The Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental organization of oil-exporting developing nations that coordinates and unifies the petroleum policies of its Member Countries. OPEC seeks to ensure the stabilization of oil prices in international oil markets, with a view to eliminating harmful and unnecessary fluctuations, due regard being given at all times to the interests of oil-producing nations and to the necessity of securing a steady income for them. Equally important is OPEC’s role in overseeing an efficient, economic and regular supply of petroleum to consuming nations, and a fair return on capital to those investing in the petroleum industry.

The Organization of the Petroleum Exporting Countries (OPEC) was founded in Baghdad, Iraq, with the signing of an agreement in September 1960 by five countries namely Islamic Republic of Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. They were to become the Founder Members of the Organization. OPEC headquarter is located in Vienna, Austria. These countries were later joined by Qatar (1961), Indonesia (1962), Libya (1962), the United Arab Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973), Gabon (1975) and Angola (2007). From December 1992 until October 2007, Ecuador suspended its membership. Gabon terminated its membership in 1995. Indonesia suspended its membership effective January 2009. Currently, the Organization has a total of 12 Member Countries. The current Members are Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela.

The OPEC Statute distinguishes between the Founder Members and Full Members – those countries whose applications for membership have been accepted by the Conference. The Statute stipulates that “any country with a substantial net export of crude petroleum, which has fundamentally similar interests to those of Member Countries, may become a Full Member of the Organization, if accepted by a majority of three-fourths of Full Members, including the concurring votes of all Founder Members.” The Statute further provides for Associate Members which are those countries that do not qualify for full membership, but are nevertheless admitted under such special conditions as may be prescribed by the Conference.

OPEC influence on global oil price.
The Oil and Energy Ministers of the OPEC Member Countries meet at least twice every year to co-ordinate their oil production policies in light of market fundamentals, ie, the likely future balance between demand and supply. The Member Countries, represented by their respective Heads of Delegation, may or may not alter production levels during these regular Meetings and any Extraordinary Meetings of the OPEC Conference. Two-thirds of the oil reserves in the world belong to its members, and 55 per cent of the oil traded internationally, any decisions to increase or reduce production may lower or raise the price of crude oil.

The impact of OPEC output decisions on crude oil prices should be considered separately from the issue of changes in the prices of oil products, such as gasoline or heating oil. There are many factors that influence the prices paid by end consumers for of oil products. In some countries taxes comprise 70 per cent of the final price paid by consumers, so even a major change in the price of crude oil might have only a minor impact on consumer prices.

History of OPEC
OPEC’s formationin September 1960 occurred at a time of transition in the international economic and political landscape, with extensive decolonization and the birth of many new independent states in the developing world. The international oil market was dominated by the “Seven Sisters” multinational companies and was largely separate from that of the former Soviet Union (FSU) and other centrally planned economies (CPEs). OPEC developed its collective vision, set up its objectives and established its Secretariat, first in Geneva and then, in 1965, in Vienna. It adopted a ‘Declaratory Statement of Petroleum Policy in Member Countries’ in 1968, which emphasised the inalienable right of all countries to exercise permanent sovereignty over their natural resources in the interest of their national development. Membership grew to ten by 1969.

OPEC rose to international prominence during 70s, as its Member Countries took control of their domestic petroleum industries and acquired a major say in the pricing of crude oil on world markets. On two occasions, oil prices rose steeply in a volatile market, triggered by the Arab oil embargo in 1973 and the outbreak of the Iranian Revolution in 1979. OPEC broadened its mandate with the first Summit of Heads of State and Government in Algiers in 1975, which addressed the plight of the poorer nations and called for a new era of cooperation in international relations, in the interests of world economic development and stability. This led to the establishment of the OPEC Fund for International Development in 1976. Member Countries embarked on ambitious socio-economic development schemes. Membership grew to 13 by 1975.

