6.debt Market and Forex Market-Theoritical
6.debt Market and Forex Market-Theoritical
6.debt Market and Forex Market-Theoritical
Importance:
Though we will not discuss Bonds in Detail here but Bonds are part of Debt markets. Bonds are part of
separate document
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Contents
1 Financial Markets in India .................................................................................................... 4
2 Money Markets relation to Debt Markets............................................................................... 5
3 Equity and Debt Markets ..................................................................................................... 5
3.1 Features of Debt Capital................................................................................................ 6
3.2 Making a Choice between Debt and Equity Capital............................................................ 7
4 Basic Concept of Debt Capital ............................................................................................... 8
5 Types of Debt Instruments ................................................................................................... 9
5.1 Government and Private Sector Debt Instruments ...........................................................10
5.2 Money Market Securities – Short Term Debt Instruments .................................................11
5.2.1 Treasury Bills T-Bills ..............................................................................................11
5.2.2 Certificate of Deposit............................................................................................12
5.2.3 Commercial Paper................................................................................................13
5.2.4 Repo and Reverse Repo ........................................................................................15
5.3 Long Term Debt Instruments ........................................................................................17
6 Hybrid Instrument – Convertible Debentures .........................................................................18
7 How des Company Issue Debt? ............................................................................................19
8 Types of issues in Primary Debt Market.................................................................................20
8.1 Public Issue ................................................................................................................20
8.1.1 Eligibility .............................................................................................................21
8.1.2 Base Issue Size.....................................................................................................21
8.1.3 Offer Document...................................................................................................21
8.1.4 Shelf Prospectus ..................................................................................................21
8.1.5 Listing of Securities ..............................................................................................21
8.1.6 Credit Rating .......................................................................................................21
8.1.7 Minimum Subscription..........................................................................................21
8.1.8 Dematerialization.................................................................................................22
8.1.9 Debenture Trustees..............................................................................................22
8.1.10 Debenture Redemption Reserve.............................................................................22
8.1.11 Creation of Securities ...........................................................................................22
8.2 Private Placement .......................................................................................................22
9 Forex Markets ...................................................................................................................23
9.1 Forex Market Structure in India.....................................................................................23
9.2 Sources of Demand and Supply for Foreign Exchange .......................................................24
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9.3 Foreign Exchange Management Act ...............................................................................24
10 MCQ’s (Multiple Choice Questions) ...................................................................................27
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1 Financial Markets in India
Financial market consists of various types of markets such as Money Markets and Capital Markets
Financial Market
Equity Debt
1. Money markets are used for a short-term basis, usually for assets up to one year.
2. Capital markets are used for long-term assets, which are any asset with maturity greater than one
year. The capital markets provide a regulated institutional framework for an efficient flow of capital
(equity and debt) from investors to business in the financial market system. It provides a channel for
allocation of savings to investments. Thus, the savings of households, business firms and
government can be channelized through the medium of Capital market to fund the capital
requirements of a business enterprise
3. Forex Market are the markets where currencies are traded with each other
In this document we will discuss about Money Markets, Debt Markets and Forex Markets. Equity
Markets are discussed in a separate Lesson.
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2 Money Markets relation to Debt Markets
In the above section we have differentiated that money markets are different from debt market. But in
reality debt can be of two types
Debt
1. Short term debt instruments which is less than 1 year is also called Money Market
2. Other type is long term debt which is greater than 1 year
1. Equity capital is available for the company to use as long as it is needed; debt capital will
have to be returned after the specified time.
2. Equity investors do not enjoy any fixed return or return of principal invested; debt
investors earn a fixed rate of interest and return of principal at maturity.
3. Equity investors are owners of the business; debt investors are lenders to the business
4. Equity investors participate in the management of the business; debt investors do
not.
Due to these fundamental differences in equity and debt securities, they are seen as two
distinct asset classes from which investors make a choice.
