CAPITAL MARKET

PRELIMS MASTER PROGRAM 2025

ECONOMY-8
GS FOUNDATION 2025
ECONOMY BOOKLET-26
1. TABLE OF CONTENTS
1. Table of Contents ..................................... 0 10) Participatory Notes (P-Notes) .......... 10
2. Capital Market – Fundamentals: .............. 1 11) Global Depository Receipts ............. 11
1) Key differences between Shares, 3. Debt Securities........................................ 11
Debentures and Bonds ................................ 1 1) What is a Debt market? ...................... 11
2) Shares (Equity, Preference, Derivatives) 2 2) Inflation indexed Bonds ...................... 12
A) Equity Shares ................................................... 2
B) Preference Share ............................................. 2 3) Convertible Bonds............................... 12
C) Derivatives ....................................................... 2
4) Masal Bond ......................................... 13
3) Government and Industrial Securities .. 3
A) Government Securities Market ........................ 3 5) What is money market? ...................... 13
B) Indutrial Securities Market .............................. 3
6) Advantage of Debt Security for Investors
4) New (Primary) Issue Market and Old 14
Issue (Secondary) Market ............................ 4
7) Importance of Debt market to the
5) Stock Exchanges ................................... 5 economy: ................................................... 14
A) Index ................................................................ 6
8) different types of Risks associated with
6) Index Providers .................................... 6 debt securities ............................................ 14
A) SEBI notified the 'Sebi Index Provider
Regulations' (March 2024) ........................................ 7 9) Debt Security market Structure ........... 14
7) Depositories ......................................... 7 10) Who regulates fixed income market
(Debt Security Market)? ............................. 14
8) SEBI (Securities and Exchange Board of
India) ........................................................... 7 11) RBI Retail Direct (RBI-RD) Scheme ... 15
9) Related Terms ...................................... 8 12) Bond Analytics ................................ 15

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4. PYQs .......................................................16

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 2. CAPITAL MARKET – FUNDAMENTALS:

▫ A capital market is the financial market for long term fund. It helps to generate bulk fund for government
and industries.

▫ The most common capital markets are the stock market and the bond market.
▫ The stock market allows companies to raise capital by selling shares of ownership in the company
(Equity Financing).
▫ The Bond Market allows companies and governments to raise capital by selling bonds (Debt
Financing).

▫ Securities Market deals with shares (equity shares, preference shares, derivatives) and debt instruments.
▫ In case of Shares (Equity financing), investors have a share in the capital and profit.

▫ In case of Debt Financing Instruments, the investors don’t have any share in the capital.
» Companies use Debt Financing instruments (bonds, debentures) to raise funds.
» It is just lending to the company, and the company is liable to pay interest on the capital
borrowed through bonds. Regardless of profit and loss the debt instrument holders are entitled
to receive income.

» Note: Debentures are a type of bond. Any unsecured bond without any collateral is a
debenture.
§ All debentures are bonds, but not all bonds are debentures. Whenever a bond is
unsecured, it may be referred as debentures.

» Note: Both bonds and debentures may be convertible (meaning that they can be converted into
company stocks)

1) KEY DIFFERENCES BETWEEN SHARES, DEBENTURES AND BONDS

Shares Debentures Bonds

Shares are fractions of the Debentures are medium/long Bonds are long term debt
company’s capital. term debt instruments that a instruments that companies
company issues to borrow capital. issue to borrow capital.
Performance of shares is highly Debentures are risky investments Bonds are safer investment
dependent on market as they are usually not backed by option, as it is backed by
fluctuation. collateral. collateral.
Investor makes investment
decision on the basis of credit
rating and reputation of the
company.

Shareholders are company Debenture holders are lenders to Bond holders are lenders to the
owners who own the fraction of the company. company.

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 company equivalent to fraction
of shares held by them.
The company may pay dividend Debenture holders receive Bond owners receive interest on
to the shareholders in case the interest payments periodically. It accrual basis. It doesn’t depend
company makes profit. depends on issuing company’s on the company’s performance.
performance.

Shares are highly liquid as they Debentures has lower liquidity Bonds have the least liquidity as
can be sold or purchased on when compared to shares these are long term debt
stock exchanges. instruments.

Shares don’t have credit rating. Debentures receive credit rating Bonds receive credit ratings from
from CRAs. CRAs.

2) SHARES (EQUITY, PREFERENCE, DERIVATIVES)

A) EQUITY SHARES

▫ Equity shares are ordinary stocks issued by a company for the purpose of raising capital to expand their
business. The investor gets partial ownership of the company. The number of equities shares an investor buy
is their portion of ownership in the company. Equity shares are non-redeemable and therefore act as a long-
term source of financing for companies.

