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Contemporary Issues in Finance: This Module Covers The Followings: 1. Types of Financial Markets

1. This module covers types of financial markets, derivatives, and the Direct Tax Code. 2. The two major types of financial markets are the money market, which deals in short-term credit, and the capital market, which handles medium and long-term credit. 3. Derivatives are financial instruments whose value is based on an underlying asset. Common derivatives include futures, forwards, options, and swaps. They allow investors to hedge risk.

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60 views

Contemporary Issues in Finance: This Module Covers The Followings: 1. Types of Financial Markets

1. This module covers types of financial markets, derivatives, and the Direct Tax Code. 2. The two major types of financial markets are the money market, which deals in short-term credit, and the capital market, which handles medium and long-term credit. 3. Derivatives are financial instruments whose value is based on an underlying asset. Common derivatives include futures, forwards, options, and swaps. They allow investors to hedge risk.

Uploaded by

maquesurat ferdous
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Module 7

Contemporary issues in finance


___________________________________________________________________________
This module covers the followings:

1. Types of Financial Markets


i. Money Market and its instruments
ii. Capital Market and its instruments
2. What are Derivatives?
3. What is Direct Tax Code (DTC)?
__________________________________________________________________________

TYPES OF FINANCIAL MARKETS

A financial market consists of two major segments:

(a) Money Market; and


(b) Capital Market.

While the money market deals in short-term credit, the capital market
handles the medium term and long-term credit.

(A). MONEY MARKET

The money market is a market for short-term funds, which deals in financial
assets whose period of maturity is upto one year. It should be noted that
money market does not deal in cash or money as such but simply provides a
market for credit instruments such as bills of exchange, promissory notes,
commercial paper, treasury bills, etc. These financial instruments are close
substitute of money. These instruments help the business units, other
organisations and the Government to borrow the funds to meet their short-
term requirement. Money market does not imply to any specific market
place. Rather it refers to the whole networks of financial institutions dealing
in short-term funds, which provides an outlet to lenders and a source of
supply for such funds to borrowers. Most of the money market transactions
are taken place on telephone, fax or Internet. The Indian money market
consists of Reserve Bank of India, Commercial banks, Co-operative banks,
and other specialised financial institutions. The Reserve Bank of India is the
leader of the money market in India. Some Non-Banking Financial
Companies (NBFCs) and financial institutions like LIC, GIC, UTI, etc. also
operate in the Indian money market.
Instruments of Money Market
Following are some of the important money market instruments or
securities.

(a) Call Money: Call money is mainly used by the banks to meet their
temporary requirement of cash. They borrow and lend money from each
other normally on a daily basis. It is repayable on demand and its maturity
period varies in between one day to a fortnight. The rate of interest paid on
call money loan is known as call rate.

(b) Treasury Bill: A treasury bill is a promissory note issued by the RBI to
meet the short-term requirement of funds. Treasury bills are highly liquid
instruments, that means, at any time the holder of treasury bills can
transfer of or get it discounted from RBI These bills are normally issued at a
price less than their face value; and redeemed at face value. So the
difference between the issue price and the face value of the treasury bill
represents the interest on the investment. These bills are secured
instruments and are issued for a period of not exceeding 364 days. Banks,
Financial institutions and corporations normally play major role in the
Treasury bill market.

(c) Commercial Paper: Commercial paper (CP) is a popular instrument for


financing working capital requirements of companies. The CP is an
unsecured instrument issued in the form of promissory note. This
instrument was introduced in 1990 to enable the corporate borrowers to
raise short-term funds. It can be issued for period rangin from 15 days to
one year. Commercial papers are transferable by endorsement and delivery.
The highly reputed companies (Blue Chip companies) are the major player of
commercial paper market.

(d) Certificate of Deposit: Certificate of Deposit (CDs) is short-term


instruments issued by Commercial Banks and Special Financial Institutions
(SFIs), which are freely transferable from one party to another. The maturity
period of CDs ranges from 91 days to one year. These can be issued to
individuals, co-operatives and companies.

(e) Trade Bill: Normally the traders buy goods from the wholesalers or
manufactures on credit. The sellers get payment after the end of the credit
period. But if any seller does not want to wait or in immediate need of
money he/she can draw a bill of exchange in favour of the buyer. When
buyer accepts the bill it becomes a negotiable instrument and is termed as
bill of exchange or trade bill. This trade bill can now be discounted with a
bank before its maturity. On maturity the bank gets the payment from the
drawee i.e., the buyer of goods. When trade bills are accepted by
Commercial Banks it is known as Commercial Bills. So trade bill is an
instrument, which enables the drawer of the bill to get funds for short
period to meet the working capital needs.