1. Equity represents a risky, long-term, growth oriented investment that can show a high
volatility in performance, depending on how the underlying business is performing.
There is no assurance of return to the equity investor, since the value of the investment
is bound to fluctuate.
2. Debt represents a relatively lower risk, steady, short-term, income-oriented investment.
It generates a steady rate of return, provided the business remains profitable and does
not default on its payments.
3. Since all residual benefits of deploying capital in a profitable business go to the equity
investor, the return to equity investor is likely to be higher than that of the debt
investor.
4. For example, if a business borrows funds at 12% and is able to earn a return of 14% on
the assets created by such borrowing, the debt investor receives only 12% as promised.
But the excess 2% earned by the assets, benefits the equity investor. The downside also
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hurts the equity investor, who may not earn anything if the return is lower than the
borrowing cost and if the business is failing
Choosing between equity and debt is a trade-off. Investors desiring lower risk, and willing to
accept a lower stable return choose debt; if they seek a higher return, they may not be able to
earn it without taking on the additional risk of the equity investment. Most investors tend to
allocate their capital between these two choices, depending on their expected return, their
investing time period, their risk appetite and their needs. This process of distributing their
investible surplus between equity and debt is called asset allocation
2. Floating or Fixed rate of interest: Some instruments pay a fixed rate of Interest like your
Fixed Deposit in the bank but there are some instruments which pay floating rate of
interest. This means, the amount of periodic interest payment will vary, depending on
the level of a pre decided interest rate benchmark. The benchmark is usually a market
interest rate such as the MIBOR (Mumbai Interbank Offer Rate). The lender and
borrower agree to refer to the benchmark at a specific reset frequency, say once in six
months, and set the rate until the next reset date, based on the level of the benchmark
3. Credit Rating: Lenders may not have access to complete information about how a
business is performing, since they are outsiders to the company. The company appoints
a credit rating agency to evaluate its ability to service a debt security being offered, for
its ability to meet interest and principal repayment obligations. The rating agency
assigns a credit rating for the debt instrument, indicating the ability to service debt. This
rating is used in the borrowing program to assure lenders that an external professional
evaluation has been completed
4. Priority: Interest to lenders is paid before taxes and before any distribution to equity
investors. Interest payment is an obligation, which if not met will be seen as a default. A
default in payment of interest and/or principal will hurt the credit rating of the
borrower and make it tough for them to raise further capital. If there is a failure of the
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business, lenders will receive their settlement before other stakeholders such as
employees and equity investors
6. Conversion: Lenders may seek a conversion of their debt into equity. This can be done
either through the issue of convertible debentures by means of which the outstanding
debt will be converted into equity at a specific date, price and time. It should be noted
that interest payments are made to the lenders till the date of conversion, after which
the holdings are treated as equity shares with all rights associated with them, and there
are not more rights as lenders. We will discuss about convertible debentures later in
detail in this document
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4. Time period for which Capital is required: If capital is required to tide over short-term
capital requirements, a firm may choose debt capital for such needs. It is common for
businesses to borrow from banks or issue debt instruments to fund working capital. If
there is a long-term need and if debt investors are unwilling to take the risk, a firm issues
equity capital
Alternately, it can access a larger pool of investors by breaking up the loan amount into smaller
denominations. Each investor lends small amount of money. The lending exposure of each
investor is limited to the extent of his investment.
The people who invest small chunks of money are called Lenders/Investors and Company who
is the borrower is also called Issuer. It is called issuer because a company issue securities in
return for money also called debt security.
