Category: Management Notes

Merchant bankers play an important role in public issue process. While acting as a banker to an issue, a merchant banker has to disclose full details to the Securities Exchange Board of India (SEBI). The details submitted by merchant banker about the public issue should contain the following.

1. Furnishing Information:

• Number of issues for which the merchant banker is engaged as banker to issue.
• Number of applications received and details of application money received
• Dates on which applications from investors were forwarded to issuing company.
• Details of amount as refund to investors.

2. Books to be Maintained:

• Books of accounts for a minimum period of 3 years
• Records regarding the company
• Documents such as company applications, names of investors, etc.

3. Agreement with issuing company

Agreement with the issuing company by the merchant banker should contain

• Number of collection centres
• Application money received
• Daily statement by each branch which is a collecting centre.

4. Action by RBI: Any action by RBI on merchant banker should be informed to SEBI by the merchant banker concerned.

5. Code of Conduct

• Having high integration in dealing with clients.
• Disclosure of all details to the authorities concerned. Avoiding making exaggerated statements.
• Disclosing all the facts to its customers.
• Not disclosing any confidential matter of the clients to third parties.

A rights issue is the offer of shares of a company to the existing shareholders. A merchant banker has the following responsibilities in Rights issue.

Responsibilities of Merchant Bankers in Rights Issue

1. The merchant banker will ensure that when Rights issues are taken up by a company, the merchant banker who is responsible for the Rights issue, shall see that an advertisement regarding the same is published in an English national daily, in an Hindi national daily and in a regional daily.

These newspapers should be in circulation in the city / town where the registered office of the company is located.

2. It is the duty of the merchant banker to ensure that the application forms for Rights issue should be made available to the shareholders and if they are not available, a duplicate composite application form is made available to them within a reasonable time.
3. If the shareholders are not able to obtain neither the original nor the duplicate application for Rights shares, they can apply on a plain paper through the merchant banker.
4. The details that should be furnished in the plain paper, while applying for Rights shares should be provided by the merchant hanker.
5. The merchant banker should mention in the advertisement, the company official to whom the shareholders should apply for Rights shares.
6. The merchant banker should also inform that no individual can apply twice, in standard form as well as in plain paper.

1. Repayment of Principal:

Bonds are issued in denomination of Rs. 1,000 but there are also bonds of values of Rs. 500 and Rs. 100 and of values as high as Rs. 5,000 and Rs. 10,000. Financial institutions are known to buy corporate bonds bearing higher values. The value of the bond is called the ‘face value, par value or maturity value’.

The face value of the bond represents the promise to repay the amount to the bondholder at the end of the specified period. This, in other words, may be called the most important feature of bond, return of the principal to the lender on a fixed date specified earlier.

2. Specified Time Period:

The second feature is the maturity date of the bond. The time specified in the bond is called the maturity date or date of repayment of principal amount. The maturity date of bonds varies according to the requirement of each organization. Some organizations issue bonds of a long-term nature. The number of years of these bonds varies from 20 years to 100 years maturity.

Other issues of bonds are for medium term and their maturity is between 5-10 years. Shorter-term bonds are identified as those whose maturity is below 4 years. The bond indenture specifically gives the maturity date of the bond. This is the promise to pay the principal amount on a specified date after the expiry of the number of years for which it is issued.

3. Call:

Bonds have an additional feature of ‘call’. This is a privilege to the issuing company to re-purchase bonds at a slightly higher price above the par value. For example, a bond of face value of Rs. 1,000 and maturity of 20 years yields an interest of Rs. 70 annually. After the first 5 years of issue, the market rate of interest on bonds falls considerably.

The ruling rate being 5% the company may choose to use the call feature and buy back the bond for Rs. 1,050. This is a little higher than the face value of Rs. 1,000. By calling the bonds, the company saves money. It may call back the bonds yielding interest of Rs. 70 and issue fresh bonds which will yield Rs. 50 per year.

The firm has been able to save Rs. 20 per year per bond for the next 15 years till the maturity of the bond. By paying Rs. 50 higher than the face value on the bond for early redemption of the bond, the company saves a much higher amount.