▫ Benefits: Capital Appreciation; Dividends.

▫ However, these benefits are not fixed and are fluctuating.

B) PREFERENCE SHARE
▫ Preference shares carry preferential rights in terms of dividend payment and repayment of capital.
▫ These shares offer shareholders fixed dividends.
▫ Preferred shareholders are given their dividends before equity shareholders receive theirs.
▫ In terms of priority and repayment of capital, preference shares can be ranked between debt and
equity.
▫ In case of bankruptcy, preferred shareholders get priority over common shareholders and receive the
company’s assets before them.
▫ At any point of time, preference shares can be converted into equity shares.
▫ Preference shares can be redeemed after a certain period or after the company successfully achieves
desired goals.

▫ Limitations: Preference shareholders don’t get right to vote or participate in decision-making events of
the company.

C) DERIVATIVES

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 ▫ Derivatives are vastly different equity stocks. They are contracts that derive their value from an
underlying asset – which could be an equity stock, a currency pair or a commodity. This leads to different
types of securities like equity derivatives, commodity derivatives, and currency derivatives.

▫ Derivatives can also be classified as futures and options based on the terms of contract.
▫ Futures: In a future contract, two parties decide to purchase and sell the underlying asset at a
specific price on a specific date in the future. This contract must be executed by both parties, and
neither party has the right to let the contract expire.

▫ Options: Options contract also derives its value from an underlying asset. It gives the holder (or the
buyer) of the options contract the right to purchase or sell the underlying asset at a fixed price on
or before a specific date. The options buyer is not obligated to carry out the terms. Options contracts
can be any one of two types – namely, call options that offer the right to buy the asset and put
options that offer the right to sell the asset.

3) GOVERNMENT AND INDUSTRIAL SECURITIES

▫ Based on the fund raised, the securities market can be classified into two types: 1) Government Securities
Market 2) Industrial Securities Market

A) GOVERNMENT SECURITIES MARKET

▫ It is a market of government and semi-government securities backed by RBI.

▫ It is also known as Gilt Edged Market. Gilt edged means “of the best quality”. The government securities are
more reliable and therefore they are called Gilt Edged Securities.

B) INDUTRIAL SECURITIES MARKET

▫ It is a market for securities of industrial and commercial organizations.

GILT-EDGED SECURITIES

Gilt edged securities are high grade bonds issued by certain national government and private
organizations.
▫ As an investment vehicle, this equates to high grade securities with relatively low yields compared
to riskier, below investment grade securities.

Why this name – ‘Gilt Edged Securities’

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 ▫ In the past, these instruments referred to the certificate issued by the Bank of England (BoE) on
behalf of the Majesty’s treasury, so named because of the paper they were printed on
customarily featured gilded (golden) edges.
Note: Government bonds in the U.K., India, and several other commonwealth countries are still known as
gilts.

4) NEW (PRIMARY) ISSUE MARKET AND OLD ISSUE (SECONDARY) MARKET

▫ Based on the nature of issue, the securities market can be classified as New Issue Market (Primary Market)
and Old Issue Market (Secondary Market).

▫ Primary Market: Here, new securities are issued for the first time. Companies/governments raise capital by
selling stocks, bonds, or other financial instruments to investors.

▫ E.g.: Initial Public Offerings (IPOs) for stocks and issuance of government bonds.

▫ The issue of securities in Primary Market can be classified as: 1) Public Issue 2) Other Issues

Issues

Public Issue Other Issues

Follow Up
Initial Public Private Sweat Equity
Public Rights Issue Bonus Issue
Offering (IPO) Placement Issue
Offering

▫ Public Issue means issue of securities to public i.e. to all people, whoever wants to invest.
» IPO: If a company or financial corporation (issuer) issues shares for the first time.
» FPO: If any company or corporation has already issued shares, issue shares again, to
raise additional funds it is called Follow on Public Offering.
» In both IPO and FPO, the issuer usually doesn’t issue the security, the issuer appoints
a merchant banker on behalf of it to carry out the fund-raising activities.

» Authorized Capital, Issued Capital, Subscribed Capital:

§ The issuer can issue to the extent of Authorized capital. Authorized capital
means the maximum amount authorized by the Memorandum of
Association (MoA) of a company that can be raised by the company. A
company need not issue the shares to the extent of authorized capital. It can
issue less than the authorized capital. The actual amount issued by the issuer
is called Issue Capital.

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 § The Subscription may be sometimes less than the issue capital. If it is so, then
it means it is unsubscribed. The actual amount of subscribed is called
subscribed capital.