A debt security denotes a contract between the issuer (company) and the lender (investor)
which allows the issuer to borrow a sum of money at pre -determined terms. The terms below
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are referred to as the features of a debt security and include the principal, coupon and the
maturity of the security:
1. Principal The principal is the amount borrowed by the issuer. The face value of the
security is the amount of the principal that is due on each debt security. Each investor,
therefore, is owed a portion of the principal represented by his investment. So if an
investor invests Rs. 100 then he might get 1 debt security with face value of 100. He
might also get 10 debt securities with face value of 10 to make it a total of 100. So it all
depends on the face value of each debt security and amount you are investing
2. Coupon: The coupon is the rate of interest paid by the borrower. The interest rate is
usually specified as a percentage of face value, and depends on factors such as the risk
of default of the issuer, the credit policy of the lender, debt maturi ty and market
conditions. The periodicity of interest payment (quarterly, semi-annually, annually) is
also agreed upon in the debt contract. For example if the coupon rate is 10% annual on
the debt security of face value 100 it means the person will get 10% of 100 = 10 each
year
3. Maturity: The maturity of a bond refers to the date on which the contract requires the
borrower to repay the principal amount. Once the bond is redeemed or repaid, it is
extinguished and ceases to exist. For example if the maturity of debt security is 10 years
from now then it means after 10 years the borrower will return back the money
(Principal) to the investor
4. Example: Company XYZ has to borrow 100 crores from the people. Obviously one person cannot
lend such a huge amount of money but various people can contribute small amount to make it a
total of 100 crores. Company in this case may issue securities with face value of 1000. So person
who wants to lend 1000 may buy one security and a person who wants to lend 2000 may buy
two securities and so on….
The issue security provided by company has face value of 1000 and coupon rate of 10% annual
and maturity date of 10 years from now. Then
1. Principal amount for each security is 1000
2. Coupon rate is 10% which means investor would get 10% of 1000 = 100 each year as interest
3. Maturity date is 10 years from now which means person would get interest of 100 each year
for next 10 years after which the principal of 1000 would be returned back
5. All the debt securities are listed on stock exchange and can be bought and sold like shares
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Debt Instruments
Commercial Paper
And Bonds – Also knows
Treasury Bills Repo and Reverse Repo Bonds
Certificate of as Debentures
Deposit
1. Debt Instruments can be short term or long term debt. Short term are basically less than 1 year
and long term are typically longer than 1 year
2. Short Term Market for Debt Instruments is also called Money Market
3. Both Government and Private Sector issue Debt instruments in the short and long term duration
debt
4. We will discuss various instruments issued by Government and Private Sector in the Long term
and short term duration debt market. But before that we will discuss the distinction between
government and Private Debt instruments
Government Securities include central government bonds, as well as quasi-government bonds issued by
local governments, state governments and municipal bodies. Government securities are considered to
be free of credit or default risk. This is because the government can unilaterally increase taxes to repay
its obligations, borrow easily from other entities, or print notes to repay debt in the extreme case .
Government issues Treasury Bills in short term market and Bonds in the Long term market. G-secs are
issued through an electronic auction system managed by the Reserve Bank of India. The RBI
publishes a half-yearly issuance calendar that gives market participants information about the
amount and tenor of g-secs to be auctioned in that year, along with approximate auction times.
G-Secs are mandated to be listed as soon as they are issued. They constitute the most liquid
segment of the Indian long-term debt market. Over 90% of the trading activity in this market is
accounted by g-secs
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Corporate bond markets are dominated by short-term commercial papers and long-term bonds. Banks
issue short-term debt securities called certificates of deposit. The rate at which corporates, banks and
institutions borrow depends upon the credit quality of the borrower. The credit or default risk of the
borrower is measured by the credit rating of the bond. Higher the credit rating, lower the risk of default
The interest rate on G-secs sets the benchmark for pricing corporate bonds of varying
maturities. Since government borrowing is considered to be free of credit risk, all other
borrowers in the system borrow at a spread over the relevant G-sec benchmark rate. For
example, if the 10-year G-sec rate is 8.4%, then a company that issues 10 year bonds will pay a
higher rate than this benchmark. This premium reflects the additional credit risk faced b
investors in corporate debt
Private Companies also raise fixed deposits from the retail investors to meet their borrowing
requirements. Such deposits are for a fixed term and carry a pre -defined interest rate.