The bond holder is on the losing side because he gets the return of the principal amount earlier than he expected. Since, the current market rate of interest is prevailing at a lower rate he cannot buy any other bond which will fetch him an income of Rs. 70 per bond per year. This feature gives a right to the issuing company.

The bondholder should be aware of the call feature before he makes an investment in bonds. He can protect himself by investing in bonds of shorter durations. Although there is risk of fluctuations in interest rates for short durations, a ten year period is considered to be good life of a bond from the point of view of the bondholder.

4. Pledge of Security:

The issuing company sometimes promises to pay to the bondholder by offering some security like property. The pledge of security is a promise to the bondholders in writing and signed under seal and presented to the trustee by the company. A simple promise to pay without the proper formalities is not considered as a pledge of security.

5. Interest:

The rate of interest to be paid to bondholder and the time of payment is recorded in the bond as well as in the indenture, ‘interest rate’ is also called the ‘coupon rate’. Interest on bond may be made by cheque or coupon. When interest is paid to the bondholder by cheque the principal amount on the bond is usually registered to interest value.

The coupons are numbered and every coupon represents, the interest payment period. When the coupon becomes due, the bondholder presents the coupon to the authorized banker and receives interest. The coupons are usually bearer bonds and are negotiable when they become due and payable.

Coupons should be kept safely because it is difficult to recover them if they are lost, since the name of the owner is not required in order to en-cash them. Interest either by coupon or by cheque is paid on the face value of the bond. The rate cannot be changed once it has been fixed. The interest is paid in Rupee Value in India. Gold bonds were issued in India in the early 1950s but now only Rupee Bonds are issued.

Interest on bonds should be paid regularly by the issuing authority. Government bonds are very reliable as they are paid in time. Sometimes, interest is not paid by companies when it is due. The bond issue in this case is considered to be in default and both the interest and principal become due and payable to the bondholder. The trustees of the bondholder at this point of time protect the interest of the bondholders.

In order to be sure that interest and principal sum on the bond will be repaid, it is necessary that the bonds are evaluated and analysed before investing in them.

An investor must look into the net operating profit of the firm as well as its net income after taxes. This will to a great extent determine the quality of the bond. It must be emphasized that bonds will be considered secure when the interest charges are low and the net operating income is high.

Sometimes, the bond issuing companies offer security through assets and in writing, assuring the bondholders of the payment of interest. Sometimes, the company promises to maintain a minimum working capital position or a particular cash position. Interest is guaranteed in assumed bond, guaranteed bond or joint bond.

Interest on bonds is also protected by the ‘acceleration clause’. When interest is due but not paid, this clause gives the right to the bondholder to represent himself through the trustee. This clause gives the bondholder the right of a creditor and he can make a claim on his assets but cannot be sure of receiving the principal amount.

The bondholder will be reassured if on an analysis of the company’s position. It is found that the company’s operating income is sufficient to cover all expenses pertaining to the company’s account inclusive of all interest charges made on its issue of debt.

6. Covenants:

Covenants are productive clauses in the bond indenture. They are agreements between the company and the bondholders through the trustees. Through these agreements the company binds itself to the bondholders.

The company agrees to control its operations and in this way offers some protection to bondholders. Sometimes, a company makes an agreement to limit the amount of dividend to be paid to its equity shareholders. Other covenants protect the bondholder by ensuring a minimum, cash balance to be maintained by the firm.

Certain covenants or agreements are specifically used on a particular class of bonds. For example, mortgage bonds may include a covenant to limit the company’s expenses or debt position up to a fixed percentage of the value of new purchases of property, for example, 75% of the property.

Covenants are agreements or promises which tone up the quality of the bonds and assure repayment of principal and interest. There are different kinds of bonds based on these special features: Repayment of principal, Maturity date, Call, Pledge of security, Interest and Covenants. 

