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  • 8/8/2019 Capital n Money Market


    Bachelor of Business Administration-BBA Semester 5

    BB0022 Capital and Money Market - 4 Credits

    Assignment Set- 1 (60 Marks)

    Note: Each question carries 10 Marks. Answer all the questions.

    Q.1 what are the different forms which an underwriting agreeme

    may take?

    "An agreement entered into before the shares are brought before the public that, in the event of public not taking

    the whole of them or the number mentioned in the agreement, the underwriter will, for an agreed commission, ta

    an allotment of such part of the shares as the public has not applied for".

    An Underwriting may take any of the following forms:

    i) Standing behind the Issue: Under this method the underwriter guarantee the sale o

    specified number of shares within a specified period. If the public does not take up the whole

    the specified amount of the issue, the underwriters standing behind the issue come forward

    purchase the balance.

    II) Outright Purchase: Underwriters purchase the issue outright and resell the securities to t

    investors. The purchase price is negotiated between the issuers and the underwriters or maydetermined by competitive bidding.

    III) The Consortium Method: Underwriting is jointly done by group of underwriters who for

    syndicate for the purpose. The method is adapted to large issues. The method enables t

    spread of risk among the members of the syndicate. No single underwriter bears the entire ris

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    Q.2 Explain the various functions performed by stock exchange.

    The stock exchange performs the following functions:

    1. The stock exchange provides a ready and continuous and permanent market for t

    purchase and sale of existing securities. Securities traded on the exchange are easmarketable and highly liquid, less risky than other types of investment.

    2. Evaluation of Securities: It is an open ,market appraisal based on a compromise between t

    opinion of willing buyers and willing sellers. Because of continuous purchase and sale, t

    current value of securities is determined.

    3. Safety in dealings:The motto of stock exchange is DICTUM MEUM PACTUM i.e.: My word is

    bond. There is high degree of commercial honour among the members of stock exchange.

    ensure honesty and integrity in trading on stock exchange, its members are selected ve

    judiciously. The members are required to observe the rules and regulations of the st

    exchange. The provision of securities contract (Regulation) Act provides an element of safetyinvestors.

    4. Mobilisation of Savings:The task of mobilising savings and directing them into productive use

    in an important function. It inculcates the habit of saving, investing and risk taking among the

    members of general public.

    5. Canalisation of Capital:Through the price quotations, stock exchange helps in canalizing

    national savings from less profitable to most profitable sectors of economy. The investors ten

    to withdraw their investments from the companies with less prospects and invest in companie

    whose prospects who seem to be better and reflected in their share quotations. Thus society

    savings are allocated to the promising issues and invested for the maximum social advantage

    6. Price Stability:The presence of a large number of buyers and sellers of securities, demand for

    and supply of different securities tend to equalise, thus eliminating the chances of sudden

    fluctuations in prices.

    7. Economic Barometer: Alfred Marshal puts it, stock exchange is not merely chief theaters of

    business transactions, and they are also barometers which indicate the general conditions of

    business in a country. It is the nerve centre of economic health of a nation. It is a very

    sensitive institution that even a small change in the political, social or economic environment

    get immediately reflected in the dealings in the stock exchange.

    8. Facilities for speculation:The stock exchange provides opportunities to shrewed businessme

    to speculate and reap profits from fluctuations in security prices. Due to speculation, the supp

    of securities at different places may be equalised with demand.

    9. Stock exchanges facilitate the growth of joint stock form of business enterprises.

    Due to the above important economic functions performed by the stock exchanges, they hav

    arned a variety of names. A stock exchange has been described as the Mart of the World

    because the security which represent the ownership property of companies all over the world

    are marketed there.

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    Since a stock exchange is the market for business in securities of business concerns, it has

    been referred to as the market where business of businesses is carried on.

    Q4. What are the basic requisites necessary for the growth

    undeveloped money market?

    (a) Highly organised commercial banking system: The commercial banks constitute

    nuclear of the whole money market. They supply short-term funds and, therefore, any pol

    they follow regarding loans and advances and investments will have repercussions on t

    entire money market. On account of their intimate relations with the Central Bank of

    country, commercial banks serve as the connecting link between the various segments of t

    money market and the Central Bank. A fully developed money market is characterized by t

    presence of a highly organised commercial banking system, while in an underdevelop

    market, the banking system is not fully developed.

    (b) Presence of Central Bank:The second essential requisite for the organization of a develop

    money market is the presence of a central bank, which should be both de jure and de fac

    monetary and banking authority in the country. Just as a State cannot exist and funct

    properly without a head, so also a money market cannot function without a Central Bank. T

    Central Bank comes to the rescue of commercial banks. and the money market as a whole

    times of shortage of funds by rediscounting eligible securities. In times of emergency and cris

    the Central Bank enables the money market to convert near-money assets into cash. Besides

    performs a valuable service through open-market operations when it absorbs surplus ca

    during of seasons and provides additional liquidity in times of financial stringency. Thus, t

    central bank is the leader of money market as well as its controller and guid

    Without an official central bank, a developed money market cannot exist. In an undevelop

    money market, either the central bank does not exist or is in its infancy without adequa

    capacity to influence and control the money market. Though the existence of a well-organis

    banking system and a bank are essential prerequisites for the development of well organis

    money market, these requisites alone are not sufficient. Professor Sen cites the exam

    of Australia where the banking system, including the central bank, has mad remarka

    progress and is very well developed but there is no organised money market in Austra

    Besides a well organised banking system and an efficient central bank, other factors shou

    also be present for the existence of a well-organized and well-developed money market.

    (c) Availability of paper credit instruments: An efficient money market will require

    continuous and adequate supply of acceptable securities such as bills of exchange, treasu

    bills, short-term government bonds, etc. at same time, there should be a number of dealers

    the money market who should buy and sell these securities. These dealers and brokers a

    responsible for borrowing funds from the banks and using them to buy and hold short-te

    assets. Without their presence, there cannot be any competition or life in the money mark

    Thus the availability of adequate short-term assets and the presence of dealers and brokers

    deal in them are essential conditions for the evolution of organized or developed mon

    market. An under developed money market, on the other hand, is characterized by the absen

    of efficient short term crdit instruments as well as dealers and brokers to deal in them.