Company deposits are credit rated but unsecured borrowings of companies. Since these are
deposits and not a debt security, they cannot be traded over stock exchange and hence there is
no liquidity. The investors hold the deposits to maturity
The central government borrows extensively in the money market for its daily operations
through the issue of short-term debt securities called Treasury bills (T-bills). They are
predominantly issued to fund the fiscal deficit of the government. T-bills are issued for
maturities of 91 days, 182 days and 364 days. They are issued through an auction process
managed by the RBI and listed soon after issue. Banks, mutual funds, insurance companies,
provident funds, primary dealers and FIs bid in these auctions
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Advantages of Treasury Bills
1. The biggest reason that T-Bills are so popular is that they are one of the few money market
instruments that are affordable to the individual investors. Treasury bills are available for a
minimum amount of Rs. 25,000 and in multiples of Rs. 25,000
2. Other positives are that T-bills (and all Treasuries) are considered to be the safest
investments in the world because the government backs them. In fact, they are
considered risk-free.
3. The secondary market of T-Bills is very active so they have a higher degree of tradability
4. Transparency
5. High liquidity because 91 days and 364 days are short term maturity
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. A certificate of deposit or what
is nothing but money market instruments that are issued by banks and select financial
institutions in lieu of the money that is deposited. They bear a specific maturity date, a
specified interest rate. Like all time deposits, the funds may not be withdrawn on demand like
those in a checking account.
CDs offer a slightly higher yield than T-Bills because of the slightly higher default risk for a bank
but, overall, the likelihood that a large bank will go broke is pretty slim. Of course, the amount
of interest you earn depends on a number of other factors such as the cu rrent interest rate
environment, how much money you invest, the length of time and the particular bank you
choose. While nearly every bank offers CDs, the rates are rarely competitive, so it's important
to shop around
For financial institutions the norms are slightly different, in the sense that the CDs should not
be issued for a period less than one year and not exceeding three years from the date of issue.
CDs that are not held in the electronic form can be freely transferred by j ust endorsement and
delivery. CDs in demat form can be transferred as per the procedure applicable to other demat
securities.
It's also important to note that loans cannot be granted against certificate of deposits. The CDs
may be presented for payment by the last holder.
Conclusion:
Certificate of deposits cannot be issued by all and sundry. There are a stipulated set of
institutions that can issue the same. Interest rates on these CDs are most likely to be pretty
competitive to interest rates that we get on government securities.
In fact, it could be marginally higher than that depending on the credibility and the market
movement of interest rates. Since these are issued by banks and institutions credibility and
repayment would not matter too much.
We wish to emphasize that these CDs are not for the common man and are generally applied
for by the institutions in the country
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 .
Since it is not backed by collateral, only firms with excellent credit ratings from a recognized
rating agency will be able to sell their commercial paper at a reasonable price
Update: Recently RBI said the issuer must receive at least two ratings from a credit agency, and would
have to assign the lower rating from these ratings to the CP, instead of only one rating required earlier
The Reserve Bank of India (RBI) issued revised guidelines for commercial paper, including mandating
that the issuer must disclose the end-use of such funds and that it cannot buy back its securities before
60 days from the sale to investors.
The central bank, in a circular, added the issuer will also need to ensure that proceeds from CP issuance
are used to finance only current assets and operating expenses
CP issuers must now also keep any lender from which it has outstanding loans informed about such
market borrowing
1. "Repo" means an instrument for borrowing funds by selling securities with an agreement to
repurchase the securities on a mutually agreed future date at an agreed price which includes
interest for the funds borrowed
2. "Reverse repo" means an instrument for lending funds by purchasing securities with an
agreement to resell the securities on a mutually agreed future date at an agreed price which
includes interest for the funds lent."
This is the general definition of Repo and Reverse Repo in India. The securities transacted here can be
either government securities or corporate securities or any other securities which the Central bank
permits for transaction. Non-sovereign securities are used in many global markets for repo operations.