(B). CAPITAL MARKET

Capital Market may be defined as a market dealing in medium and long-


term funds. It is an institutional arrangement for borrowing medium and
long-term funds and which provides facilities for marketing and trading of
securities. So it constitutes all long-term borrowings from banks and
financial institutions, borrowings from foreign markets and raising of capital
by issue various securities such as shares debentures, bonds, etc.

Types of Capital Market

1. PRIMARY MARKET

The Primary Market consists of arrangements, which facilitate the


procurement of longterm funds by companies by making fresh issue of
shares and debentures. Examples: initial public offers (IPOs) made recently
by a number of public sector undertakings such as ONGC, GAIL, NTPC and
the private sector companies like Tata Consultancy Services (TCS), Biocon,
Jet-Airways and so on.

2. SECONDARY MARKET

The secondary market known as stock market or stock exchange plays an


equally important role in mobilising long-term funds by providing the
necessary liquidity to holdings in shares and debentures. It provides a place
where these securities can be encashed without any difficulty and delay. It
is an organised market where shares, and debentures are traded regularly
with high degree of transparency and security. In fact, an active secondary
market facilitates the growth of primary market as the investors in the
primary market are assured of a continuous market for liquidity of their
holdings. The major players in the primary market are merchant bankers,
mutual funds, financial institutions, and the individual investors; and in the
secondary market you have all these and the stockbrokers who are members
of the stock exchange who facilitate the trading.
Derivatives

 A derivative is a financial instrument whose pay-offs is derived from


some other asset which is called as an underlying asset.
 There are a large number of simple derivatives like futures or forward
contracts or swaps. Options are more complicated derivatives.
 Derivatives are tools to reduce a firm’s risk exposure. Hedging is the
term used for reducing risk by using derivatives.
Derivatives are of Four types.
a) Forward

1. Forward Contract

A forward contract is a contract in which currency is delivered in future date


at an agreed exchange rate. For Example you promise me to give your
second hand Maruti car next month and I promise you to pay Rs. 1Lac.
So next month you give me your car and I give you Rs. 1 Lacs. This is
known as forward contract.
Features-
1. Non Standardized Contracts.
2. Traded at over the counter the market.
3. Fear of Default.
4. No involvement of third party.
5. Party knows to each other very well.

2. Future Contract

A future contract is contract in which seller agrees to make delivery of


specified currency at specified future date at specified exchange rate. A
Future contract is stated in details. Under Future contract both the parties
have to put a margin to clearing house. In case of default the margin of the
respective party is seized.

Features –
 1. Standardized Contract.
 2. Between two parties who not necessarily know each other.
 3. No default, guarantee for performance by a clearing corporation or
clearing house.
 4. Margin placement to the clearing house.
 5. Marking to market happens in future contract.
3. Options

(a) Call Option- A call option is that agreement in which the writer gives
the right to purchase a specified currency at specified exchange rate
to the option buyer or investor. A call option is purchased to minimize
the risk of hiking the price of underlying currency.

For ex.- A call option is available in CME over $1,00,000/-, Exercise price-
45/$, maturity is 3 months, op-Re2/$-

(b) Put Option- A Put option is that agreement in which the writer gives
the right to sell a specified currency at specified exchange rate to the
option holder or investor. A put option is purchased to minimize the
risk of decline the price of underlying currency.
For ex.- A put option is available in CME over Re100,000/-, Exercise price-
50/$, maturity is 3 months, op-Re 2/$-

Different Types of Investment


Opportunities

Equities

Other Mutual
Securities Funds

Investment
Oppotunities

Derivative
Financial
&
Bonds
Commodity

Govt.
Securities

Direct Taxes Code

The Direct Taxes Code (DTC) is said to replace the existing Indian Income
Tax Act, 1961 Salient features

1. DTC removes most of the categories of exempted income. Equity


Mutual Funds (ELSS), Term deposits, NSC (National Savings
certificates), Unit Linked Insurance Plans (ULIPs), Long term
infrastructures bonds, house loan principal repayment, stamp duty
and registration fees on purchase of house property will lose tax
benefits.
2. Only half of Short-term capital gains will be taxed
3. Surcharge and education cess are abolished.
4. For incomes arising of House Property: Deductions for Rent and
Maintenance would be reduced from 30% to 20% of the Gross Rent.
Also all interest paid on house loan for a rented house is deductible
from rent.
5. Tax exemption on Education loan to continue.
6. Tax exemption on LTA (leave travel allowance) is abolished.
7. Taxation of Capital gains from property sale : For sale within one year,
gain is to be added to taxable salary .
8. Tax on dividends: Dividends will attract 5% tax.
9. Medical reimbursement : Max limit for medical reimbursements has
been increased to rupees 50,000 per year from current rupees 15,000
limit

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