» Private Placement includes offering shares directly to financial institutions, mutual

funds, and high worth investors.

▫ Other Issues:
» Right Issue: Offer of security to existing shareholders in the FPO. It flows to the
existing shareholders as a matter of legal rights. So, it is called the Rights issue.
» Bonus Issue: It refers to the offer of shares against distributable profit to the existing
shareholders. It is also known as the scrip issue or the capitalization issue.
» Sweat Equity Issue: It denotes offer of shares to employees or Directors of the
company which issues shares as recognition of their hard labour (sweat), which
results in contribution to the company in the form of intellectual property rights,
technical know-how etc.

▫ Secondary Market (Old Issue Market): Here, previously issued securities are traded among investors.
▫ E.g. Stock market where investors buy and sell shares, Bond trading platforms.
▫ Stock Exchange: It is an institution for orderly buying and selling of listed securities.
▫ Over the counter exchange: Platform for trading in securities that are ‘not listed’ on a recognized stock
exchange.

▫ Regulation: In India, both New Issue and Old Issue markets are regulated by the Securities and Exchange Board
of India (SEBI).

5) STOCK EXCHANGES

▫ In India, there are several small and big stock exchanges. The most prominent are National Stock Exchange
(NSE) and Bombay Stock Exchange (BSE).

▫ National Stock Exchange (NSE) was incorporated in 1992 on the recommendation of Pherwani Committee.
IDBI is the main promoter of the exchange. Some other leading financial institutions (SBI, LIC etc) are also
promoters of its along with IDBI.

▫ It is the 5th largest stock exchange in the world by total market capitalization of listed companies,
exceeding $5 trillion in Sep 2024.

▫ In the calendar year 2024, NSE became top global stock exchange by IPO proceeds marking a
milestone in global equity markets. In CY 2024, NSE helped companies raise Rs 1.67 lakh crore
($19 billion) with 268 IPOs.

▫ NSE EMERGE is NSE’s new initiative for SME and starup companies. These companies get listed on
NSE without an IPO. This platform helps SMEs and Startups connect with investors and help them
with the raising of funds. In July 2024, NSE Emerge saw its 500th listing.

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 ▫ Bombay Stock Exchange (BSE): Established in 1887. It is Asia’s oldest Stock exchange and was initially known
as ‘The Native Share and Stockbrokers Association’. It was owned by stockbrokers. Now it is demutualized
(i.e. made a public owned organization).

A) INDEX
▫ Like CPI and WPI which measure the rise/fall in the price of commodities, there are share price
indices which measure the rise and fall of a bucket of shares. The most prominent indices in India
are Sensex, Nifty, and Nifty Junior.

▫ Sensex stands for Sensitive Index. This is the index of the BSE and measures the price movement of
top 30 company shares. The top 30 companies are called Blue Chip Companies.

▫ NIFTY stands for National Index for fifty. This and Nifty junior are the indices of National Stock
Exchange. NIFTY measures the price movement of top 50 companies. Nifty junior is an index of next
50 top companies.
▫ How are top companies selected: On the basis of total value of shares that are traded in the stock
exchange.
▫ Value of traded shares = Price of one share x Number of shares traded
▫ This value is called free float market capitalization. The value of all (both traded and non-
traded (the shares that are kept for a long time)) shares is called market capitalization.
▫ Market Capitalization is the value of shares that were sold to public which are called
outstanding shares. Market Capitalization = Price X Total outstanding shares.

6) INDEX PROVIDERS

- Index Providers are companies that design, create, calculate and manage indexes. They have the
responsibility to set the rules that decide what securities to include in each index, how the index will be
managed, and how securities will be added or removed from that index over time.
» Examples of Index Providers: MSCI, Standard & Poors (S&P), Dow Jones, Nasdaq, FTSE Russell,
Solactive, Morningstar

» Note: The first index - Dow Jones Transportation Average - was created in 1884 to measure
average performance of railroad stocks in the US.

- In India, Index providers are subsidiaries of stock exchanges.

» For e.g.
§ NSE Indices Ltd: It is the largest index provider in India. It manages the popular Nifty
indices, including the benchmark Nifty 50 Index, Nifty Bank Index etc.

§ Asia Index Pvt Ltd (APIL): It is a 50-50 partnership between S&P Dow Jones Indices LLC,
the world's largest provider of financial market indices and BSE Ltd, Asia's oldest stock
exchange and home to iconic SENSEX Index.