The Reserve Bank of India (RBI) defines government securities as “tradable instruments issued by the Central Government or State Governments.” These securities carry a minimum risk of default and are sometimes called “risk-free gilt-edged instruments.” The following are some securities offered by the RBI:

Treasury Bills

These are short-term government securities with maturities of up to one year. They are currently issued in three different types, that is, the ninety-one day, the one hundred and eighty-two day, and the three hundred- and sixty-four-day bills. Since they do not pay interest, the investor’s profit is the difference between the discounted issue price and the face value. The RBI performs weekly auctions to issue the treasury bills.

Cash Management Bills

These are short-term securities that are highly flexible since they can be issued when needed. Their tenure and date of issue are based on the temporary cash needs of the government; however, the chosen tenure must still be less than 91 days. Like Treasury Bills, they are given at discounts on the face value via RBI auctions.

Dated Government Securities

These are long-term securities that have either a fixed or floating rate of interest. The investor benefits from the interest paid (coupon) on each bond. These securities are termed “dated” because of the explicitly stated date of maturity; for instance, a January 1st, 2019 security will mature on January 1st of 2019. The RBI sells these securities via auctions. The main investors in dated securities are primary dealers such as commercial banks and insurance companies. Examples of dated securities are fixed and floating rate bonds, zero coupon bonds, capital indexed bonds, and bonds with call or put options.

State Development Loans

These are dated securities that are issued by state governments for purposes of meeting their budgetary requirements. The RBI facilitates the issuance of these security types via auctions through the Negotiated Dealing System. These auctions are usually done once every two weeks. The rates of interest for these securities are determined at the time of auction, though their rates are often slightly higher than for the Dated Government Securities.

FURTHER READING:

https://rbi.org.in/scripts/FAQView.aspx?Id=79

Open Market Operations (OMO) are a monetary policy tool used by the central bank to regulate money supply, credit availability, and liquidity in the economy. The concept revolves around the buying and selling of government securities in the open market to influence banking liquidity, control inflation, and maintain financial stability.

OMO is based on the principle that by adjusting the level of liquidity in the banking system, the central bank can indirectly influence interest rates, lending activity, and overall economic growth. In India, OMOs are a crucial instrument used by the Reserve Bank of India (RBI) to achieve price stability and economic growth.

Meaning of Open Market Operations

Open Market Operations refer to the purchase or sale of government securities by the central bank in the open market to control the supply of money and credit.

• Purchase of securities by the central bank injects liquidity into the banking system, increasing credit availability and stimulating economic activity.

• Sale of securities withdraws liquidity from the banking system, reducing credit availability, curbing excessive spending, and controlling inflation.

OMO is considered a flexible, market-based tool because it can be applied rapidly and adjusted according to changing economic conditions.

Definitions of Open Market Operations

• R.S. Sayers

“Open market operations are operations by the central bank involving the buying and selling of securities in the open market to regulate liquidity and credit in the economy.”

• H.L. Hart

“Open market operations are the purchase and sale of government securities in the open market by the central bank to control the volume of money and credit in the economy.”

• Reserve Bank of India (RBI)

According to RBI, “Open market operations are the buying and selling of approved government securities by the central bank in the secondary market to regulate liquidity and credit conditions in the country.”

Objectives of Open Market Operations

• Control of Money Supply

One of the primary objectives of Open Market Operations is to regulate the overall money supply in the economy. By buying government securities, the central bank injects liquidity, increasing credit availability and stimulating investment and consumption. Conversely, selling securities absorbs liquidity, reducing excessive money supply and controlling inflation. In India, the Reserve Bank of India uses OMO as a flexible tool to ensure that the money supply matches the needs of economic growth.

• Price Stability

A key objective of OMO is to maintain price stability by preventing inflation or deflation. Excessive liquidity can lead to inflation, while insufficient money supply can cause deflation and economic slowdown. Through the sale or purchase of government securities, the central bank controls liquidity, stabilizing prices in the economy. In India, RBI uses OMO to ensure that inflation remains within the target range, supporting sustainable economic growth.