Unlike them, Indian repo market predominantly uses sovereign securities, though repo is allowed on
corporate bonds and debentures
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Structure of Repo and Reverse Repo
I. In the first leg seller sells securities and receives cash while the purchaser buys securities and
parts with cash
II. In the second leg, securities are repurchased by the original holder. He pays to the counter
party the amount originally received by him plus the return (Interest) on the money for the
number of days for which the money was used by him, which is mutually agreed
III. The duration between the two legs is called the ‘repo period’
IV. The consideration amount in the first leg of the repo transactions is the amount borrowed by
the seller of the security. Suppose seller sells the securities to the buyer in Rs. 1000 then seller
is borrowing 1000 from the buyer. Sometimes the buyer does not give the buyer the whole
amount and keeps certain amount as margin. This is called haircut. In our example suppose
buyer pays only 900 to the seller and keeps 100 as the haircut amount. The haircut amount is
security in case the value of securities decreases and seller does not buy back the securities in
the second leg. In case seller does not buyback in second leg then buyer has to sell them to
some other person at lower prices
V. The interest paid in the second leg is calculated on the basis of the repo rate agreed at the start
of the contract
VI. A repo is also called a ready forward transaction as it is a means of funding by selling a security
held on a spot (ready) basis and repurchasing the same on a forward basis.
VII. Some people see Repo’s as mixture of selling/purchasing of securities and Collateral Based
Lending. The use of haircut makes it more of collateral based lending. On the other hand the
repo buyer's right to trade the securities during the term of the agreement, by contrast,
represents a transfer of ownership that typically does not occur in collateralized lending
arrangements.
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The reverse of the repo transaction is called ‘reverse repo’. In a reverse repo transaction, the securities
should be purchased in the first leg at prevailing market prices and sold in the second leg at the
derived/calculated prices. When the reverse repurchase transaction matures, the counterparty returns
the security to the entity concerned and receives its cash along with a profit spread. One factor which
encourages an organization to enter into reverse repo is that it earns some extra income on its
otherwise idle cash. In short when a repo takes place it’s a reverse repo from the buyer’s perspective
Types of Repo
1. Overnight Repo: The maturity Contract with 1 day maturity is called Overnight repo
2. Term Repo: The maturity Contract with certain specified contract date more than 1 day is
called Term Repo
3. Open Repo: The maturity Contract with no specified contract date is called Term Repo
Some have also argued that debentures are secured debt instruments, while bonds are
unsecured. These differences have vanished over time. The terms, bonds and debentures are
usually used interchangeably these days. So in this document bonds and Debentures would
mean the same thing
The market for long term corporate debt is made up of two segments:
a. Bonds issued by public sector units (PSU), including public financial institutions, and
b. Bonds issued by the private corporate sector
PSU bonds can be further categorized as taxable and tax-free bonds. Tax-free bonds are mainly
issued by PSUs in the infrastructure sector. The government may authorize specific PSUs to
issue tax-free bonds. Interest income earned from tax-free bonds is not taxable for the investor.
Another category of PSU bonds, called capital gains bonds, are issued by National Highway
Authority of Indian (NHAI), NABARD and National Housing Bank and such specifically notified
entities. Investment in capital gain bonds allows investors to save tax on long-term capital gains
under Section 54 EC of the Indian Income Tax Act
PSU and institutional bonds dominate overall issuance in the corporate bond market. In terms
of sectors, the financial sector accounts for around 70% of total bond issuance and the
manufacturing sector accounts for the remaining 30%.