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 - Regulation of Index Providers:

A) SEBI NOTIFIED THE 'SEBI INDEX PROVIDER REGULATIONS' (MARCH 2024)

- SEBI has mandated registration of index providers managing "significant indices" based on
securities listed in India.
» The global index providers, however, may not have to register under the SEBI unless indices
are used as benchmarks by domestic asset managers with large corpus.
» SEBI has excluded indices that are exclusively used in a foreign jurisdiction.
» Benchmarks regulated by RBI are also excluded from these regulations.
» Industry players like NSE limited, APIL etc. will have to register with SEBI
- Other than registration, the index providers covered under the regulation will also have to make the
methodology documents public, follow a code of conduct, and bring more transparency on inclusion
and exclusion.
- Significance:
» It is aimed at fostering transparency and accountability in governance and administration of
financial benchmarks in the market.

7) DEPOSITORIES

- Basics
» Depositories are institutions that keep securities of investors in electronic format (Demat
format).
• The change in ownership of shares is done electronically.
» Depository is an institution or a kind of organization which holds securities with it, in which
trading is done among shares, debentures, mutual funds, derivatives, F&O and commodities.

» Intermediaries perform their actions in variety of securities at Depositary on behalf of their

clients. These intermediaries are known as Depositary Participants(DPs). Depository interacts
with its client / investors through its agents, called DPs. For any investor/client, to avail services
provided by the Depository, has to open a depository account known an Demat A/c, with any
of the DPs.
§ The relationship between the DPs and the depository is governed by an agreement made
between the two under the Depositories Act.
§ In a strictly legal sense, a DP is an entity who is registered as such with SEBI under the
subsection 1A of Section 12 of SEBI act. As per the provisions of this act a DP can offer
depository related services only after obtaining a certificate of registration from SEBI.

- In India, there are two depositories NSDL, Mumbai and CDSL, Mumbai
» National Security Depositary Limited(NSDL): It is the first depository in the country. It was
established by UTI, NSE and IDBI.

» Central Depositary Service (India) Ltd (CDSL).

• It was established by BSE, Bank of India, Bank of Baroda, SBI and HDFC Bank.

8) SEBI (SECURITIES AND EXCHANGE BOARD OF INDIA)

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 - SEBI is the regulator for the securities market in India. It was established in the year 1988 and given
statutory powers on 12th April 1992 through the SEBI act, 1992.
- Functions and Responsibilities
▫ Basic Function: The Preamble of the Securities and Exchange Board of India describes the basic
functions of the SEBI as "to protect the interests of investors in securities and to promote the
development of, and to regulate the securities market and for matters connected therewith or
incidental thereto.
▫ SEBI has to be responsive to the needs of three groups, which constitute the market:
» The issuer of security
» The investors
» The market intermediaries

▫ SEBI has three functions rolled out into one body: quasi-legislative, quasi-executive and quasi-
judicial.
» It drafts regulation in its legislative capacity.
» It conducts investigation and enforcement action in its executive function.
» It passes rulings and orders in its judicial capacity.

▫ Though, this makes it very powerful, there is an appeal process to create accountability. There
is a Securities Appellate Tribunal which is a three-member tribunal. A second appeal lies directly
to Supreme Court.
▫ SEBI has taken a very proactive role in streamlining disclosure requirements to international
standards.

- Composition: The SEBI is managed by its members, which consist of Chairman and 8 other members.
▫ The chairman is nominated by the Union Government of India
▫ Two members i.e., officers from Union Finance Ministry
▫ One member of reserve bank of India
▫ The remaining five members are nominated by Union government of India, out of them at least
three shall be whole-time members.

9) RELATED TERMS

1. P/E Ratio: Price to Earnings Ratio, is a metric used to assess a company's stock valuation. It essentially
compares a company's share price to its earning.

2. Face Value and Issue Price:

o Face value is the actual value of shares. It is a fixed nominal value assigned to a share by the
company during its incorporation.

o Issue Price is the price at which company shares are sold to the public for the first time during
an IPO.
• Premium is the extra price a share claims in the market due to high demand for it.

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3. Short Selling: Sellers sells the securities without owning the securities. He borrows the securities and
sells it.
4. Beta: It is a measure of stock's volatility in relation to the overall market.
o By definition, the market has a beta of 1.0 and individual stocks are ranked according to how
much they deviate from the market.

5. Bull and Bear Trading:

o In bull trading, buyer buys more shares in expectation of price increase in future.
o In Bear trading, the sellers sell the securities, with the intention to avoid loss, in the expectation
that the security prices will fall.