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    (d) Existence of a number of sub-markets: The fourth condition for the evolution o

    developed money market is the existence of a number of sub-markets, each specializing

    particular type of short-term asset. For instance, in the London money market, which

    probably the most developed in the world, they are the call money market, the commerc

    money market, the treasury bill market, the foreign exchange market, and so on. Each type

    short-term asset depending upon the nature of the asset and period of maturity involved

    dealt with in a separate market. Professor Sen states, The larger the number of sub-marke

    the broader and more developed will be the structure of the money market. An undevelop

    money market does not possess all the important and essential sub-markets, particularly t

    bill market. Besides, there is no co-ordination between the different sectors of the mon

    market in an undeveloped money market, because the interconnection between them is oft

    loose and uncoordinated. As a result of this, there are great differences in money rates in t

    different sub-markets in an undeveloped money market.

    Tow important points should be emphasized as regards the existence of sub-market. First of

    each sub-market should consist of a good number of dealers in reasonably high competitio

    and should possess adequate source of supply of funds for dealing in particular short-teassets. A second point is that the sub-market should not be independent or isolated but sho

    form an integrated structure in which every part of the money is in intimate relationship w

    each other. This is essential for the free flow of funds from one sub-market to another, for t

    existence of a common rate of interest in all sub markets and for the effective control of t

    entire money market by the central bank.

    (e)Availability of ample resources: a developed money market assumes the existence

    ample resources to finance the dealings in the various sub-markets. These resources com

    from generally within the country but it is also possible that foreign funds may also

    attracted. Well, developed money markets like London and New York, attract funds form

    over the world, undeveloped money markets do not attract foreign funds mainly because

    political instability and absence of stable exchange rates.

    (f) Other contributory factors: Apart from these above important factors which are responsi

    for the evolution of a developed money market over a number of years, there are many oth

    contributory factors also, bills of exchange, great industrial development leading to t

    emergence of a stock market, stable political conditions, absence of discrimination agai

    foreign concerns, and so on.

    London money market is the best example of a fully developed money market, for all t

    characteristics of a developed money market are to be found there.

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    Q5. Describe various sectors of Money Market.The money market is not a single homogenous market. It is composed of several sectors of su

    markets. For each type of short term credit transactions, there is specialized sub-market. T

    important sectors or sub-markets are:

    (i) Call Money Market: Call money market is an important sector of the money market. It is t

    market where extremely short-term funds called call money or call loans are lent and borrow

    Call loans are given just for a night, a day or a maximum of 14 days. As these loans can

    called back on demand or at a short notice of 1 day, they are called call loans. They a

    generally, given without any collateral securities. Such types of market fulfill the financ

    requirements of Bill brokers and dealers in stock exchange.

    These loans are preferred by commercial banks for two reasons. First, as they are given

    short periods, they satisfy the requirements of liquidity. In fact, they are liquid next only

    cash. They are the second line of defence to the banks. Secondly, unlike cash, they are so

    what profitable.

    (ii) Collateral loan market: Collateral loan market is one of the important sectors of the mon

    market. This market deals with collateral loans (i.e., loans against collateral or tangi

    securities). Collateral loans are given for a period of 3 months or 6 months against eas

    realizable collateral securities. When the borrowers repay the loans, the collateral securities w

    be returned to the borrowers. Incase the borrowers fail to repay the loans; the collatesecurities will be taken over by the leaders. Collateral loans are mainly granted by t

    commercial banks. Commercial banks prefer to invest their money on collateral loans for ma

    reasons. First, they are highly profitable, because they fetch the highest yield. Secondly,

    they are given against collateral securities, they are safe. Thirdly, as they are given for sh

    periods, they are liquid. The main borrowers for collateral loans are business and industr

    concerns. Stock exchange dealers and private individuals also borrow collateral loans.

    (iii) Acceptance Market: Acceptance market was a very prominent section of the money mar

    in the past. But, today, its importance has declined considerably.

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    Acceptance market is a sub-market, which is considered with the acceptance of commerc

    bills, inland as well as foreign, either by specialized institutions and acceptance houses as

    England or by commercial banks, on behalf of their customers. Generally a trader who se

    goods on credit to a buyer may agree to draw a bill of exchange on the buyer himself, i

    knows the buyer. Incase he does not know the buyer, the seller may be reluctant to sell t

    goods on credit and draw the bill on the buyer. In such a case, the buyer approaches

    acceptance house or a commercial bank and requests it to accept the bill on his behalf. T

    acceptance house or the bank accepts the bill on behalf of the buyer and enables him to b

    the goods on credit. The bill of exchange, which is accepted by an acceptance house o

    commercial bank, can be easily discounted in the money market either with a discount house

    with a commercial bank.

    (iv) Bill Market or discount Market: the bill market or the or the discount market is a su

    market where short-term commercial bills of exchange and Government treasury bills a

    discounted. In the past (i.e., before the First World War), most of the bills discounted in t

    market consisted of commercial bills. But, after the First World War, the number of commerc

    bills has declined and that of Government treasury bills has increased. But, both trade bills a

    treasury bills, are discounted either by specialized institutions called discount houses as

    England or by commercial banks. Discounting of commercial bills is popular, especially in t

    London money market for many reasons. First, as the bills are short dated, they are sufficienliquid. In respect of liquidity, they rank next only to cash and call loans. Secondly, they a

    profitable, as they fetch good discount. Thirdly, they are safe, as the commercial bills arise o

    of commercial transactions and also bear the acceptances or endorsements of acceptan

    houses or commercial banks. Discounting of treasury bills is very popular in all the mon

    markets, as treasury bills are safe, highly liquid and also profitable.

    Q6. Explain the various constituents of organized sector in India

    Money market.

    The Indian Money market is constituted by variety of institutions. On the basis of nature and functio

    of various institutions it can be classified on the basis of the following:

    (a) On the basis of persons

    (b) On the basis of organizations, and

    (c) On the basis of sub-markets.

    (i) Classification on the basis of persons: The classification of money market on the basispersons associated may be divided into two parts as creditors and debtors. The persons

    institutions, which ask for credit, are called debtors. On the other hand persons or institutio

    that provide credit in the market are called creditors.

