Capital and Money Market

Every company is in need of long-term capital as well as short-term capital. Long-term capital is required essentially for investment in land, buildings, plant and machinery and other fixed assets, which are pre-requisites for the production of goods and services. Short-term capital or working capital is required for financing the day-to-day operations of the business, such as raw-material, work-in-progress, finished goods, etc. Money Market A money market is defined as the market for lending and borrowing of short term funds. It is the place where the short-term surplus investible funds at the disposal of the banks and other financial institutions are bid by the borrowers comprising companies, individuals and the government. The RBI occupies a pivotal position in the Indian money market as it controls the flow of currency and credit into the market. The Indian money market comprises of two sectors: 1. Unorganized sector: indigenous bankers who pursue the banking business on traditional lines. 2. Organized sector: comprises the RBI, the State Bank of India and its associate banks, the 20 nationalized banks and other private sector banks, both Indian and foreign. 3. Sub-markets: Bill Market bill (billette, a note, a letter of formal exchange, later a bill of exchange, later still, a cheque).a well organized bill market is necessary for linking up the various credit agencies ultimately and effectively to RBI. No bill market was developed due to some historical accidents banks keeping a large amount of cash for liquidity purposes, preference of industry and trade for borrowing rather than discounting bills, preference for cash transactions in certain lines of activity, etc. The is a treasury bill market in India (treasury bills are finance bills) but the commercial bill market has not been fully developed, even though there is a general appreciation of the need for such a market: (a) banks with surplus funds like to buy (i.e. discount) commercial or trade bills, as they yield a good rate of return, they are for a short period (90 days) and they are self liquidating. (b) Commercial bills are useful to RBI for its open market operations. In times of monetary shortage, RBI can buy bills from the market

and pump in additional funds and help create more bank credit. In time of glut of funds in the money market, RBI can sell bills in the market and absorb the surplus funds. Certificates of Deposits important instruments of money market they are issued by banks in multiples of Rs.25 lakhs subject to a minimum of Rs. 1 cr; maturity is between 3 months to 1 year. Commercial papers (CP) issued by companies with a net worth of Rs.10 cr, later reduced to Rs. 5 cr. issued in multiples of Rs.25 lakhs subject to a min issue of Rs.1 cr.; maturity is between 3 to 6 months. The purpose is to enable high-level corporate borrowers to diversify their sources of short-term borrowing on the one hand, and provide an additional instrument to the banks and financial institutions in the money market, on the other. Capital Market Capital Market is the market for long-term funds . It refers to all the facilities and institutional arrangements for borrowing and lending term funds (medium-term and long-term funds). It does not deal with capital goods but is concerned with the raising of money capital for the purpose of investment. The demand for long-term money capital comes predominantly from private sector manufacturing industries and agriculture and from the government largely for the purpose of economic development. The supply of funds for the capital market comes largely from individual savers, corporate savings, banks, insurance companies, specialized financing agencies and the government. Among institutions we may refer to: (a) commercial banks are important investors, but are largely interested in government securities and to a small extent in debentures of companies; (b) LIC and GIC are of growing importance in the Indian capital market, though their major interest is still government securities. (c) Provident Funds constitute a major medium of savings but their investments too are mostly in government securities; and (d) Special institutions set up since Independence, viz. IFCI, ICICI (Industrial Credit and Investment Corp of India), IDBI, UTI, etc. all these aim at providing long-term capital to the private sector.

The Indian capital market is divided into the gilt edged market and the industrial securities market. 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 issue 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. Both markets are equally important but often the new issues market is much more important from the point of view of economic growth. The capital market is also classified into primary capital market and secondary capital market. The former refers to the new issue market which relates to the issues of shares, preference shares and debentures of nongovernment public limited companies, and also to the raising of fresh capital by government companies and the issue of public sector bonds. The secondary capital market is the market for old and already issued securities. It 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. Development Financial Institutions Soon after independence, the GOI set up a series of financial institutions to be of special help in the private sector industries in the matter of finance. IFCI was the first institution (1948), followed by the SFCs to provide long term finance to small and medium industrial units. ICICI (1955), IDBI (1964) and UTI (1964); LIC (1956) was set up to mobilize small savings and to invest part of the savings in the capital market. These institutions have been doing very useful work in subscribing to the shares and debentures of new and old companies, in giving loan assistance, in underwriting new issues, etc. LIC and UTI mobilize resources from the public and place them at the disposal of the capital market. On the other hand, the DFIs are engaged in providing funds to the private sector enterprises. Merchant Banks In India manage and underwrite new issues; they undertake syndication of credit; they advise corporate clients on fund raising and other financial aspects. (They do not undertake banking business, viz. deposit banking, lending and forex services.)

Merchant banks are banks that specialize in activities that facilitate trade and commerce. This typically involves international finance (because of their size and complexity), long term loans to companies, and underwriting. Merchant banks do not offer usual banking services to the general public. E.g. VLS Finance Ltd. (Provides the following fee-based services: a) Private Equity and Debt Placements for Corporate across the globe - main focus being for projects in India, USA and Europe; b) Venture Capital arrangements; c) Identifying and tying up Joint Venture Partners in India and abroad; d) Domestic Bank Financing); Startegic Capital Corporation Private Ltd. Mutual Funds Several to thousands of individual stocks that you pay someone to manage for you. Several public sector banks and financial institutions have set up mutual funds on a tax-exempt basis: their main function is to mobilise the saving from the general public and invest them in stock market securities. E.g. Kotak Mahindra Mutual Fund, UTI, Darashaw & Company Private Ltd. Four Corporate majors, the Tata Group, the Birla Group, the Reliance Group and the SBI have enetered into this field. Venture Capital Companies There is a significant scope for emergence of technocrat entrepreneurs who have technical cometence but lack capital. Financial institutions generally insist on greater promoter contribution to investment financing. Venture capital companies give commecial support to new ideas for the introduction and adaptation of new technologies. There is a high degree of risk involved in venture financing. A venture capital fund is a pooled investment vehicle (often a partnership) that primarily invests the financial capital of third party investors in enterprises that are typically too risky for typical equity investors or bank loans. In most cases, the venture capitalist becomes part owner of the new venture. The roles performed by a venture capitalist are: directly providing funds for high risk, high return ventures arranging additional financing from other sources assessing and revising the proposed business model reformulating the overall strategy finding and hiring key managers