6. Buy Back: Issuer buying the securities again to accumulate shares in his hands.

7. Arbitrage: Arbitrage refers to simultaneous purchase and sale of the same or similar asset in different
markets in order to profit from tiny differences in the asset’s listed price.

o For e.g. buying shares of a listed company from BSE; and Selling the same at NSE; or Buying at
NYSE and selling at LSE.
o Arbitrage is most commonly made in stocks, commodities, and currencies, but can be
accomplished in with any asset.
o It takes advantage of the inevitable inefficiencies in markets.
o By exploiting market inefficiencies, however, the act of arbitrage brings market closer to
efficiency.

8. Hedging:
o Hedging is a risk management strategy employed to offset losses in investment by taking an
opposite position in a related asset.
• The reduction in risk provided by hedging also typically results in a reduction in potential
profits.
• Hedging requires one to pay money for the protection it provides, known as premium.
• Hedging strategies typically involve derivatives, such as options and future contracts.
o E.g -1:
• Suppose Mr. A owns shares of Reliance Industries. Although A believes in the company
in long run, A is worried about some short term losses in Reliance industries.
▫ To protect yourself from a fall in Reliance, you can buy a put option on the
company, which gives you right to sell reliance at a specific price (also called the
strike price). This strategy is called a married put. If your stock prices tumble
below the strike price, these losses will be offset by gains in the put option.
o E.g.-2:
• Let’s consider the scenario of a Refinery company X; Suppose X is worried about volatility
of crude oil prices. The company may face deep trouble if the crude oil prices sky rocket.
▫ To protect against the uncertainty of crude oil prices, X can enter into a future
contract (or less regulated forward contract). A future contract is a hedging
instrument that allows the company to buy the crude oil at a specific price at a
set date in the future.

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 9. Perfect Hedge: A perfect hedge is a position that eliminates the risk of existing position or one that
eliminates all market risks. A perfect hedge position has a 100% inverse correlation to the initial
position where the profit and loss from the underlying asset and hedge position are equal.
o A perfect hedge is rarely achieved. It is rarely worth the cost except in the most volatile markets.
o Liquid assets like cash and short-term notes and investments like gold and real estate, can be
considered a perfect hedge in volatile markets.
o Negative: It often limits the gain of the stock position while trying to protect the underlying
asset.

10. Hedge Ratio: It is the ratio of the value of a position protected through a hedge with the size of entire
position.
o For e.g. if you hold $1,000 in foreign equity, and enter into a hedge to protect against losses,
you may hedge $ 5,000 with a currency position, creating a hedge ration of 0.5
($5,000/$10,000).

11. Basis risk: It is the financial risk that offsetting investment in a hedging strategy will not experience price
changes in entirely opposite direction from each other.

10) PARTICIPATORY NOTES (P-NOTES)

- Introduction
▫ PNs (Offshore derivative instruments - ODIs) are instruments issued by the registered foreign
institutional investors (FIIs) to overseas investors, who wish to invest in the Indian stock markets
without registering themselves with the market regulator, the SEBI.
§ FIIs use these instruments for facilitating the participation of their overseas clients, who
are not interested in participating directly in the Indian stock market.
- Advantages for investor
▫ Anonymity: PNs allows large hedge funds to carry out their operations without disclosing their
identity
▫ Ease of trading as participatory notes are like contract notes transferable by endorsements and
delivery.
▫ Tax Saving as the investor can invest through tax haven countries.
- Advantages for India
▫ More Investment in the country

- Key Controversy
▫ Hides the identity of the investor
§ According to a white paper on black money by government, a considerable portion of
PNs are used by wealthy individuals as a mechanism to channelize black money kept in
foreign countries to India.
§ SIT on black money has also called for phasing out of the participatory notes.
▫ Money Laundering
§ P-notes has become one of the key money laundering mechanism in the country.

- SEBI has not banned P-Notes because:

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 § Used globally in many markets
§ SEBI believes that P-notes are legitimate instruments required for normal financial transactions
and are prevalent in all the larger markets.
§ Then there are business reasons to permit these transactions through P-notes.
- SEBI has taken a number of steps to tighten the norms

11) GLOBAL DEPOSITORY RECEIPTS

- A 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 receipt (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.
GDRs enable a company, the issuer, to access investors in capital markets outside of its home country.

3. DEBT SECURITIES

1) WHAT IS A DEBT MARKET?

▫ The debt market is the market where fixed income securities of various types and features are issued
and traded. This includes fixed income securities from governments, municipal corporations,
government bodies, and commercial entities including Financial Institutions, Banks, PSUs, Public Ltd
companies etc.

What are the different types of instruments which are traded in debt market?

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 .