    (ii) Classification on the basis of organization: On this basis, Indian Money Market can

    divided into the following two parts viz.,

    (a) Organized, and

    (b) Unorganized

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    Organized sector: the organized sector of the Indian Money Market is well organized. It consists

    managed financial institutions. The following are the important constituents of organized sector.

    (1) Reserve Bank of India: The Reserve Bank of India was formed on 1st April, 1935. It is t

    Central Bank of the country. It occupies an important space in the Indian Money Market. It h

    direct and close contact with th various institutions in the organized sector of the money mark

    But, unfortunately, it has no connection with the unorganized sector or indigenous sector. As su

    it has effective control only over the organized sector, and not over the indigenous sector.

    (2) State Bank of India: The state Bank of India was formed on 1st

    July, 1955 after tnationalization of the Imperial Bank of India. It is the biggest Commercial Bank in the country

    occupies an important position in the Indian Money Market. It receives all types of deposits fro

    the public and provides short-term loans to merchants and manufacturers. Of late, it has be

    laying emphasis on providing finance to co-operative institutions, farmers and small industries

    also undertakes foreign exchange business.

    (3) Subsidiaries of the State Bank of India: today, there are subsidiary banks of the State Ba

    of India. They are:

    (i) The State Bank of Bikaner and Jaipur

    (ii) The State Bank of Hyderabad

    (iii)The State Bank of Mysore

    (iv) The State Bank of Patiala

    (v) The State Bank of Sourashtra

    (vi) The State Bank of Travancore

    (vii) The State Bank of Indore.

    These banks are also Commercial Banks. They receive various typs of deposits and provide short-te

    loans to trade and industry.

    (4) Twenty Nationalized Banks: Fourteen major joint stock banks with deposits of Rs. 50 cro

    or more were nationalized on 19th July, 1969. They are:

    (i) The Central Bank of India

    (ii) The Bank of India

    (iii) The Punjab National Bank

    (iv) The Bank of Baroda

    (v) The Commercial Bank

    (vi) The United Bank of India

    (vii) The Canara Bank

    (viii) The Dena Bank

    (ix) The Syndicate Bank

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    (x) The Union Bank of India

    (xi) The Allahabad Bank

    (xii) The Indian Overseas Bank

    (xiii) The Bank of Maharashtra and

    (xiv) The Indian Bank.

    Again on 15th

    April, 1980, six more joint stock banks nationalized. They are:

    (i) The Vijaya Bank Ltd

    (ii) The Corporation Bank Ltd

    (iii)The Andhra Bank Ltd

    (iv) The Bank of India Ltd

    (v) The Oriental Bank of Commerce, and

    (vi) The Punjab and Sindh Bank Ltd.They are Commercial Banks. They occupy an important position in the Indian Money Market. W

    more than 40,000 branches, they control about 60% of the total deposits of the country. They provi

    short-term funds to industries, traders, farmers, and others. Some of them do foreign exchange also

    (5) Foreign Exchange Banks:There are fourteen foreign exchange banks today, in the count

    These are foreign banks undertaking Indias foreign exchange business through their braches

    India. They also finance the internal trade of the country. They perform even ordin

    commercial banking business, such as acceptance of deposits.

    (6) Co-operative Credit institutions: Co-operative credit institutions are institutions, which a

    concerned with the provision of agricultural finance. There are three types of co-operat

    credit institutions in the country. They are:

    (i) Primary Credit Societies at Village Level

    (ii) Central Co-operative Banks at District Level and

    (iii) State Co-operative Banks at State Level.

    All these institutions provide short-term finance. The state co-operative finance provides short-te

    finance to the central co-operative banks. The central co-operative bank provides short-term fundsthe primary credit societies. The primary credit societies provide short term funds to the farmers. T

    co-operative credit institutions also occupy an important position in the Indian Money Market. Tod

    they finance about 35% of the needs of agriculturists in India.

    (7) Other institutions: These segments of Indian Money Market can b classified into t

    categories viz.,

    (a) Public Sector Institutions:These institutions mainly include the following:

    (i) All India Term Leading Institutions These are the following:

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    (a) Industrial Development Bank of India (IDBI)

    (b) Industrial Credit and Investment Corporation of India (ICICI)

    (c) Industrial Finance Corporation of India (IFCI)

    (d) Industrial Reconstruction Bank of India (IRBI)

    (e) National Bank for Agriculture and Rural Development (NABARD)

    (f) Export-Import Bank of India (EXIM)

    (g) National Housing Bank of India (NHB)

    (h) Discount and Financial Bank of India (DFHI)

    (i) Small Industries Development Bank of India (SIDBI)

    (ii) State Level Institutions These are the following:

    (a) State Finance Corporation

    (b) Small Industries Development Corporation.(iii)Investment Institution These are the following:

    (a) Life Insurance corporation of India

    (b) General Insurance Corporation

    (c) Unit Trust of India.

    (iv) Other institutions These are the following:

    (a) Export Credit and Guarantee Corporation of India (ECGC)

    (b) Deposit Insurance and Credit Guarantee Corporation of India (DICGCI)

    (B) Other Institutions in Private Sector These are the following:

    (a) Chit Fund Companies

    (b) Hire Purchas Companies

    (c) Investment Companies

    (d) Corporation and other Institutions.

    Unorganized Sector: The indigenous bankers and moneylenders are in the unorganized sector

    the Indian Money Market. They are unorganized. They do not have any connection with the Rese

    Bank of India. They do not have contact even with the commercial banks or other institutions in t

    organized sector of the money market. As such, they are not under the control of the Reserve Bank

    India. Though they are not properly organized, they play a ver prominent role in rural finance. Th

    meet more than50% of the financial requirements of the rural people. They provide short-term loa

    to farmers, artisans and other people in rural areas. There are nearly 2,500 indigenous bankers in t

    country. They are known as shroffs, multanis, chettiars, khatris, etc.