After reaching record levels early in the 1980s, prices began to weaken, before crashing in 1986, responding to a big oil glut and consumer shift away from this hydrocarbon. OPEC’s share of the smaller oil market fell heavily and its total petroleum revenue dropped below a third of earlier peaks, causing severe economic hardship for many Member Countries. Prices rallied in the final part of the 80s, but to around half the levels of the early part, and OPEC’s share of newly growing world output began to recover. This was supported by OPEC introducing a group production ceiling divided among Member Countries and a Reference Basket for pricing, as well as significant progress with OPEC/non-OPEC dialogue and cooperation, seen as essential for market stability and reasonable prices. Environmental issues emerged on the international energy agenda.

Prices moved less dramatically than in the 1970s and 1980s, and timely OPEC action reduced the market impact of Middle East hostilities in 1990–91. But excessive volatility and general price weakness dominated in 90s and the South-East Asian economic downturn and mild Northern Hemisphere winter of 1998–99 saw prices back at 1986 levels. However, a solid recovery followed in a more integrated oil market, which was adjusting to the post-Soviet world, greater regionalism, globalisation, the communications revolution and other high-tech trends. Breakthroughs in producer-consumer dialogue matched continued advances in OPEC/non-OPEC relations. As the United Nations-sponsored climate change negotiations gathered momentum, after the Earth Summit of 1992, OPEC sought fairness, balance and realism in the treatment of oil supply. One country left OPEC, while another suspended its Membership.

An innovative OPEC oil price band mechanism helped strengthen and stabilise crude prices in the early years of the decade. But a combination of market forces, speculation and other factors transformed the situation in 2004, pushing up prices and increasing volatility in a well-supplied crude market. Oil was used increasingly as an asset class. Prices soared to record levels in mid-2008, before collapsing in the emerging global financial turmoil and economic recession. OPEC became prominent in supporting the oil sector, as part of global efforts to address the economic crisis. OPEC’s second and third summits in Caracas and Riyadh in 2000 and 2007 established stable energy markets, sustainable development and the environment as three guiding themes, and it adopted a comprehensive long-term strategy in 2005. One country joined OPEC, another reactivated its Membership and a third suspended it.

OPEC on recent oil price drop
In its 166^th meeting on 27^th Nov 2014, OPEC records its concern over the rapid decline in oil prices in recent months, the Conference concurred that stable oil prices at a level which did not affect global economic growth but which, at the same time, allowed producers to receive a decent income and to invest to meet future demand were vital for world economic well being. Accordingly, in the interest of restoring market equilibrium, the Conference decided to maintain the production level of 30.0 mb/d, as was agreed in December 2011. As always, in taking this decision, Member Countries confirmed their readiness to respond to developments which could have an adverse impact on the maintenance of an orderly and balanced oil market.

OPEC Fund for International Development (OFID)
The OPEC Fund for International Development (OFID) is the development finance institution established by the Member States of OPEC in 1976 as a collective channel of aid to the developing countries. OFID works in cooperation with developing country partners and the international donor community to stimulate economic growth and alleviate poverty in all disadvantaged regions of the world. It does this by providing financing to build essential infrastructure, strengthen social services delivery and promote productivity, competitiveness and trade. OFID’s work is people-centered, focusing on projects that meet basic needs – such as food, energy, clean water and sanitation, healthcare and education – with the aim of encouraging self-reliance and inspiring hope for the future. OFID’s resources consist of voluntary contributions made by OPEC Member Countries and the accumulated reserves derived from its various operations. At the close of the year 2013, contributions pledged by the OPEC Member Countries totalled US$4,431m, out of which US$3,459m was direct contributions to OFID. The Reserve Account stood at US$2,624 million.

Tumbling oil prices is the biggest energy story in the world right now as global oil prices are in free fall over the past seven months. In the mid of 2014 oil prices were around $115 per barrel but since than the prices have fallen below $50 per barrel for the first time since May 2009. Steep fall in oil prices leads to significant revenue shortfalls in many energy-exporting nations, while many importing countries are likely to pay less for their requirements.