Note-1: STRIPS – Separate Trading of Registered Interest and Principal of Securities: STRIPS are the
securities created by way of separating the cash flows associated with regular G-Sec i.e. each semi-annual
coupon payment and final principal payment to be received from the issuer, into separate securities. They
are essentially Zero coupon bonds. However, they are created out of existing securities only and unlike
other securities, are not issued through auction. Being G-Sec, STRIPS are eligible for SLR.

Note-2: The G-Secs are known as SLR securities in the Indian markets as they are eligible securities for the
maintenance of SLR ratio by the banks.

2) INFLATION INDEXED BONDS

- An inflation indexed bonds is a bond that generates a return higher than the rate of inflation if it is
held to maturity.
- IIBs link their interest rates (capital appreciation), or coupon payments, to inflation rate. These are
also known as real-return bonds or real return securities.
- Offers lower coupons (interest rates): Given the safety of these securities, interest rates on inflation
indexed bonds is generally lower than other high-risk notes.

3) CONVERTIBLE BONDS

- Convertible bonds are corporate bonds that can be converted into the common stock of the issuing
company.
• Companies issue convertible bonds to lower the coupon rates on debt and to delay dilution.
• A bonds conversion ratio determines how many shares an investor will get.

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 • Companies can force conversion of the bonds if the stock prices is higher than if bond were to
be redeemed.

4) MASAL BOND

- Masala bonds are bonds issued outside India but denominated in Indian rupees. The payment of
interest and principal is made in rupees, not in the currency of foreign investors.
• They give Indian issuers the option to raise funds abroad.
• Indian companies can rise money at lower interest rates as interest rates in the developed
markets are generally lower.
• Masala bonds can be privately placed or listed on exchange.
- They have helped Indian investors secure foreign loans without requiring them to deal with volatility
associated with foreign currency.

5) WHAT IS MONEY MARKET?

▫ The money market is basically concerned with the issue and trading of securities with short term
maturities and quasi-money instruments.

▫ Instruments traded in money market are: Treasury Bills, Certificate of Deposits (CDs), Commercial
Papers, Bills of Exchange and other instruments of short term maturities (i.e. not those exceeding 1 year
with regard to the original maturity).

▫ Treasury Bills (already studied with fiscal policy chapter)

▫ Certificate of Deposits (CoD): A CoD is a saving product that earn interest on a lump sum for a fixed
period of time. CD differs from saving account as the money has to remain untouched for the entire
period or risk penalty fee or lost interest. It has higher interest rates than saving accounts as an incentive
for lost liquidity. They are safer and more conservative investment than stocks and bonds, offering lower
opportunity for growth, but with a non-volatile, guaranteed rate of return. Virtually every bank, credit
union, and brokerage firm offers a menu of CD options. Although you lock into a term of duration when
you open a CD, there are options for exiting early should you encounter an emergency or change of
plans.

▫ Commercial Papers: Commercial Paper is an unsecured, short-term debt instrument issued by

corporations. It's typically used to finance short term liabilities such as payroll, accounts payable, and
inventories. It is usually issued at a discount from face value i.e. the commercial paper is issued at a
discount and matures at its face value. It reflects prevailing market interest rates.

▫ Bill of Exchange: A bill of exchange is a written document used primarily in international trade. It’s
essentially an instruction from one party (the drawer) to another party (the drawee) to pay a fixed
amount of money to a third party (the payee) at a specific date in the future, or on demand.
» Drawer: The person or entity who creates the bill and instructs the payment.
» Drawee: The person or entity who is instructed to make the payment (often the buyer in a trade
transaction)
» Payee: The person or entity who is supposed to receive payment.

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6) ADVANTAGE OF DEBT SECURITY FOR INVESTORS

▫ Predictable stream of payments.

▫ Debt securities like government bonds are also highly secure and very less volatile.
▫ Note: The return earned on the government securities are normally taken as the benchmark rates of
returns and are referred to as the risk-free return in financial theory. The Risk-free rate obtained by
G-Sec rates is often used to price the other non-government securities in financial market.

▫ It indicates wide-based efficient portfolio diversification.

7) IMPORTANCE OF DEBT MARKET TO THE ECONOMY:

▫ Efficient mobilization and allocation of resources

▫ Financing the development activities of government
▫ Transmitting signals to monetary policy.
▫ Development of heterogeneity among market participants

8) DIFFERENT TYPES OF RISKS ASSOCIATED WITH DEBT SECURITIES

i) Default Risk (Credit Risk): When issuer of a bond is unable to make timely payment of interest or principal
on a debt security.

ii) Interest Rate Risk: This can be defined as the risk emerging from an adverse change in the interest rate
prevalent in the market.
- E.g. Upswing in the prevailing interest rate scenario leading to a situation where the investors’ money
is locked at lower rates.

iii) Reinvestment Rate Risk: Probability of a fall in the interest rate resulting in a lack of options to invest the
interest received at regular intervals at higher rates than the comparable rates in the market.