• Interest Rate Stabilization

Open Market Operations also aim to stabilize short-term interest rates in the financial markets. When the central bank injects liquidity through OMOs, borrowing becomes cheaper, reducing interest rates. Conversely, liquidity absorption increases rates. Stabilizing interest rates ensures predictable lending and borrowing conditions, encourages investment, and promotes financial stability. In India, RBI uses OMOs to maintain a balance between economic growth and monetary stability.

• Liquidity Management

A critical objective of OMO is effective liquidity management in the banking system. By buying securities, RBI provides banks with additional funds for lending, enhancing economic activity. By selling securities, excess liquidity is absorbed, preventing overheating in the economy. This helps commercial banks maintain adequate cash reserves and meet daily credit requirements. Proper liquidity management ensures smooth functioning of the financial system.

• Promotion of Economic Growth

OMOs support economic growth by ensuring adequate credit for productive sectors. When RBI purchases government securities, banks have more funds to lend for agriculture, industry, infrastructure, and MSMEs. Increased credit availability stimulates production, investment, and employment generation. Thus, OMOs act as a developmental tool of monetary policy, complementing quantitative and qualitative measures to support growth objectives in India’s developing economy.

• Financial Market Development

Open Market Operations help in the development and stability of financial markets. By buying and selling securities, RBI ensures sufficient liquidity and fosters active trading in government bonds. This strengthens the money and capital markets, enhances investor confidence, and ensures smooth price discovery. Active financial markets are essential for mobilizing resources efficiently, which supports both economic growth and monetary stability.

• Support to Government Borrowing

OMOs indirectly support government borrowing programs. By managing liquidity through purchase or sale of government securities, the central bank ensures stable demand and supply for government debt instruments. This helps maintain low borrowing costs for the government and efficient public debt management. RBI’s OMO operations play a vital role in ensuring fiscal stability alongside monetary objectives.

• Counter-Cyclical Economic Stabilization

A final objective of OMOs is to counter economic fluctuations. During periods of economic slowdown, RBI purchases securities to inject liquidity and boost credit, stimulating growth. During periods of excess demand or inflation, it sells securities to absorb liquidity and cool down the economy. Through OMOs, RBI applies a counter-cyclical policy that ensures both financial stability and sustained economic development.

Features of Open Market Operations

Open Market Operations (OMO) are a key tool of monetary policy used by central banks, like the Reserve Bank of India (RBI), to regulate liquidity, credit, and money supply in the economy. OMOs involve the buying and selling of government securities in the open market to achieve economic stability, control inflation, and maintain financial system health. The features of OMO highlight its importance as a flexible and market-oriented instrument.

• Conducted by the Central Bank

Open Market Operations are exclusively carried out by the central bank of a country. In India, the RBI is authorized to buy and sell approved government securities to influence liquidity in the banking system. Commercial banks or private entities cannot conduct OMOs, as this function is central to monetary control.

• Market-Based Operations

Open Market Operations are conducted in the open market, which includes the money market and government securities market. The central bank interacts with commercial banks and other financial institutions to buy or sell securities. This market-oriented mechanism ensures transparency and allows smooth transmission of monetary policy.

• Liquidity Management Tool

The primary feature of Open Market Operations is its role in liquidity management. By purchasing government securities, the central bank injects liquidity into the banking system, increasing the availability of credit. By selling securities, it absorbs excess liquidity, controlling inflation and preventing overheating of the economy. OMOs help maintain adequate liquidity for financial stability.

• Flexible and Adjustable

OMOs are highly flexible and can be used for short-term or long-term monetary management. The central bank can adjust the volume, timing, and type of operations based on economic conditions. This flexibility makes OMOs an effective instrument to respond quickly to inflation, deflation, or liquidity shortages.

• Indirect Control over Money Supply

Unlike direct tools, OMOs provide indirect control over credit and money supply. The central bank does not force commercial banks to act; instead, changes in liquidity and interest rates influence lending behavior. This ensures that monetary policy is market-driven and less intrusive.

• Dual Objective: Inflation Control and Growth

Controlling Inflation: Selling securities absorbs excess liquidity and prevents price rise and Promoting Growth: Buying securities injects funds, encourages credit flow, and stimulates investment.