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    Sub-Market: Money market can be classified on the basis of sub-markets as follows:

    (i) Call money Market: The market for extremely short term funds is called the Call Mon

    Market. Bill brokers and dealers in stock exchange require loan for support periods to finan

    their customer in trading on margin and their own holding of securities and such funds a

    provided by the Commercial Banks. These funds are provided for only for upto 7 days but mo

    often from day to day or overnight only, and do not require any collateral securities. The

    loans are commonly known as call loans, i.e. call money since the banks can call them at t

    shortest notice. Thus, call loans are highly liquid.

    (ii) Treasury bill Market: In this market purchase and sale of short-term government securit

    (generally 182 days treasury Bills) take place. They are very popular now days because of th

    safety. Recently they have come to prominence.

    (iii)Collateral Loan Market: Collateral loan market refers to collateral loans also known

    brokers loans or street loans. They are on call basis re-payable on demand or call on one d

    notice by the bank advancing it to brokers and dealers in securities or business houses by

    pledge of stocks and bonds. It is subject to legal restrictions regarding amounts, margin to

    kept, etc. They are not very popular now days.

    (iv) Bill Market:The market in which short-term papers of bills are bought and sold is knoas the bill discount market. The most important types of short-term papers are the bills

    exchange and the treasury bills.

    Bachelor of Business Administration-BBA Semester 5

    BB0022 Capital and Money Market - 4 Credits

    (Book ID: B0101)

    Assignment Set- 2 (60 Marks)

    Note: Each question carries 10 Marks. Answer all the questions.

    Q.1 Why the buy back of shares should be permitted?

    MEANING OF BUYBACK OF SHARESA corporation's repurchase of stock or bonds it has issued. In the case of stocks, this reduces tnumber of shares outstanding, giving each remaining shareholder a larger percentage ownershipthe company. This is usually considered a sign that the companys management is optimistic abothe future and believes that the current share price is undervalued. Reasons for buybacks incluputting unused cash to use, raising earnings per share, increasing internal control of the compaand obtaining stock for employee stock option plans or pension plans. When a compan

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    shareholders vote to authorize a buyback, they aren't obliged to actually undertake the buyback. Acalled corporate repurchase.

    Arguments For Buybacks

    Buyback deception was supported by two main arguments.

    First, it was claimed that buybacks did not forced up stock prices, but rather that highprices were the result of improved corporate earnings, productivity, innovation, and good

    economic times. Second, it was said that even if buybacks pushed prices upwards, this benefitedinvestors.

    Buybacks, it was claimed, were just a more tax-efficient form of dividends. In other essays, weshow how the arguments regarding earnings, productivity were misleading.

    What remains to be seen is whether buybacks were beneficial for the long-term investors thatmade up most of the market. Those who deny that stock buybacks drive up prices point to specificases in which stock prices fell, despite repurchases. Buybacks were not able to support prices inthe Crash of 2000-2001, although repurchase programs were ratcheted up to record levels.

    Some even contend that SEC rules against manipulation are so strict that companies are not

    allowed to manipulate prices. With so much money involved, alternative explanations andrationalizations are to be expected. To be sure that we have not misjudged the motives ofcorporate executives, we must look into the counter-arguments supporting stock buybacks.

    SEC Rule 10b-18

    There is an argument that buybacks cannot influence stock prices, because to do so would beagainst the law. American securities law has prohibited stock manipulation since the 1930s. Themarket manipulation that went on in the 1920s, with tricks such as wash sales, round-robintrading, and pump-and-dump schemes, inspired these rules.

    SEC Rule 10b-18, however, provides corporations with a safe harborfrom charges of manipulation

    when the issuer follows certain guidelines on timing, price, volume, and the method ofrepurchasing stock. This rule does not stop a company from forcing prices up, which is bound tohappen when stocks are taken from the market. The SEC Rule 10b-18 restrictions focus on a smalset of manipulative practices that might mislead investors.

    For example, the SEC bars buybacks in the last thirty minutes of a trading session, becausespeculators often refer to closing prices when opening the market the next day. Issuers also maynot buy their own stocks at prices higher than the previous trade, nor may they use more than

    one broker on any day, since such tactics might be used to fake transactions.Rule 10b-18 says that company purchases of company stock on the exchange may not exceedtwenty-five percent of the average trading volume in the last month, but there is no limit to largeblock purchases.

    An issuer can privately purchase large blocks off the market and still buy twenty-five percent ofthe stock traded before the last half-hour of the session, as long as each trade is not higher thanthe last independent price.

    With excess supply removed, an independent investor trying to acquire stock will have to pay ahigher price, and once a higher independent price is established, the issuer may move back intothe market and force prices even higher. After September 11, 2001, the SEC loosened even these

    lax requirements, with the intent of encouraging issuers to manipulate prices upwards following

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    the terrorist attack on America. Obviously, if the SEC has bothered to issue a safe harbor rule onbuybacks, the government must recognize that buybacks are indeed manipulative.

    The SEC seems to be saying, manipulation is OK, as long as it is orderly and brokers get theircommissions.

    Failed Buybacks

    Another non sequitur argument is that buybacks do not always work. When news about acompany is bad and when investors are motivated to sell, issuers are powerless to keep prices

    from falling. Equity prices are set by the small percentage of shareholders that come to themarket. When there are few buyers, other than the issuer, sellers may swamp the market.

    However, if the news on the company is favorable and there is no selling panic, a strong buybackprogram can easily force prices upwards. Furthermore, in Capital Flow Analysis we do not focus onindividual companies, but rather on result of what many companies do and that together movesthe market. When the overall supply of stocks is reduced relative to demand, covariance betweenstock prices will result in an upward trend in average prices, although individual stock buybackprograms may fail.

    Buybacks will also fail to jack up prices in bear markets. In a market crash, issuers acting inconcert cannot stand against an army of determined sellers. In the Crash of 2000-2001, the valueof stocks in circulation was thirty times corporate earnings. All the cash that corporations could

    scrape together was not enough to counter determined selling pressure by investors. Also, foreignissuers sold into the 2000-2001 bear market, neutralizing the effect of domestic buybacks.

    There is high covariance among stocks in the market. Buybacks inflate prices of issuers thatengage in repurchase programs. When many issuers are engaged in buybacks, many stocks rise,and stocks of companies without buyback programs also rise.