9) DEBT SECURITY MARKET STRUCTURE

- The debt markets in India and all around the world are dominated by Government securities which account
for 50-75% of the trading volumes and the market capitalization in all markets.
- In India, Government Securities (G-Sec) account for 70-75% of the outstanding value of issued securities
and 90-95% of the trading volumes in the Indian debt markets.
- State Government securities & Treasury Bills account for around 3-4% of thre daily trading volumes.

10) WHO REGULATES FIXED INCOME MARKET (DEBT SECURITY MARKET)?

Government securities and issues by Banks and Institutions are regulated by RBI.

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 Non-Government securities comprising basically of Corporate Debt issues is regulated by SEBI.

11) RBI RETAIL DIRECT (RBI-RD) SCHEME

In Nov 2021, RBI announced the activation of RBI Retail Direct Scheme. The scheme brings G-sec within
reach of common man by simplifying the process of investment.

Under this scheme, retail individual investors will be able to open a Retail Direct Gilt (RDG) Account with
RBI, using an online portal (https://rbiretaildirect.org.in).

Investments can be made using the following routes:

a. Primary issuance of government securities: Investors can place bid as per the non-competitive
scheme for participation in primary auction of government securities and procedural guidelines for
SGB issuance.
b. Secondary market: Investors can buy and sell government securities on NDS-OM (‘Odd Lot’ and
‘Request for Quotes’ segments).

Note: NDS-OM is a screen based electronic anonymous order matching system for secondary market
trading in Government securities owned by RBI.

12) BOND ANALYTICS

- Bond Basics: When a bond is issued, the issuing entity determines its duration, face value (also called its par
value), and the rate of interest that it pays (coupon rate). These characteristics are fixed, remaining
unaffected by changes in the bond’s market.

▫ E.g.: A Government bond with Rs 1 crore face value and a 7% coupon rate pays 7 lakhs in interest
annually.

- What is yield?
▫ Yield refers to the percentage rate of return paid on a stock in the form of dividend, or the effective
rate of interest paid on a bond or note.

▫ There are many different kinds of yields depending on the investment scenario and the characteristics
of the investment.
1. Current Yield of Bonds: Current yield of bond is calculated by dividing the annual coupon payment
by bond’s current market value.
» E.g.
i. Let’s say Bond’s face value is Rs 1 crore.
ii. Coupon is 10%.
iii. Bond’s market value is Rs 1.1 crore.
» Current yield in percentage = Annual Coupon Payment/ Bond Price
= (10 lakh/ 1.1 crores) = 0.0909 = 9.09%

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 » Significance: The current yield calculation helps investors drill down on bonds that generate
the greatest returns on investment each year.

2. Yield to Maturity: It is the % rate of return paid on a bond, note, or other fixed income security, if
you buy and hold the security till its maturity. It’s a more complicated calculation and not relevant
for our preparation.

- How is the Price determined in the Debt Market?

▫ The price of bond in the debt market is determined by the forces of demand and supply.

▫ The price fluctuates according to change in:

1. Economic Condition
2. General Money market condition including the state of money supply.
3. Interest rate prevalent in the market
4. Future interest rate expectations
5. Credit quality of the issuer

▫ There is, however, a theoretical underpinning to the determination of the price of the bond in the
market based on the measure of the yield of the security.

- Bond Yield as a function of Price:

▫ Yield and Bond Prices are inversely related. So, a rise in price will decrease the yield and a fall in the
bond price will increase the yield.
▫ When the prevailing interest rate in market rise, the prices of outstanding bonds will fall to equate the
yield of older bonds with higher-interest rates of new issues. This will happen as there will be very few
takers for the lower coupon bonds resulting in a fall in their prices.

▫ When the prevailing interest rate in market falls, the price of outstanding bonds will rise, until the yield
of older bonds is low enough to match the lower interest rate on the new bond issue.

4. PYQS
PYQs:
1 In India, which of the following can trade Corporate Bonds and Government Securities [Prelims 2024]
1. Insurance Companies
2. Pension Funds
3. Retail Investors
Select the correct answer using the code given below:
A. 1 and 2 only
B. 2 and 3 only
C. 1 and 3 only
D. 1, 2 and 3

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2 In the context of finance, the term 'beta' refers to: [Prelims 2023]
A. The process of simultaneous buying and selling of an asset from different platforms
B. An Investment strategy of a portfolio manager to balance risk versus rewards
C. A type of systematic risk that arises where perfect hedging is not possible
D. A numeric value that measures the fluctuations of a stock to changes in the overall stock market

3 Consider the following markets:

1. Government Bond Market
2. Call Money market
3. Treasury Bill Market
4. Stock Market

How many of the above are included in capital markets?