Corporate bonds are issued at a spread to the G-sec yield. The difference between the two
yields is called credit spread. Credit spread depends on the credit rating and the expected
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default probability associated with the issuing company, its industry of operation as well the
overall credit and liquidity situation in the economy. Higher the credit rating, lower the credit
spread and lowers the rate at which bonds can be issued
For more details on the “Bonds’ i.e. long term securities we have different document which you
can read after finishing this document
Convertible debentures are debt instruments that can be converted into equity shares of the
company at a future date. The security has features of both debt and equity. It pays periodic
coupon interest just like any other debt instrument
At the time of redemption of the debenture, the investors can choose to receive shares of the
company instead of return of principal invested. The issuer specifies the details of the
conversion at the time of making the issue. This will include
1. The date on which the conversion will be made
2. The ratio of conversion i.e. the number of shares that the investor will be eligible to get
for each debenture
3. The price at which the shares will be allotted to the investor on conversion. Usually this
is at a discount to the market price
4. The proportion of the debenture that will be converted into equity shares
Debentures may be fully convertible debentures (FCD) where the entire face value of the
debenture is converted into equity shares or they may be partly convertible debentures (PCD)
where a portion of the debenture is converted into equity. The non -convertible portion will
continue to remain as debentures, earn interest income and will be repaid on redemption
Optionally convertible debentures (OCDs) are convertible into equity shares at the discretion
of the debenture holders. They may choose to convert into equity, or continue to hold the
instrument as debt depending on their need, and the terms of conversion
The advantage to the issuer of convertible debenture lies in the fact that convertible
debentures usually have a lower coupon rate than pure debt instruments. This is because the
yield to the investor in such debenture is not from the coupon alone but also the possibility of
capital appreciation in the investment once the debentures are converted into equity.
Moreover, the issuer does not have to repay the debt on maturity since shares are issued in lieu
of repayment. The disadvantage to this is that stakes of the existing shareholders get diluted
when fresh shares are issued on conversion. As more shareholders come in, the proportionate
holding of existing shareholders will fall
The advantages to investors in a convertible debenture are of equity and debt features. They
earn coupon income in the initial stages, usually when the company’s project is in its nascent
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stage. Once the debenture is converted into shares, the investor may benefi t from the
appreciation in the value of the shares
Markets
Primary Secondary
1. When Company issues debt to people or certain private individuals it is called Primary Market.
The primary market refers to the market where equity or debt capital is raised by issuers
from public investors through an offer of securities. It is called the primary market
because investors purchase the security directly from the issuer. It is also cal led the
“new issue market” where securities are issued for the first time. The process of
expanding the ability of an issuer to raise capital from public investors, who may not
have been associated with the initial stages of the business, is also known as “going
public.” The issuance of securities in the primary markets expands the reach of an issuer
and makes long-term capital available to the issuer from a larger number of investors
2. When one person buy/sell from another person it is called secondary market. Company has no
role in the secondary market
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Securities are listed on the stock exchange after the public issue, so they can be traded
between investors who may like to buy or sell them. The stock market is also called the
secondary market, because investors purchase and sell securities among themselves,
without engaging with the issuer. While the primary market enables the issuer to raise
capital, the secondary market enables liquidity for securities bought by investors to
subscribe to such capital. Secondary markets also enable new investors to purchase
securities from the existing investors, who may like to sell the securities. Activities in the
secondary market do not modify the capital available to the issuer
A company can make a public issue of debt securities, such as, debentures by making an offer
through a prospectus. The issue of debt securities is regulated by the provisions of the
Companies Act and SEBI’s Issue and Listing of Debt Securities Regulations, 2008. The company
will appoint a lead manager who will ensure compliance with all the regulatory requirements
for the issue
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8.1.1 Eligibility
A public issue of debt securities is possible by a company registered as a public limited company
under the Companies Act, 2013. An unlisted company, in other words a company that has not
made an initial public offer of its shares and listed the shares on a stock exchange, can make a
public issue of debentures and list them on a stock exchange
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8.1.8 Dematerialization
The issuer has to enter into an agreement with a depository f or dematerialization of the
securities proposed to be issued
1. Investors are better informed and there are less regulatory compliances in issuances to
them
2. Issuing securities is less time consuming and cost-efficient since there are fewer
procedures
According to the Companies Act of 2013, an offer to subscribe to securities is made to not more
than 50 persons is called private placement of securities. The requirements of SEBI’s regulations
with respect to a public issue will not apply to a private placement
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9 Forex Markets
Although the document is on Debt Markets but we are including the Forex market related informat ion in
this document itself and Forex Market is not a big topic.