This dual objective makes OMOs essential for balanced economic development.

• Short-Term and Long-Term Tool

Open Market Operations can target both short-term liquidity needs and long-term credit management. Short-term operations involve repurchase agreements (repo and reverse repo) to manage daily liquidity, while outright purchase or sale of securities targets medium-to-long-term money supply adjustments.

• Enhances Financial Market Stability

By influencing liquidity and credit, OMOs stabilize the money and government securities markets. A well-managed OMO ensures sufficient supply of funds, smooth trading in securities, and stability in short-term interest rates. This enhances investor confidence and supports financial market development.

• Complements Other Monetary Tools

Open Market Operations are not used in isolation. They complement other quantitative and qualitative instruments like repo/reverse repo rates, CRR, SLR, and credit rationing. Together, these tools ensure effective control over money supply, credit allocation, and economic stability.

• Predictable and Transparent

Open Market Operations operations are generally pre-announced and systematic, ensuring predictability for banks and financial markets. Transparency in OMOs ensures that market participants can adjust their lending and borrowing behavior in line with central bank actions.

Types of Open Market Operations

Open Market Operations (OMO) are conducted by a central bank, such as the Reserve Bank of India (RBI), to regulate liquidity, credit, and money supply in the economy. OMOs can be broadly classified into different types based on the duration, purpose, and method of operation. Understanding the types of OMO helps in analyzing how the central bank controls short-term and long-term monetary conditions.

1. Outright Operations

Definition: Outright operations involve the permanent buying or selling of government securities by the central bank in the open market.

• Outright Purchase: The central bank buys government securities from commercial banks or the market, injecting permanent liquidity into the banking system. This increases money supply and encourages lending and investment.

• Outright Sale: The central bank sells government securities to absorb liquidity from banks, reducing the money supply and controlling inflation.

Purpose: Outright operations are mainly used for long-term liquidity adjustments and to influence the overall money supply permanently.

2. Repurchase (Repo) Operations

Definition: Repo operations involve the sale of government securities by banks to the central bank with an agreement to repurchase them at a fixed price after a short period.

• This is a short-term liquidity management tool.

• Repo Rate: The interest rate at which banks borrow funds from the central bank against securities.

Purpose: Repo operations are used to inject liquidity temporarily into the banking system and influence short-term credit conditions.

3. Reverse Repo Operations

Definition: Reverse repo is the opposite of repo operations. It involves the central bank borrowing funds from commercial banks by selling government securities with an agreement to repurchase them later.

• Reverse Repo Rate: The rate at which RBI absorbs funds from banks.

Purpose: This is used to absorb excess liquidity from the banking system and control inflation or overheating in the economy.

4. Fine-Tuning Operations

Definition: Fine-tuning operations are short-term interventions by the central bank to manage temporary liquidity fluctuations in the market.

• These can include overnight repo/reverse repo operations or short-term outright transactions.

• Used mainly to stabilize short-term interest rates and maintain smooth functioning of money markets.

Purpose: To address daily or weekly liquidity mismatches in banks without altering long-term credit conditions.

5. Variable OMOs (Flexible OMOs)

Definition: Variable OMOs allow the central bank to adjust the volume, duration, and type of OMO according to changing market conditions.

• RBI may conduct OMOs for different maturity periods, such as short-term (14 days), medium-term (1–3 months), or long-term (up to 1 year).

• Helps the central bank respond to unexpected liquidity shocks or inflationary pressures.

Purpose: Provides flexibility and precision in liquidity management and monetary policy implementation.

6. Compulsory OMOs

Definition: Compulsory OMOs are mandated transactions where banks are required to buy or sell securities according to central bank directives.

Purpose: These are used rarely, usually in emergency conditions when the central bank needs to quickly adjust liquidity and credit in the economy.

7. Purchase or Sale Operations in Secondary Market

Definition: The central bank may conduct OMOs in the secondary market of government securities rather than the primary market.

• Buying in secondary market: Injects liquidity and encourages lending.