A. Only one
B. Only two
C. Only three
D. All four

4 With reference to the Indian Economy, what are the advantages of "Inflation Indexed Bonds" (IIBs)?
[Prelims 2022]
1. Government can reduce the coupon rates on its borrowings by way of IIBs
2. IIBs provide protection to the investors from uncertainty regarding inflation
3. The interest received as well as capital gain on IIBs are not taxable
Which of the statements given above are correct?
A. 1 and 2 only
B. 2 and 3 only
C. 1 and 3 only
D. 1, 2 and 3

5 With reference to Convertible Bonds, consider the following statements: [Prelims 2022]
1. As there is an option to exchange the bond for equity, Convertible bonds pay a lower rate of
interest
2. The option to convert to equity affords the bondholders a degree of indexation to rising
consumer prices
Which of the statements given above is/are correct?
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither nor 2

6 With reference to India, consider the following statements: [Prelims 2021]

1. Retail investors through Demat accounts can invest in 'Treasury Bills" and 'Government of Indian
Debt Bonds' in the primary market

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 2. The 'Negotiated dealing system-order matching' is a government securities trading platform of
the RBI
3. The 'Central Depository Services Limited' is jointly promotes by RBI and Bombay Stock Exchange

Which of the above statements is/are correct?

A. 1 only
B. 1 and 2 only
C. 3 only
D. 2 and 3 only

7 Indian Government Bond Yields are influenced by which of the following? [Prelims 2021]
1. Action of United States Federal Reserve
2. Actions of Reserve Bank of India
3. Inflation and Short-term interest rates
Select the correct answer using the codes given below:
A. 1 and 2 only
B. 2 only
C. 3 only
D. 1, 2 and 3

8 Consider the following statements:

1. Foreign Currency Convertible Bonds
2. Foreign Institutional Investment with certain conditions
3. Global Depository Receipts
4. Non-Resident external deposits

Which of the following can be included in Foreign Direct Investments (FDIs)?

A. 1, 2 and 3
B. 3 only
C. 2 and 4 only
D. 1 and 4 only

9 With reference to the Indian economy, consider the following statements: [Prelims 2020]
1. Commercial Paper is a short-term unsecured promissory note
2. Certificate of Deposit is a long-term instrument issued by the RBI to a corporation
3. 'Call Money' is a short-term finance used for interbank transaction
4. 'Zero-coupon Bonds' are the interest bearing short-term bonds issued by the Scheduled
Commercial Banks to corporations

Which of the statements given above is/are correct?

A. 1 and 2 only
B. 4 only
C. 1 and 3 only
D. 2, 3 and 4 only

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10 Which of the following is issued by registered foreign portfolio investors to overseas investors who want
to be part of the Indian stock market without registering themselves directly? [Prelims 2019]

(a) Certificate of Deposit

(b) Commercial Paper

(c) Promissory Note

(d) Participatory Note

11 With reference to `IFC Masala Bonds', sometimes seen in the news, which of the statements given below
is/are correct? [2016]

1. The International Finance Corporation, which offers these bonds, is an arm of the World Bank.
2. They are the rupee-denominated bonds and are a source of debt financing for the public and
private sector.
Select the correct answer using the code given below

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither1 nor 2

12 What is/are the purpose/purposes of Government's 'Sovereign Gold Bond Scheme' and 'Gold
Monetization Scheme"? [2016]

1. To bring the idle gold lying with Indian households into the economy
2. To promote FDI in the gold and jewellery sector
3. To reduce India's dependence on gold imports
Select the correct answer using the code given below.

(a) 1 only

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 (b) 2 and 3 only

(c) 1 and 3 only

(d) 1, 2 and 3

13 What does venture capital mean?

A. A short term capital provided to industries
B. A long-term start up capital provided to new entrepreneurs
C. Funds provided to industries at times of incurring losses
D. Funds provided for replacement and renovation of industries

14 Participatory Notes (PNs) are associated with which one of the following? [2010]
(a) Consolidated Fund of India
(b) Foreign Institutional Investors
(c) United Nations Development Program
(d) Kyoto Protocol
15 A rise in 'Sensex' means: [Prelims 2000]
A. A rise in prices of shares of all companies registered with BSE
B. A rise in shares of all companies registered with NSE
C. An overall rise in prices of shares of group of companies registered with BSE
D. A rise in prices of shares of all companies registered with Bombay Stock Exchange

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