By the second half of 2014, world oil supply was on track to rise much higher than actual demand and, in September, prices started falling sharply. The oil price is partly determined by actual supply and demand, and partly by expectations of the market participants. Demand for energy is closely related to economic activity. It also spikes in the winter in the northern hemisphere, and during summers in countries that use energy to cool the internal temperature with air conditioning. Supply can be affected by weather (which prevents tankers loading) and by geopolitical upsets. If producers think the price is staying high, they invest more on technology and exploration, which after a lag boosts supply. Similarly, low prices lead to an investment drought. As per the International Energy Agency (IEA) Oil Market Report for November 2014, the production of oil in November stood at 94.1 mbpd and demand estimates stood at 92.4 mbpd.

Reasons behind the oil price nosedive
To understand this story, we first have to go back to the late 2000s. World oil prices experienced a sustained upward movement. By far the most important reason for this long-term trend is the rising demand for these products stemming from rapid economic growth in China and other emerging-market economies including India. That led to large price spikes, and oil hovered around $100 per barrel between 2011 and 2014. This robust growth in oil demand encouraged companies in US to step up for exploration, developing higher cost sources, and making some major technological breakthroughs to start drilling for new, hard-to-extract crude in shale formations in North Dakota and oil sands in Alberta. This slowly led to a glut in oil production. Here are some main reasons of big drop in oil prices.

US Shale oil production
America’s oil boom is well documented. Shale oil production has grown by roughly 9 million barrels per day (mbpd), that is just 1m b/d short of Saudi Arabia’s output. Imports from OPEC have been cut in half and for the first time in 30 years, the U.S. has stopped importing crude from Nigeria. Bursting US oil production has transformed one of the world’s leading oil consumers into one of its leading producers. Innovative drilling that has unlocked oil and natural gas deposits trapped in shale rock. Their manic drilling—they have completed perhaps 20,000 new wells since 2010, more than ten times Saudi Arabia’s tally which boosted US oil production by a third after Russia & Saudi. The International Energy Agency has predicted that U.S. oil output will overtake Saudi Arabia’s by 2020.

Price war
The pace of the slide accelerated in November when the Organization of Petroleum Exporting Countries (OPEC) decided to maintain production at 30 million barrels per day on big meeting of their members in Vienna. Some members like, Venezuela and Iran, wanted the cartel (mainly Saudi Arabia) to cut back on production in order to prop up the price. These countries need high prices in order to “break even” on their budgets and pay for all the government spending they’ve racked up. But on the other hand Saudi Arabia opposed to cutting production and willing to let prices keep dropping because it don’t want to sacrifice its own market share to restore the price. Saudi Arabia has taken a lesson from what happened in the 1980s, when prices fell and the country tried to cut back on production to prop them up. The result was that prices kept declining anyway and Saudi Arabia simply lost market share.

OPEC’s refusal to cut production seemed like the boldest evidence yet that the oil price drop was really an oil price war between Saudi Arabia and the US. It is relatively cheap to pump oil out of places like Saudi Arabia and Kuwait. But it’s more expensive to extract oil from shale formations in places like Texas and North Dakota. Saudi Arabia can tolerate lower oil prices quite easily. It has over $700 billion in foreign currency reserves. Its own oil costs very little (around $5-6 per barrel) to get out of the ground. So as the price of oil keeps falling, some US producers may become unprofitable and go out of business. And the price of oil will stabilize. At least that’s what OPEC members hope.

Libya and Iraq are back
Till the mid 2014 oil prices are rising, the US Shale boom had little effect on oil prices because at the same time geopolitical conflicts were flaring up in key oil regions, There was a civil war in Libya and Syria, Russia’s annexation of the Crimea and broad advances by Sunni insurgents across northern Iraq. Turmoil in Iraq and Libya, two big oil producers with nearly 4m barrels a day combine, has not affected their output at a time when demand is low.