    Q.2 Explain the meaning of stock index futures with appropria


    Agreements to buy or sell a standardized value of a stock index, on a future date at a specified pric

    such as trading New York Stock Exchange composite index on the New York Futures Exchange (NYF

    As an investment instrument it combines features ofsecurities trading based on stockindices with t

    features ofcommodity futures trading. It allows investors to speculate on the entire stock
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    markets performance, short sell (see short sale) an index with a futures contract, or to hedge a long

    position against a decline in value.

    A stock index future can be defined as a futures contract where the underlying asset is a stock index

    A futures contract is an agreement between two parties to purchase an asset at a fixed price and at

    later date. Futures contracts are traded on a futures exchange and are subject to a daily settlement

    guarantee to each party that the claims against the other party will be paid. Stock index futures are

    settled through cash.


    1. Stock index futures are based on the indices of common stock. The indices, such as S&P or the Dow Jones, are not trade

    directly, but are traded only through futures contracts. The settlement of the contracts is based on cash and not the actua

    delivery of stock certificates.


    2. Stock index futures trade in terms of number of contracts. The dollar value of a stock index futures contract is calculated

    using the quoted futures price and multiple. The contract's multiple is a dollar amount fixed by the index.

    Value Equation

    3. A simple equation used to calculate the dollar value of a stock index futures contract using the quoted futures price and

    quoted multiple is as follows: dollar value of a stock index futures contract equals futures price times the multiple.

    Daily Settlement

    4. At the end of each trading day, the individual losses and gains on a stock index futures contract are credited or debited b

    the exchange to the trader's account. This is called the "daily settlement" procedure. The investor is required to have eno

    cash in the account to fund these daily variations.

    Margin Requirements

    5. The exchange requires cash margins to be maintained by the investor to fund the daily trade variations. This includes an

    upfront "initial margin" amount and a "maintenance margin," which is a minimum level of cash that the account should hav

    until the contract is settled.

    Q.3 Name the various players of the futures market who buy and se

    futures contract.
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    A futures market, like any market, is a place where buyers and sellers meet in order to transact. Forevery buyer, there is a seller and for every seller, there is a buyer. Matching these two together sothat a trade can be consummated requires the participation of a host of individuals and organizationeach having specific roles, which in the aggregate make the futures market the efficient mechanismthat it is today. Throughout this section, reference is made solely to the futures market only forconvenience and simplicity of presentation. The market for options on futures is structured in verymuch the same manner.

    The Futures and Options ExchangeThe central player of a futures market is a futures exchange. A futures exchange is a meeting place

    where futures contracts are bought and sold. Trading occurs against a background of regulatorysurveillance and guidelines from the exchange itself and from the Commodity Futures TradingCommission (CFTC). Each exchange has its own list of products that it trades, and each product istraded in a designated futures trading pit. A trading pit is an area of floor, usually round withconcentric steps leading down into the center. The trading pits are each divided into a number ofsections designated for trading in particular contract months. No trading may occur outside acontract's assigned pit, nor is trading permitted at any time other than during those hours which havbeen designated by the exchange. (Some exchanges also use automated trading facilities orcomputer networks which serve as trading pits.)

    In addition to providing the market place for trading futures and regulating trading within its pits,futures exchanges also design and specify their futures contracts. Futures contracts are very specifiin terms of the quality and quantity of goods underlying the contract. You may have wondered whodetermines these specifications. The answer is the futures exchange. Working with participants in thindustry such as traders, fund managers and natural hedgers, a futures exchange designs a contracto meet the greatest need. If the exchange succeeds, it will have designed a futures product thatmany players can use or trade, and volume in the futures will grow. Contract specifications cansometimes be changed by the exchange, and is usually done to keep the contract viable. For thisreason, it is a good idea to periodically check the specifications of the contracts that you trade or wato trade.

    The Futures BrokerBuying or selling a futures contract or an option on a futures contract can only be done in one placethe trading pit on the floor of a futures exchange. To stand in a trading pit, you need to buy anexchange membership, pay annual dues, and register with various regulatory agencies. Naturally, fepeople would trade futures if it required that they stand in the trading pit. To solve this problem, insteps the futures broker. Your broker acts as a communication link between the trading pit and you,taking orders from you, the customer, and executing them in the futures pit.This is the traditional path that a futures order takes as it passes through the system (there are somexciting new developments in the world of trading, such as online trading where you place the ordethrough an online broker or via specialized software):

    You, the customer, decide to buy or sell a futures contract.

    You phone your order to the futures order desk of our Futures Commission Merchant (FCM).

    The order desk relays by telephone your order to the phone clerk on the exchange floor.

    The clerk writes the futures order, time stamps it, and delivers it to the executing floor broker in thetrading pit. If a market order, the order is executed. If any other kind of order, it is placed in a "deckalong with other orders ready to be executed if triggered by price movements.

    Once executed, the floor broker informs the clerk who informs the order desk who, in turn, informsyou. You now have a futures position.

    The FCM prepares a trade confirmation report and mails it to you.

    The FCM marks-to-market your futures position against the margin in your trading account.

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    As you can see, there are several players, each having different roles, who are involved in theprocess. Despite the steps involved, the process has become very efficient - orders can often beexecuted within a minute or two while you wait on the phone.

    You may wonder why a futures broker requires an FCM to complete this process. By law, futuresbrokers do not have the authority to take customer funds and hold them in deposit. Only an FCM cado this. For this reason, a futures broker needs to team up with an FCM in order to provide orderexecution services to its customers.

    The Futures Commission MerchantThe Futures Commission Merchant (FCM) is responsible for holding customer funds of the marginaccount, clearing the futures trade, and performing all back-office recording functions such asmarking-to-market your futures account, sending trade confirmations and account summaries, andyear-end tax forms. Customers who open a futures trading account deposit their margin funds at anFCM.

    The Clearing CorporationThe clearing corporation guarantees the performance of every buyer and seller of a futures or optiocontract. In a literal sense, it stands as a buyer to every seller and a seller to every buyer. As a futurtrader, that means that you don't have to worry about any default of a futures counterparty. Forinstance, say that you purchase several Swiss franc futures and the price goes up so that you haveaccrued a $4,500 profit. Whoever sold those futures contracts (and there is a seller for every buyer,and vice-versa) has incurred a loss of $4,500. What happens if that person can't pay? Do you sacrifiyour profit? The answer is "NO". The clearing corporation guarantees the transaction. The clearingcorporation's elimination of such counterparty credit risk provides a great benefit to the futures andoptions markets.