Forex, also known as foreign exchange, FX or currency trading, is a decentralized global market where
the entire world's currencies trade. The forex market is the largest, most liquid market in the world with
an average daily trading volume exceeding $5 trillion. All the world's combined stock markets don't even
come close to this
The foreign exchange market is the "place" where currencies are traded. Currencies are important to
most people around the world, whether they realize it or not, because currencies need to be exchanged
in order to conduct foreign trade and business. If you are living in the U.S. and want to buy cheese
from France, either you or the company that you buy the cheese from has to pay the French for the
cheese in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value
of U.S. dollars (USD) into euros. The same goes for traveling. A French tourist in Egypt can't pay in euros
to see the pyramids because it's not the locally accepted currency. As such, the tourist has to exchange
the euros for the local currency, in this case the Egyptian pound, at the current exchange rate
One unique aspect of this international market is that there is no central marketplace for foreign
exchange. Rather, currency trading is conducted electronically over-the-counter (OTC), which means
that all transactions occur via computer networks between traders around the world, rather than on
one centralized exchange. The market is open 24 hours a day, five and a half days a week, and
currencies are traded worldwide in the major financial centers of London, New York, Tokyo, Zurich,
Frankfurt, Hong Kong, Singapore, Paris and Sydney - across almost every time zone. This means that
when the trading day in the U.S. ends, the forex market begins anew in Tokyo and Hong Kong. As such,
the forex market can be extremely active any time of the day, with price quotes changing constantly
3. The Reserve Bank intervenes in the market essentially to ensure orderly market conditions. The
Reserve Bank undertakes sales/purchases of foreign currency in periods of excess
demand/supply in the market. Foreign Exchange Dealers’ Association of India (FEDAI) plays a
special role in the foreign exchange market for ensuring smooth and speedy growth of the
foreign exchange market in all its aspects. All ADs are required to become members of the FEDAI
and execute an undertaking to the effect that they would abide by the terms and conditions
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stipulated by the FEDAI for transacting foreign exchange business. The FEDAI is also the
accrediting authority for the foreign exchange brokers in the interbank foreign exchange market
On the other hand, the demand for foreign exchange emanates from
On many occasions, the pressure on exchange rate through increase in demand emanates from
“expectations based on certain news”. Sometimes, such expectations are destabilizing and often give
rise to self-fulfilling speculative activities. The role of the Reserve Bank comes into focus during such
times when it has to prevent the emergence of such destabilizing expectations. In such cases, recourse is
undertaken to direct purchase and sale of foreign currencies, sterilization through open market
operations, management of liquidity under liquidity adjustment facility (LAF), changes in reserve
requirements and signaling through interest rate changes
The main objective behind the Foreign Exchange Management Act (1999) is to consolidate and amend
the law relating to foreign exchange with objective of facilitating external trade and payments and for
promoting the orderly development and maintenance of foreign exchange market in India
FEMA is applicable to the all parts of India. The act is also applicable to all branches, offices and agencies
outside India owned or controlled by a person who is resident of India.
FERA, in place since 1974, did not succeed in restricting activities such as the expansion of Multinational
Corporations. The concessions made to FERA in 1991-1993 showed that FERA was on the verge of
becoming redundant. After the amendment of FERA in 1993, it was decided that the act would become
the FEMA. This was done in order to relax the controls on foreign exchange in India. FEMA served to
make transactions for external trade and easier – transactions involving current account for external
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trade no longer required RBI’s permission. The deals in Foreign Exchange were to be ‘managed’ instead
of ‘regulated’. The switch to FEMA shows the change on the part of the government in terms of for the
capital
FERA was repealed in 1998 by the government of Atal Bihari Vajpayee and replaced by the Foreign
Exchange Management Act, which liberalized foreign exchange controls and restrictions on foreign
investment
Activities such as payments made to any person outside India or receipts from them, along with the
deals in foreign exchange and foreign security is restricted. It is FEMA that gives the central
government the power to impose the restrictions.
