Understanding Key Financial Instruments and Market Dynamics
Commercial Bill Market Operations
Commercial Bill Market in India: Operation Explained
The Commercial Bill Market in India is a sub-market of the money market, where short-term negotiable instruments called commercial bills (or bills of exchange) are traded. These are used primarily to finance working capital needs of businesses, especially for trade transactions.
How Commercial Bills Operate
Issuance of the Bill (Trade Transaction)
A seller (drawer) sells goods on credit to a buyer (drawee). To ensure payment, the seller draws a bill of exchange on the buyer, indicating the amount due and the payment date (usually 90 days or less). The buyer accepts the bill, committing to pay the amount on the maturity date.
Discounting of Bill
Instead of waiting for the due date, the seller may discount the bill with a commercial bank, i.e., sell it at a lower price for immediate cash. The bank deducts a discount rate (interest) and pays the seller the net amount.
Rediscounting (Optional)
The bank can rediscount the bill with other financial institutions (like SIDBI or NABARD) or with the RBI under certain schemes. This process adds liquidity to the banking system and helps spread risk.
Payment on Maturity
On the maturity date, the buyer pays the face value of the bill to the holder (bank or financial institution). If the buyer defaults, the responsibility falls back on the original seller (endorser).
Types of Commercial Bill Markets
Inland Bill Market
Deals with bills drawn and payable within India. Most common in domestic trade transactions. Used by Indian sellers and buyers for local credit purchases.
Example: A textile company in Gujarat selling goods on credit to a retailer in Delhi.
Foreign Bill Market
Involves bills drawn in India but payable outside India, or vice versa. Used in export and import transactions. Requires additional documentation like a letter of credit, and is subject to FOREX regulations.
Example: An Indian exporter draws a bill on a US-based importer payable in dollars.
Demand Bill Market
Involves bills payable on demand or at sight. No specific maturity period – payment is made as soon as the bill is presented.
Use Case: Common in situations where the buyer has agreed to pay immediately upon receiving the bill or goods.
Usance Bill Market
Deals with bills payable after a certain time period (e.g., 30, 60, 90 days). These bills are discounted by banks, and are widely used in trade finance.
Example: A company draws a 90-day usance bill for goods sold on credit.
Primary Bill Market
Where the original bill is created during a trade transaction. The first point where the seller draws a bill and it is accepted by the buyer.
Secondary Bill Market (Rediscount Market)
After being discounted by a commercial bank, the bill may be rediscounted with another financial institution or bank. This enhances liquidity and helps banks manage their short-term funds.
Understanding Book Building for Shares
When a company wants to raise money, it plans to offer its stock to the public. Companies all over the world use either fixed pricing or book building as a mechanism to price their shares. Over time, the fixed price mechanism has become obsolete, and book building has become the de-facto mechanism used in pricing shares while conducting an Initial Public Offer (IPO).
Book Building is basically a process used in an IPO for efficient price discovery. If the company is not sure about the exact price at which to market its shares, it can decide a price range instead of an exact figure. During the period for which the IPO is open, bids are collected from investors at various prices, which are above or equal to the floor price. The offer price is determined after the bid closing date. This process of discovering the price by providing the investors with a price range and then asking them to bid on it is called the book building process.
It is considered to be one of the most efficient mechanisms of pricing securities in the primary market. This is the preferred method recommended by all major stock exchanges and, as a result, is followed in all major developed countries in the world. The introduction of book building in India was done in 1995 following the recommendations of an expert committee appointed by SEBI. The committee recommended, and SEBI accepted in November 1995, that the book-building route should be open to issuer companies, subject to certain terms and conditions. In January 2000, SEBI came out with a compendium of guidelines, circulars, and instructions to merchant bankers relating to the issue of capital.
Features of the Money Market in India
The money market in India possesses several important features that distinguish it from other segments of the financial market. Here are some of the key features:
Short-Term Instruments
Money market instruments in India have short maturities, typically ranging from overnight to one year, making them highly liquid and suitable for short-term financial needs.
High Liquidity
Money market instruments are highly liquid, allowing investors to quickly convert them into cash or use them as collateral for borrowing, providing a crucial source of short-term liquidity.
Low Risk
These instruments are generally considered low-risk, particularly government-issued Treasury Bills, which are virtually risk-free. This makes them a safe haven for investors looking to preserve capital.