    You may wonder how the clearing corporation does this. The answer lies in the margin deposit thatyou and every other futures trader must make before trading any contract. This margin is available the clearing corporation and, together with other reserve cash and various protection funds, are useto cover any customer default. A clearing corporation is composed of clearing members, most ofwhich are large FCM's. It is a mark of distinction for an FCM to be a clearing member.

    Regulation of the Futures MarketAll futures industry-related operations, including exchanges, brokers and FCMs are regulated andlicensed by the Commodity Futures Trading Commission (CFTC), a federal agency with jurisdictionover the United States commodities markets. The CFTC regulates in conjunction with the NationalFutures Association (NFA), the industry's only national association. The primary purpose of the NFA to ensure, through self-regulation, high standards of professional conduct and financial responsibiliton the part of the individuals and organizations that are its members: Futures Commission MerchanIntroducing Brokers,

    Commodity Trading Advisors, Commodity Pool Operators, and Associated Persons. In connection witits regulatory responsibilities, the NFA conducts periodic audits of its members' financial and otherrecords, monitors sales practices and provides a mechanism for the arbitration of futures relateddisputes between NFA members and the investing public.

    Example:A silversmith must secure a certain amount of silver in six months time for earrings and bracelets thhave already been advertised in an upcoming catalog with specific prices. But what if the price ofsilver goes up over the next six months? Because the prices of the earrings and bracelets are alreadset, the extra cost of the silver can't be passed on to the retail buyer, meaning it would be passed oto the silversmith. The silversmith needs to hedge, or minimize her risk against a possible priceincrease in silver. How?

    The silversmith would enter the futures market and purchase a silver contract for settlement in six

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    months time (let's say June) at a price of $5 per ounce. At the end of the six months, the price of silvin the cash market is actually $6 per ounce, so the silversmith benefits from the futures contract anescapes the higher price. Had the price of silver declined in the cash market, the silversmith would, the end, have been better off without the futures contract. At the same time, however, because thesilver market is very volatile, the silver maker was still sheltering himself from risk by entering intothe futures contract.

    So that's basically what hedging is: the attempt to minimize risk as much as possible by locking inprices for future purchases and sales. Someone going long in a securities future contract now canhedge against rising equity prices in three months. If at the time of the contract's expiration the

    equity price has risen, the investor's contract can be closed out at the higher price. The opposite cohappen as well: a hedger could go short in a contract today to hedge against declining stock prices the future.

    A potato farmer would hedge against lower French fry prices, while a fast food chain would hedgeagainst higher potato prices. A company in need of a loan in six months could hedge against risinginterest rates in the future, while a coffee beanery could hedge against rising coffee bean prices nexyear.

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    Q.4 Describe the role played by dealers in the Money Market.

    Primary dealers are large commercial banks which operate under the supervision of the U.S. Federabank or broker-dealers registered with the SEC. They are required to have a capital base in accordwith Tier 1 and Tier 2 capitalization, which covers both equity capitalization and core capitalization.Capitalization is a significant qualification for being a primary dealer because PDs keep the FederalReserve trading desk operations running efficiently.

    Primary dealers buy securities from those issuing them and then sell them to smaller investors. Thesystem of dealing through primary dealers gives the sellers an assurance that all the securities onissue will be sold. But at the same time it gives the primary dealers a lot of power and the ability to

    manipulate the process of buying and selling securities.

    For this reason strict laws have been enacted to prevent any collusion between dealers and to ensuthat they cannot take undue advantage of their monetary power.

    Role of Government :To increase the stability of Financial Institutions and Markets, Government intervenes in the interestrates and money supply in the Money Markets. Government has several ways to control income andinterest rates, which can be divided into two broad groups, fiscal policy and monetary policy. Thegovernment to adjust the exchange rate intervenes with the foreign exchangeMarkets; there may be an effect on the monetary base and the supply of money. When the currencyfalling, foreign currencies must be sold and the currency must be bought to stabilize its price. The uof deposits of the national currency to do this suggest that the operational deposits of the bankingsector must be reduced, causing the monetary base to fall, affecting the supply of money. Converseby selling the national currency to reduce its rate, the monetary base will rise. Securities may be soon the open market in an attempt to dampen the effects of inflows of the national currency, but thiswould imply an increase in interest rates and cause the currency to rise further still. A number ofinstitutions can affect the supply of money, but the greatest impact on the money supply is had bythe central bank and the commercial banks.

    Role of Central Bank : Firstly, the central bank could do this by setting a required reserve ratio, which would restrict theability of the commercial banks to increase the money supply by loaning out money. If thisrequirement were above the ratio the commercial banks would have wished to have, then the bankswill have to create fewer deposits and make fewer loans then they could otherwise have profitablydone. If the central bank imposed this requirement in order to reduce the money supply, thecommercial banks will probably be unable to borrow from the central bank in order to increase theircash reserves if they wished to make further loans. They might try to attract further deposits fromcustomers by increasing their interest rates, but the central bank may retaliate by increasing therequired reserve ratio.

    The central bank can affect the supply of money through special deposits. These are deposits at thcentral bank, which the banking sector is required to lodge. These are then frozen, thus preventingthe sector from accessing them, although interest is paid at the average treasury bill rate. Makingthese special deposits reduces the level of the commercial banks operational deposits, which forcesthem to cut back on lending. The supply of money can also be controlled by the central bank byadjusting its interest rate, which it charges when the commercial banks wish to borrow money (the

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    discount rate). Banks usually have a ratio of cash to deposits, which they consider to be the minimusafe level. If demand for cash is such that their reserves fall below this level, they will able to borrowmoney from the central bank at its discount rate. If market rates were 8%, and the discount rate wealso 8%, then the banks could reduce their cash reserves to their minimum ratio, knowing that ifdemand exceeds supply they will be able to borrow at 8%. The central bank, though, may raise itsdiscount rate to a value above the market level, in order to encourage banks not to reduce their casreserves to the minimum through excess loans. By raising the discount value to such a level, thecommercial banks are given an incentive to hold more reserves, thus reducing the money multiplierand the money supply.