Without general or specific permission of the MA restricts the transactions involving foreign
exchange or foreign security and payments from outside the country to India – the transactions
should be made only through an authorized person.
Deals in foreign exchange under the current account by an authorized person can be restricted by
the Central Government, based on public interest generally.
Although selling or drawing of foreign exchange is done through an authorized person, the RBI is
empowered by this Act to subject the capital account transactions to a number of restrictions.
Residents of India will be permitted to carry out transactions in foreign exchange, foreign security or
to own or hold immovable property abroad if the currency, security or property was owned or
acquired when he/she was living outside India, or when it was inherited by him/her from someone
living outside India.
FEMA is applicable to Individuals (you and me!), HUFs, companies, firms and AOPs and BOIs.
FEMA is applicable to a person ‘Resident’ in India – as opposed to FERA’s citizenship criteria – which
means if the status of any person, who is a citizen of India or not, is ‘Resident’ he or she shall be
covered under the FEMA for any forex transaction as per the given provisions.
Under FEMA – a person, who has been residing in India for more than 182 days, will be considered
a ‘Resident’!
‘Currency’ under FEMA includes debit cards, ATM cards and credit cards too!
FEMA treats offences committed under the Act as civil offences.
We are permitted by RBI to buy forex from Post Offices in the form of postal/ money orders! Easy
availability in the time of emergency requirements!
Any monetary transaction with Nepal or Bhutan – in rupees – these two countries recognize and
accept ‘Rupees’ – will not fall under FEMA!
‘Capital Account’ transactions are those transactions which alter the assets and liabilities of a
person – buying/ selling of foreign securities, borrowing/ lending of loans, purchase/ sale of
immovable properties etc – and all these being across national boundaries!
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‘Current Account’ transactions are those other than capital and are mostly personal in nature like
remittances for living expenses for studies/ medical treatment abroad, foreign travel, for business
etc.
Current Account transactions are categorized into three explicitly drawn out categories which spell
out the transactions allowed and not allowed.
I. Those which are prohibited by FEMA,
II. Those which require Central Government’s permission,
III. And those which require RBI’s permission.
Prohibited Current Account transactions (V. Imp!!!!) – you can’t draw foreign exchange for:-
1. Forex can’t be drawn for making payment to any person in Nepal or Bhutan! Use Rupees!
2. Remitting lottery winnings outside India. Remitting any income from winning in any races/ horse
races/ hobbies etc.
3. You can’t remit any money outside India for the purchase of lottery tickets, or banned
magazines, sweepstakes, betting etc.
1. For infrastructure projects – if the consultancy is taken from outside India and the remittance for
such exceeds USD 1,00,00,000 per project.
2. For any other projects – if the consultancy is taken from outside India and the remittance for such
exceed USD 10, 00,000.
3. Approval of RBI needed to release forex in excess of USD 10,000 in one financial year.
4. Approval of RBI needed for gift/ donation remittances in excess of USD 5,000 in one financial year,
per remitter or donor (the receiver of the gift remittance)
5. Exceeding USD 1, 00, 000 for persons going abroad for employment/ emigration.
6. Exceeding USD 25,000 for business travel, attending conference etc.
7. Medical treatment abroad – based on doctor’s estimate of expenses – if doctor’s estimate exceeds
USD 1,00, 000 – then no approval is required.
The limit under Liberalised Remittance Scheme, has been increase to USD 2,50,000 per financial
year for permissible current or capital account transaction or a combination of both, whereby all
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resident individuals, including minors, are allowed to freely remit to that extent – the increase came
in 2015
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