finding supportive service companies and other business contacts firing existing managers where they think this is necessary buying-out existing partners (owners) where they think this is necessary providing operational and technical guidance to enhance overall business efficiency prepare the company for a potential exit (e.g. acquisition or initial public offering)

Leasing and Hire-Purchase Companies Hire Purchase (HP) is a well-established method of financing the purchase of assets by businesses. Under a HP agreement the customer will pay an initial deposit, with the remainder of the balance and interest paid over a period of time. The finance company which provides finance is known as the "creditor". It will purchase the asset on behalf of the customer, who is known as the "hirer" The finance company owns the asset until the final installment is paid for the asset. Leasing is a contract between the leasing company, the "lessor", and the customer, the "lessee"; The leasing company buys and owns the asset that the lessee requires The customer hires the asset from the leasing company and pays rental over a pre-determined period for the use of the asset The leasing company can sometimes claim capital allowances on the assets. These benefits are usually passed onto the lessee in the form of reduced repayments. Need to Raise Funds through Equity: After the Industrial Revolution, as the size of the business enterprises grew, it was no longer possible for proprietors or even partnerships to raise colossal amounts of money required for undertaking large entrepreneurial ventures. Such huge requirement of capital could only be met by the participation of a very large number of investors their numbers running into hundreds, thousands and even millions, depending upon the size of the business venture. 1. In general, small-time proprietors, partners of proprietary or partnership firm are likely to find it rather difficult to get out of their

business should they for some reason wish to do so coz it is not always possible to find buyers for an entire business or even part of a business, just when one wishes to sell it. 2. It is not easy for someone with savings, especially with a small amount of savings, to readily find an appropriate business opportunity, for investment. 3. These problems are further magnified in larger proprietorships and partnerships investments would not be easily forthcoming since their savings would be very difficult to convert into cash (for better investment opportunity, marriage, education, death, health etc.) (Clearly then, big enterprises will be able to raise capital from the public at large, only if there were some mechanism by which the investors could purchase and sell their share of the business as and when they wish to do so. This implies that ownership of the business has to be broken up into a large number of small units, such that each unit may be independently bought and sold without hampering the business activity as such. Also, such breaking up of business ownership would help mobilize small savings in the economy into entrepreneurial ventures.) Advantages of Equity Financing: 1. Permanent capital: since ordinary shares are not redeemable (capital received on the issue of shares can be redeemed/paid back on the winding up of the company only), the company has no liability for cash outflow associated with its redemption. It is a permanent capital and is available for use as long as the company goes on. 2. Borrowing base: it increases the companys financial base, and thus its borrowing limit. Lenders generally lend in proportion to the companys equity capital. By issuing ordinary shares, the company increases its financial capability. It can borrow when it needs additional funds. 3. Dividend payment discretion: a company is not legally obliged to pay dividend. In times of financial difficulties, it can reduce or suspend payment of dividend. In practice dividend cuts are not very common and frequent. A company tries to pay dividend regularly. It cuts dividend only when it cannot manage cash to pay dividends. E.g. in 1986 the Reliance Industries experienced a sharp drop in profits and to had a severe liquidity problem; as a consequence, it had to cut its dividend rate from 50% to 25%. The company however, increased the dividend rate next year when its performance improved.

Trading in Stock Market 1. Fundamental Analysis (Transaction) Fundamental analysis looks at the 'big-picture' in macro-fundamentals, where important factors such as inflation and interest rates are discussed. Micro-fundamentals take a look at the individual company and financial ratios. At the end of the day, an investor is in a position to decide if the share is under- or overvalued relative to the company's intrinsic value. Market value is determined on the fundamental value of the share => the price investors are prepared to pay for a share = present value of the future benefits which they expect the share to yield in the form of dividends, at a rate which they expect to earn on the equity of the firm. Constant dividend growth rate model: D1 P0 = ---------(k-g) where P0 = market price at time 0 D1 = dividend /share at the end of 1st period k = rate of return on equity expected by investors g = constant rate of growth in dividends/share/period. 2. Technical Analysis (or transaction timing) (Transaction) According to the prevailing sentiments in the market (bull/bear). Another method of market price determination is the Technical Analysis => price is determined by the demand for and supply of shares => notwithstanding the day-to-day fluctuations, share prices move in a discernible pattern and that these patterns last for long enough periods to be identified by them => based on the belief that by knowing the past prices of the shares, they can predict the future prices. Based on simple price charts such as bar charts and line charts before moving onto explaining simple moving averages and then technical indicators such as overbought and oversold, stochastic and RSI's.

Theories of Technical Analysis => 1. Dow Theory: propounded by Charles Dow of Dow Jones fame => got prominence after it predicted the big crash of the market just before the Great Depression of the thirties. 2. Odd Lot Theory: follow the strategy of a consistent winner or else the exact opposite the strategy of a consistent loser!!