• Selling in secondary market: Absorbs liquidity to control inflation.

Purpose: To influence money supply and interest rates without interfering with government borrowing requirements.

Advantages of Open Market Operations

• Flexibility in Monetary Management

OMOs are highly flexible. The central bank can buy or sell government securities in different volumes, durations, and types, allowing for quick responses to changes in liquidity and credit conditions.

• Short-Term and Long-Term Utility

OMOs can manage both short-term liquidity fluctuations and long-term credit supply. Short-term operations like repo and reverse repo stabilize daily liquidity, while outright operations adjust overall money supply.

• Market-Oriented Instrument

OMOs operate through the open market, making them market-driven and transparent. Banks and financial institutions participate voluntarily, ensuring efficient and predictable results.

• Indirect Control over Money Supply

Unlike direct controls, OMOs influence money supply and credit indirectly. By adjusting liquidity, the central bank affects banks’ lending behavior without imposing rigid restrictions.

• Stabilizes Interest Rates

By managing liquidity, OMOs help maintain short-term interest rate stability. Predictable interest rates encourage borrowing, lending, and investment, supporting economic growth.

• Inflation Control

Selling government securities through OMOs absorbs excess liquidity, reducing credit availability and controlling inflation. It is an effective tool to prevent demand-pull inflation.

• Supports Economic Growth

Buying government securities injects liquidity into the banking system, increasing credit flow to productive sectors like agriculture, industry, and MSMEs, stimulating economic growth.

• Enhances Financial Market Stability

OMOs ensure smooth functioning of money markets and government securities markets. Adequate liquidity reduces volatility, encourages investment, and boosts confidence in the financial system.

Limitations of Open Market Operations

• Dependence on Market Conditions

OMOs are effective only if there is active participation by banks and financial institutions. In illiquid or underdeveloped markets, OMOs may fail to achieve desired outcomes.

• Limited Impact in Underdeveloped Markets

In countries with a thin or shallow securities market, OMOs cannot significantly influence liquidity or credit, reducing their effectiveness.

• Short-Term Nature

Some OMOs, especially repo/reverse repo operations, affect liquidity temporarily. Long-term monetary control requires other instruments like CRR, SLR, or bank rate adjustments.

• Delayed Transmission

The impact of OMOs may take time to filter through the banking system into lending, investment, and consumption, limiting immediate effectiveness.

• Interest Rate Volatility

Frequent OMO operations can lead to fluctuations in short-term interest rates, affecting borrowing costs and financial stability.

• Dependence on Government Securities

OMOs rely on a sufficient supply of government securities. Limited availability may restrict the central bank’s ability to manage liquidity efficiently.

• Complexity in Implementation

OMO operations require expertise, monitoring, and coordination with banks and financial markets. Mismanagement can lead to liquidity mismatches or market instability.

• Cannot Address Sector-Specific Credit Needs

OMOs are general instruments affecting overall liquidity. They cannot direct credit to specific sectors or priority areas like agriculture or MSMEs, requiring qualitative instruments for targeted credit allocation.

A primary dealer is a firm that buys government securities directly from a government, with the intention of reselling them to others, thus acting as a market maker of government securities. The government may regulate the behaviour and number of its primary dealers and impose conditions of entry. Some governments sell their securities only to primary dealers; some sell them to others as well. Governments that use primary dealers include Australia,[1] Belgium, Brazil,[2] Canada, China, France, Hong Kong, India, Italy, Japan, Singapore, Spain, the United Kingdom, and the United States.

Role of Primary Dealers in the government securities market are:

PDs are expected to play an active role in primary the government securities market, both in its primary and secondary segments. A Primary Dealer will be required to have a standing arrangement with RBI based on the execution of an undertaking and the authorisation letter issued by RBI covering inter-alia the following aspects:

(i) A Primary Dealer will have to commit to aggregative bid for Government of India dated securities on an annual basis of not less than a specified amount and auction Treasury Bills for specified percentage for each auction. The agreed minimum amount/ percentage of bids would be separately indicated for dated securities and Treasury Bills.