In July, Libyan rebels opened two key export terminals, Es Sider and Ras Lanuf, that had been shut down for a year. Libyan exports rose unexpectedly. Initially, it had been assumed that Libya’s output would hover around 150,000-250,000 thousand barrels per day but it turns out that Libya has sorted out their disruptions much quicker than anticipated, producing 810,000 barrels per day in September and expecting 1.2 million barrels a day by early this year.

European Economic Slowdown
Oil prices are falling because of changes in world supply and world demand. Demand has slowed because Europe is an economic wreck. European economies, meanwhile, are weak. Combined with the weak euro, which is near its all-time low, that means Europeans are less inclined to use energy. One of the reasons for an extension in the decline was the disappointing German output that reinforced worries that global oil demand will falter, it’s exports were down 5.8 percent in August, stoking the fears of anxious investors that the EU’s largest economy had double dipped into recession last quarter. Across the Eurozone, the IMF again lowered its growth forecast to 0.8 percent in 2014 and 1.3 percent in 2015. Austerity measures and decreased consumption across Europe are curbing oil demand.

Weak Asian Demand
The remarkable fall in global oil prices is continuing because of a mismatch in demand and supply. Demand is down because of Eurozone’s economic stagnation, Japan’s slipping into recession and China’s slowdown. Output, on the other hand, is rising on account of the U.S. shale boom. A global economic slowdown has left Asian demand weaker than expected and number of Asian countries have begun cutting energy subsidies, resulting in higher fuel costs despite a drop in global oil prices. In India between 2008-2012, diesel demand grew between 6 percent and 11 percent annually. In January 2013, the country started cutting the subsidies of diesel. Since then, diesel consumption has stablised. The US is producing record amounts of oil, and there’s plenty of supply out of OPEC and Russia. But there’s not enough demand from China and India, to consume all the oil that’s being supplied.

Impact of Oil Price Plummet: Winners & Losers
Oil prices affect almost everyone, for better or for worse. Petroleum products are a big slice of families’ budgets and a significant cost of production for a myriad of industries. It is no surprise that lower oil prices benefit consumers and hurt producers. For the users of oil, a lower price is like a tax cut. The positive effect will work its way through the economy via two channels: first, it will give consumers more disposable income, which they can spend on goods and services; second, it will reduce input costs and encourage production in sectors other than oil, especially energy-intensive sectors.

The dramatic drop in oil prices over the past few months to lowest since 2009 is leading to significant revenue shortfalls in many energy exporting nations. Meanwhile other economies that are large net importers of oil, such as China, Japan and Europe, will also get a boost to their economic growth.

The Losers:
The decline in oil prices has clear adverse effects, however, on oil-exporting emerging economies. Some of these countries, which have relied on high oil prices to balance their budgets, could face financial stress. Some examples are:

Russia
The Russian currency plunged against the dollar on the back of a decline in the price of crude oil, the country’s main revenue earner. Russia’s currency has lost some 16 percent against the dollar since the start of the year after dropping by around 41 percent in 2014. Russia is one of the world’s largest producers and its oil & gas exports accounts 70% of total export revenues. Russia’s central bank has been struggling to deal with this crisis. On December 15, the country suddenly hiked interest rates from 10.5 percent to 17 percent in an attempt to stop people from selling off rubles.

The economy is slowing sharply as Western sanctions over the Ukraine crisis deter foreign investment and spur capital flight, and as a slump in oil prices severely reduces Russia’s export revenues and pummels the ruble. The slump in oil prices has clouded Russia’s economic outlook, as the country relies heavily on revenues generated by exporting oil and gas to finance its budget. Russia loses about $2bn in revenues for every dollar fall in the oil price, and the World Bank has warned that Russia’s economy will shrink 2.9 percent in 2015 if oil prices do not recover. Russian Finance Minister Anton Siluanov said the budget faces a shortfall of up to $240 billion in revenue, most of it, about $180 billion is due to the oil-price collapse.