Regulation and Oversight
Money market activities in India are regulated and supervised by regulatory bodies such as the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) to ensure transparency, integrity, and investor protection.
Diverse Instruments
The money market encompasses a wide range of instruments, including Treasury Bills, Commercial Paper, Certificates of Deposit, Repos, and interbank call and notice money, providing flexibility to market participants.
Influence on Interest Rates
Money markets have a significant impact on short-term interest rates, which, in turn, affect the broader interest rate structure in the economy. This influence plays a vital role in monetary policy transmission.
Multiple Participants
Money market participants include commercial banks, financial institutions, corporations, mutual funds, government entities, and individual investors, contributing to market depth and liquidity.
Role in Monetary Policy
The money market serves as a channel for the implementation of monetary policy, allowing the central bank (RBI) to manage money supply, influence interest rates, and control inflation.
Continuous Trading
Money market instruments are actively traded in organized markets, providing participants with the opportunity to engage in buy and sell transactions on a continuous basis.
Predominance of OTC Markets
Over-the-counter (OTC) trading is common in the money market, where transactions take place directly between buyers and sellers, often facilitated by brokers.
Factors Influencing Stock Market Movements
The movement of stock markets is influenced by a complex interplay of various factors, reflecting the dynamic nature of financial markets. Here are some key factors that can impact movements of stock markets:
Economic Indicators
Economic data, such as GDP growth, employment figures, inflation rates, and manufacturing output, provide insights into the overall health of an economy. Positive economic indicators can boost investor confidence and drive stock prices higher, while negative indicators may lead to market declines.
Interest Rates
Central banks set interest rates, which influence borrowing costs, consumer spending, and corporate profits. Lower interest rates often stimulate economic activity and can be positive for stocks, while higher rates may increase the cost of borrowing and potentially dampen economic growth, affecting stock prices negatively.
Corporate Earnings
The financial performance of companies, as reflected in their earnings reports, is a fundamental driver of stock prices. Positive earnings growth and strong corporate fundamentals generally contribute to higher stock valuations, while declining earnings can lead to market declines.
Global Economic Factors
Global economic conditions, including international trade, geopolitical events, and currency fluctuations, can impact stock markets. Economic interconnectedness means that developments in one part of the world can have ripple effects on markets globally.
Market Sentiment
Investor sentiment, emotions, and perception of market conditions play a significant role in stock market movements. Positive sentiment can lead to buying activity, while negative sentiment may trigger selling. News, social media, and market rumors can heavily influence sentiment.
Government Policies
Government policies, including fiscal and monetary measures, taxation policies, and regulatory changes, can impact stock markets. For example, stimulus packages and accommodative monetary policies may boost markets, while regulatory changes or tax increases could have adverse effects.
Technological Advances
Technological innovations and disruptions can influence the performance of specific industries and companies, affecting their stock prices. Investors often respond to advancements in technology and changes in consumer behavior.
Natural Disasters and Pandemics
Unexpected events, such as natural disasters or pandemics, can have profound effects on economies and markets. For instance, the COVID-19 pandemic in 2020 triggered a global economic downturn and substantial market volatility.
Market Liquidity
The ease with which assets can be bought or sold without causing significant price fluctuations is a crucial factor. Low liquidity can lead to increased volatility and wider bid-ask spreads, impacting stock prices.
Psychological Factors
Behavioral finance plays a role in stock market movements. Psychological factors, such as fear, greed, and herd behavior, can drive market trends. Emotional reactions to news and events can lead to abrupt and sometimes irrational market movements.
ADR vs. GDR: A Comparison
Acronym
ADR: American Depository Receipt
GDR: Global Depository Receipt
Meaning
ADR: A negotiable instrument issued by a U.S. bank, representing non-U.S. company stock, trading in the U.S. stock exchange.
GDR: A negotiable instrument issued by an international depository bank, representing foreign company stock trading globally.
Relevance
ADR: Allows foreign companies to trade in the U.S. stock market.
GDR: Allows foreign companies to trade in any country’s stock market other than the U.S. stock market.
Issued In
ADR: United States domestic capital market.
GDR: European capital market.
Disclosure Requirement
ADR: Onerous (strict disclosure requirements).
GDR: Less onerous (less strict).
Market
ADR: Retail investor market.
GDR: Institutional market.