(ii) A Primary Dealer would be required to achieve a minimum success ratio of 40 per cent for dated securities and 40 per cent for Treasury Bills.

(iii) Underwriting of Dated Government Securities: Primary Dealers will be collectively offered to underwrite up to 100% of the notified amount in respect of all issues where the amounts are notified.

A Primary Dealer can offer to underwrite an amount not exceeding five times of its net owned funds. The amount so arrived at should not exceed 30% of the notified amount of the issue. If two or more issues are floated at the same time, the limit of 30% is applied by taking the notified amounts of both the issues together.

In the case of devolvement, allotment of securities will be at the competitive cut-off price/yield decided at the auction or at par in the case of pre-determined coupon floatation. Obligations under items (i) to (iii) above would be confined for the present only to Central Government dated securities and obligations under items (i) to (ii) to Treasury Bills.

(iv) Treasury bill issues are not underwritten. Instead, Primary Dealers are required to commit to submit minimum bids at each auction. The commitment of Primary Dealer’s participation in treasury bills subscription works out as follows:

(a) Each Primary Dealer individually commits, at the beginning of the year, to submit minimum bids as a fixed percentage of the notified amount of treasury bills, in each auction.

(b) The minimum percentage of the bids for each Primary Dealer is determined by the Reserve Bank through negotiation with the Primary Dealer so that the entire issue of treasury bills is collectively apportioned among all Primary Dealers.

(c) The percentage of minimum bidding commitment determined by the Reserve Bank remains unchanged for the entire financial year or till furnishing of undertaking on bidding commitments for the next financial year, whichever is later. In determining the minimum bidding commitment, the Reserve Bank takes into account the offer made by the Primary Dealer, its net owned funds and its track record.

(v) A Primary Dealer shall offer firm two-way quotes either through the Negotiated Dealing System or over the counter telephone market or through a recognised Stock Exchange of India and deal in the secondary market for Government securities and take principal positions.

(vi) A Primary Dealer shall maintain the minimum capital standards at all points of time.

(vii) A Primary Dealer shall achieve a sizeable portfolio in government securities before the end of the first year of operations after authorisation.

(viii) The annual turnover of a Primary Dealer in a financial year shall not be less than 5 times of average month end stocks in government dated securities and 10 times of average month end stocks in Treasury Bills.

Of the total, turnover in respect of outright transactions shall not be less than 3 times in respect of government dated securities and 6 times in respect of Treasury Bills. The target should be achieved by the end of the first year of operations after authorisation by RBI.

(ix) A Primary Dealer shall maintain physical infrastructure in terms of office, computing equipment, communication facilities like Telex/Fax, Telephone, etc. and skilled manpower for efficient participation in primary issues, trading in the secondary market, and to advise and educate the investors.

(x) A Primary Dealer shall have an efficient internal control system for fair conduct of business and settlement of trades and maintenance of accounts.

(xi) A Primary Dealer will provide access to RBI to all records, books, information and documents as may be required,

(xii) A Primary Dealer shall subject itself to all prudential and regulatory guidelines issued by RBI.

(xiii) A Primary Dealer shall submit periodic returns as prescribed by RBI.

(xiii) A Primary Dealer’s investment in G-Secs and Treasury Bills on a daily basis should be at least equal to its net call borrowing plus net RBI borrowing plus net owned funds of Rs 50 crore.

The Reserve Bank would extend the following facilities to PDs to enable them to effectively fulfill their obligations: (i) Access to Current Account facility with Reserve Bank Of India, (ii) Access to Subsidiary General Ledger (SGL) Account facility (for Government securities), (iii) Permission to borrow and lend in the money market including call money market and to trade in all money market instruments, (iv) Access to liquidity support through Repo operations with RBI in Central Government dated securities and Auction Treasury Bills up to the limit fixed by RBI. The Scheme is separately notified every year, (v) Access to Liquidity Adjustment Facility (LAF) of Reserve Bank of India, (v) Favoured access to open market operations by Reserve Bank of India.