    Another way the money supply can be affected by the central bank is through its manipulation ofthe interest rate. This is akin to the discount rate mentioned above. By raising or lowering interestrates, the demand for money is respectively reduced or increased. If it sets them at a certain level, can clear the market at level by supplying enough money to match the demand. Alternatively, it coufix the money supply at a certain rate and let the market clear the interest rates at the equilibrium.Trying to fix the money supply is not easy, so central banks usually set the interest rate and providetheamount of money the market demands. The central bank may also affect the money supply through operating on the open market. Thisallows it to manipulate the money supply through the monetary base. It may choose to either buy osell securities in the marketplace, which will either inject or remove money respectively. Thus, themonetary base will be affected, causing the money supply to alter. To illustrate this, suppose thecentral bank sold gilts(Risk-free bonds) worth $10 million. $10 million would flow from the deposits othe purchasers to the central bank, taking the $10 million out of the monetary base. To inject moneinto the economy, the central bank would have to buy the gilts.

    As lenders and borrowers: Banks and institutions such as commercial banks, both Indian and foreignState Bank of India, Cooperative Banks, Discount and Finance House of India ltd. (DFHL) and SecuritTrading Corporation of India (STCI).As lenders: Life Insurance Corporation of India (LIC), Unit Trust of India (UTI), General InsuranceCorporation (GIC), Industrial Development Bank of India (IDBI),National Bank for Agriculture and RurDevelopment (NABARD), specified institutionsAlready operating in bills rediscounting market, and entities/corporate/mutual funds.

    The participants in the call markets increased in the 1990s, with a gradual opening upof tcall markets to non-bank entities. Initially DFHI was the only PD eligible to participate in the cmarket, with other PDs having to route their transactions through DFHI, and subsequently STCI.1996, PDs apart from DFHI and STCI were allowed to lend and borrow directly in the call markePresently there are 18 primary dealers participating in the call markets. Then from 1991 onwarcorporate were allowed to lending the call markets, initially through the DFHI, and later through anythe PDs. In order to be able to lend, corporate had to provide proof of bulk lendable resources to tRBI and were not suppose to have any outstanding borrowings with the banking system. Tminimum amount corporate had to lend was reduced from Rs. 20 crore, in a phased manner to Rscrore in 1998.There were50 corporate eligible to lend in the call markets, through the primary dealeThe corporate which were allowed to route their transactions through PDs, were phased out by eJune 2001.

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    Q.5 List the basic features of the Indian Money Market.

    Every money is unique in nature. The money market in developed and developing countries differ

    markedly from each other in many senses. Indian money market is not an exception for this. Though

    is not a developed money market, it is a leading money market among the developing countries.

    Indian Money Market has the following major characteristics :-1. Dichotomy Structure: It is a significant aspect of the Indian money market. It has asimultaneous existence of both the organized money market as well as unorganized money

    markets. The organized money market consists of RBI, all scheduled commercial banks and otherecognized financial institutions. However, the unorganized part of the money market comprisesdomestic money lenders, indigenous bankers, trader, etc. The organized money market is in fullcontrol of the RBI. However, unorganized money market remains outside the RBI control. Thus bothe organized and unorganized money market exists simultaneously.

    2. Seasonality : The demand for money in Indian money market is of a seasonal nature. Indiabeing an agriculture predominant economy, the demand for money is generated from theagricultural operations. During the busy season i.e. between October and April more agriculturalactivities takes place leading to a higher demand for money.

    3. Multiplicity of Interest Rates : In Indian money market, we have many levels of interest

    rates. They differ from bank to bank from period to period and even from borrower to borrower.Again in both organized and unorganized segment the interest rates differs. Thus there is anexistence of many rates of interest in the Indian money market.

    4. Lack of Organized Bill Market : In the Indian money market, the organized bill market is nprevalent. Though the RBI tried to introduce the Bill Market Scheme (1952) and then New BillMarket Scheme in 1970, still there is no properly organized bill market in India.

    5. Absence of Integration : This is a very important feature of the Indian money market. At thsame time it is divided among several segments or sections which are loosely connected with eaother. There is a lack of coordination among these different components of the money market. R

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    has full control over the components in the organized segment but it cannot control thecomponents in the unorganized segment.

    6. High Volatility in Call Money Market : The call money market is a market for very shortterm money. Here money is demanded at the call rate. Basically the demand for call money comfrom the commercial banks. Institutions such as the GIC, LIC, etc suffer huge fluctuations and thuit has remained highly volatile.

    7. Limited Instruments : It is in fact a defect of the Indian money market. In our money markethe supply of various instruments such as the Treasury Bills, Commercial Bills, Certificate of

    Deposits, Commercial Papers, etc. is very limited. In order to meet the varied requirements ofborrowers and lenders, It is necessary to develop numerous instruments.

    Q.6 what are the various efforts made by the Government to make thegovernment securities an attractive investment?

    From a narrow ownership base, Government securities market has been increasingly becoming broabased over the recent years. The main holders of government securities are banks, Primary/ SatellitDealers, LIC, All India Financial Institutions, Provident Fund Trusts, Gilt Funds and lastly corporate

    entities and retail holders, mainly through Mutual Funds. Although Foreign Institutional Investors areallowed to invest in government securities such investments have not picked up. A large part ofoutstanding government securities are held by the Reserve Bank mainly as back up for its currencyissue liabilities and for conducting Open Market Operations. Introduction of the system of PrimaryDealers have ensured that underwriting of the primary issues is shouldered mainly by Primary Dealeand automatic devolvement on RBI does not happen.

    The main participants in the Government Securities market such as banks, Primary Dealers, FinanciInstitutions enter into transactions in government securities market mainly as a part of theirinvestment and trading functions. RBI has issued detailed instructions to banks about thecategorization and valuation of government securities. Further banks, which maintain "Trading Bookcan do so, only subject to compliance with certain preconditions specified by the RBI from risk

    management angle.

