converting the shares so purchased into ADRs/ GDRs.
Two-way fungibility Scheme: Under the limited two-way fungibility Scheme, a
registered broker in India can purchase shares of an Indian company on behalf of a
person resident outside India for the purpose of converting the shares so purchased
into ADRs/GDRs.
The Indian company issuing ADRs / GDRs has to furnish to the Reserve Bank, full
details of such issue in the Form enclosed in Annex -10, within 30 days from the date
of closing of the issue.
The company should also furnish a quarterly return in the Form enclosed in Annex 11, to the Reserve Bank within 15 days of the close of the calendar quarter.
The quarterly return has to be submitted till the entire amount raised through
ADR/GDR mechanism is either repatriated to India or utilized abroad as per the
Reserve Bank guidelines.
In case of private placement, details of investors and ADRs/GDRs issued to each of
them:
o
o
o
o
o

Number of GDRs/ADRs issued

Ratio of GDRs/ADRs to the underlying shares
Details of Issue related expenses
Details of listing arrangements
Amount raised and the amount repatriated

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Main agreements to be executed and related documents

In Case of GDR issue

Escrow Agreement to be executed by the Escrow Agent.

Placing Agreement to be executed by the Lead Manager and the Issuer.
Deposit Agreement to be executed by the Depository.
Offering Circular.

Procedural requirements for a GDR/ADR issue

The procedural requirements for issue of GDRs/ADRs are briefly set out here below:
U.S. Generally Accepted Accounting Principles ("GAAP")
Preliminary Meetings
Authorization by Board of Directors
Organizational Meetings
Legal and accounting due diligence on Issuer
Authorization by the share holders
Statutory Approvals
Application for listing the additional shares on the Indian Stock Exchange
Filings

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