RBI will have access to records and accounts of an authorised Primary Dealer and the right to inspect its books. A Primary Dealer will be required to submit prescribed returns to RBI, IDM Cell a daily report on transactions and market information, monthly report of transactions in securities, risk position and performance with regard to participation in auctions, quarterly return on capital adequacy, an annual report on its performance together with annual audited accounts and such other statements and returns as are prescribed either specifically or generally by Reserve Bank of India vide any of its institutions/circulars/ directives.

Further, PDs are required to meet such registration and other requirements as stipulated by Securities and Exchange Board of India (SEBI) including operations on the Stock Exchanges. Authorised PDs are expected to join self-regulatory organisations (SROs) like Primary Dealers Association of India (PDAI) and Fixed Income Money Market and Derivatives Association (FIMMDA) and abide by the code of conduct framed by them and such other actions initiated by them in the interests of the securities markets.

In respect of transactions in government securities, a Primary Dealer should have a separate desk and should maintain separate accounts and have an external audit of annual accounts. The Primary Dealer should maintain separate accounts in respect of its own position and customer transactions.

A Primary Dealer should bring to the RBI’s attention any major complaint against it or action initiated/taken against it by authorities such as the Stock Exchanges, SEBI, CBI, Enforcement Directorate, Income Tax, etc.

Reserve Bank of India reserves the right to cancel the Primary Dealership if, in its view, the concerned institution has not fulfilled any of the prescribed performance criteria contained in the authorisation letter. Reserve Bank of India reserves its right to amend or modify these guidelines from time to time, as may be considered necessary.

Government bonds: The government bond sector is a broad category that includes “sovereign” debt, which is issued and generally backed by a central government. Government of Canada Bonds (GoCs), U.K. Gilts, U.S. Treasuries, German Bunds, Japanese Government Bonds (JGBs) and Brazilian Government Bonds, Indian govt. bonds are all examples of sovereign government bonds. The U.S., Japan and Europe have historically been the biggest issuers in the government bond market.

A number of governments also issue sovereign bonds that are linked to inflation, known as inflation-linked bonds or, in the U.S., Treasury Inflation-Protected Securities (TIPS). On an inflation-linked bond, the interest and/or principal is adjusted on a regular basis to reflect changes in the rate of inflation, thus providing a “real,” or inflation-adjusted, return. But, unlike other bonds, inflation-linked bonds could experience greater losses when real interest rates are moving faster than nominal interest rates.

In addition to sovereign bonds, the government bond sector includes subcomponents, such as:

• Agency and “quasi-government” bonds: Central governments pursue various goals supporting affordable housing or the development of small businesses, for example through agencies, a number of which issue bonds to support their operations. Some agency bonds are guaranteed by the central government while others are not. Supranational organizations, like the World Bank and the European Investment Bank, also borrow in the bond market to finance public projects and/or development.
• Local government bonds: Local governments whether provinces, states or cities borrow to finance a variety of projects, from bridges to schools, as well as general operations. The market for local government bonds is well established in the U.S., where these bonds are known as municipal bonds. Other developed markets also issue provincial/local government bonds.

Corporate bonds: After the government sector, corporate bonds have historically been the largest segment of the bond market. Corporations borrow money in the bond market to expand operations or fund new business ventures. The corporate sector is evolving rapidly, particularly in Europe and many developing countries.

Corporate bonds fall into two broad categories: investment grade and speculative-grade (also known as high yield or “junk”) bonds. Speculative-grade bonds are issued by companies perceived to have lower credit quality and higher default risk than more highly rated, investment grade companies. Within these two broad categories, corporate bonds have a wide range of ratings, reflecting the fact that the financial health of issuers can vary significantly.

Speculative-grade bonds tend to be issued by newer companies, companies in particularly competitive or volatile sectors, or companies with troubling fundamentals. While a speculative-grade credit rating indicates a higher default probability, higher coupons on these bonds aim to compensate investors for the higher risk. Ratings can be downgraded if the credit quality of the issuer deteriorates or upgraded if fundamentals improve.