    In order to develop the market on sound lines, RBI has initiated various reforms. Thus the prices atwhich different securities are bought/sold are made available to the market participants on a dailybasis. National Stock Exchange also publishes the security prices in respect of transactions reportedto them. As mentioned earlier system of DVP has been introduced to reduce counterparty risk insecurity transfers.

    In order to protect the interest of retail holders of government securities using the system ofConstituents SGL Accounts, RBI have issued guidelines regarding maintenance of such accounts. Asystem of retail holding through Bond Ledger Form has also been introduced in respect of certain

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    securities. Bond Ledger Accounts can be opened with branches of specified banks and this is expectto make it convenient for retail holders, although at present only Relief Bonds can be so held.

    RBI extends liquidity support to Mutual Funds Dedicated to Investments in Government Securities(GILT FUNDS) to encourage such Mutual Funds, which is a convenient way of indirect investments ingovernment securities by individuals and other market participants.

    Primary Dealers play an important role in the government securities market. A brief account of theirrole is provided in the following paragraphs:

    Primary Dealers

    The Guidelines for Primary Dealers (PDs) in Government Securities were announced by the Bank inMarch 1995. The objectives of setting up the system of Primary Dealers are:

    i. To strengthen the infrastructure in the government securities market in order to make itvibrant, liquid and broad based.

    ii. To ensure development of underwriting and market making capabilities for governmentsecurities outside the RBI so that the latter will gradually shed these functions.

    iii. To improve secondary market trading system, which would contribute to price discovery,enhance liquidity and turnover and encourage voluntary holding of government securities

    amongst a wider investor base.iv. To make PDs an effective conduit for conducting open market operations.

    Eligibility for being considered for Primary Dealership

    The following are the eligibility standards:

    i. The entity should be a subsidiary of a scheduled commercial bank/an All India FinancialInstitution dedicated predominantly to the securities business and in particular to thegovernment securities market, or a company incorporated under the Companies Act, 1956 anengaged predominantly in the securities business and in particular the government securitiesmarket, and

    ii. The applicant should have Net owned funds of a minimum of Rs.50 crore.

    Three basic parameters would have to be necessarily fulfilled by an applicant for PD-ship, i.e., thecompany should have (a) net owned funds of Rs.50 crore (b) sizeable business in governmentsecurities and (c) should not be a loss making company.

    The relationship between the Bank and the entities in their capacity as PDs is not statutory, butcontractual in nature. Primary Dealership is renewed every year on the basis of agreement to beentered into between the Bank and these entities. Legally they are non-banking financial companiesand are subject to the registration requirements for NBFCs. However, if a PD does not accept publicdeposits it is exempt from the related regulations. On account of the special responsibilities assigneto them in the Government Securities Market, RBI has been monitoring their activities by undertakinoff as well as on site surveillance through scrutiny of prescribed returns and also by on-siteinspections to check compliance with the Guidelines and other terms of appointment. RBI hasprescribed capital adequacy standards to be observed by Primary Dealers. The Primary Dealers'responsibilities are:

    i. A Primary Dealer will be required to commit to aggregative bid for Government of India datedsecurities and auction Treasury Bills on an annual basis of not less than a specified amount. Tagreed minimum amount of bids would be separately indicated for dated securities and

    Treasury Bills.ii. The Primary Dealer would have to achieve a minimum success ratio of 40 per cent for both

    dated securities and Treasury Bills (vis--vis bidding commitment).

    iii. To maintain risk based capital adequacy as per RBI instructions

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    iv. The PD has to quote two-way at least in a few securitiesv. PDs have to underwrite primary auction of government securities.

    Issues of Treasury Bills are not underwritten. Instead, PDs have to commit to submit minimum bids aeach auction covering the entire issue amounts.

    The percentage of minimum bidding commitment so determined by the Reserve Bank will remainunchanged for the entire financial year. In determining the minimum bidding commitment, RBI willtake into account the offer made by the PD, its net owned funds and its track record.

    Facilities extended to the PDs

    The following facilities have been extended to PDs:

    i. Entitlement to open one Current Account and two Subsidiary General Ledger (SGL) Accounts government securities (one for own operations and the second for operations on behalf ofconstituents), at all offices of the RBI.

    ii. Permission to borrow and lend in the money market including call money market and to tradeall money market instruments.

    iii. Liquidity Support through Repos operations/demand loans with RBI collateralized by CentralGovernment dated securities and Auction Treasury Bills upto the limit fixed by RBI.

    iv. Favored access to Open Market Operations.v. Permission to raise Commercial Paper as per the provisions contained in the "Primary Dealers(Acceptance of Deposits through Commercial Paper) Directions, 1996" issued in terms ofSection 45 K and 45 L of the RBI Act, 1934.

    vi. Facility of transfer of funds from one centre to another centre under RBIs Remittance FacilityScheme and also of clearing of cheques arising out of Government securities transactions,tendered at RBI counters.

    Other Obligations of PDs

    The following important obligations are cast on them under the PD Guidelines:

    i. Obligation to offer a firm two-way quotes for government securities and take principal positioii. Achieving prescribed turn over ratios in government securities.iii. Maintenance of physical infrastructure in terms of office, computing equipment, communicati

    facilities like Telex/Fax, Telephone, etc., and skilled manpower for efficient participation inprimary issues, trading in the secondary market, and to provide advice and education toinvestors.

    iv. Putting in place efficient internal control system.v. Obligation to provide to RBI access to all records, books, information and documents as may Adherence to all prudential and regulatory guidelines prescribed by RBI from time to time.vii. Formation of self regulatory organization (SRO).viii. Maintenance of a separate desk for government securities business and separate accounts a

    has an external audit of annual accounts.ix. Maintenance separate accounts in respect of its own position and customer transactions.x. Responsibility to bring to RBIs attention any major complaint against him or action

    initiated/taken against him by authorities such as the Stock Exchanges, SEBI, CBI, EnforcemeDirectorate, Income Tax, etc.

    xi. Setting up prudential ceilings, with the prior approval of the Board of Directors of the companon borrowings from the money market including repos, as a multiple of net owned funds,subject to the guidelines, if any, issued by the Reserve Bank in this regard.