Venezuela
Venezuela is among the world’s largest oil exporters and is also tens of billions of dollars in debt, so their economy was struggling even before the oil prices dropped. Venezuela’s economy, which is heavily dependent on oil for 95 percent of its export revenue, has been crippled by the fall in oil prices and set to shrink some 3 percent this year and inflation is rampant.

The country already has some of the world’s cheapest petrol prices, fuel subsidies cost Caracas about $12.5bn a year, but President Maduro has ruled out subsidy cuts and higher petrol prices. The country’s needs an oil price of $118 per barrel to balance its external accounts, but oil is falling rapidly towards $40 per barrel and so far, Venezuela has failed to persuade other oil producers to reduce production in order to support the price. Venezuela’s foreign exchange outflows now substantially exceed its inflows, not least because it is supporting a complex and unhelpful exchange rate system: its US $ reserves are down to $22bn and falling fast.

Iran
Iran may be in the most trouble as it’s economy had recently started recovering after the geopolitical conflicts. IMF projected that the country will grow 2.3 percent next year, but now it is precarious situation to country after the oil price plummets. One big problem for Iran is that it also needs oil prices at $100 per barrel to balance its budget, especially since Western sanctions have made it much harder to export crude. If oil prices keep falling, the Iranian government may need to make up revenues elsewhere, it could by paring back domestic fuel subsidies. It spent 25% ($100 billion) of its GDP on consumer subsidies last year. As oil makes up about 80 %of total export earnings and 50 to 60% of government revenues, the economy could grow substantially under this scenario. With no deal, cheap oil could mean a 60% drop in fiscal revenues, down to $23.7 billion in 2015 from its peak of $120 billion in 2011/12. According to world bank report under this scenario, a loss of about 20% of GDP would be expected, bringing GDP growth down to zero (from the previous year’s 1.5%), and the economy would continue to shrink. This will put tremendous pressure on inflation, unemployment, the fiscal deficit and the currency.

Saudi Arabia
Saudi Arabia leads this pack and is now forecasting the biggest fiscal deficit in its history. The deficit for 2015 is expected to amount to $38.6 billion, announced by government. The Saudis can ride through this because they have a huge amount of foreign exchange reserves amounting to over $700 billion, which is why they remain steady in letting prices fall, mainly to ensure the production of U.S. shale oil does not increase and take some of their share of the market.

The Winners
Globally the big winner is the world economy. Tom Helblin of the IMF says that a 10% change in oil prices is associated with around 0.2% change in a global GDP. This essentially shifts the resources from the producers to consumers who are more likely to put that money back into the market.
Slumping oil prices could prove to be a boon for the many Asian economies that depend on crude imports as oil prices breaks the 5.6 years low. Falling oil prices should help lift emerging Asia’s gross-domestic-product growth this year to 4.7% from an estimated 4.3% in 2014.

China
China is the one of the largest net importers of oil, and fortunately most of its manufactured exports have not dropped in price, so its economy should benefit greatly from this plunge in oil prices. Oil prices have a big impact on the trade position of China, it has registered a record trade surplus for 2014 of $382bn, up by 47% from 2013, so nearly doubling its surplus from the previous year. Yet, trade growth has been weaker than targeted. China’s oil imports grew by nearly 10 percent last year, to nearly 2.3 billion barrels (308 million tons). As prices have fallen from around $115 a barrel in June to less than $50, importers are saving tens of billions of dollars.
Among the Asian economies, none is more dependent on oil imports than China. The country spent $234.4 billion to import oil in 2013. According to IEA December oil market report notes a sharp slowdown in Chinese oil demand growth, estimation of total Chinese demand growth is just 2.5 percent in 2014 and 2015. Despite recent falls in oil prices, Chinese government move in late November to hike consumption taxes for oil products has resulted in small price change to Chinese consumers, negating an expected economic benefit that would have come from lower prices.

Tumbling oil prices are still seen as a net benefit for the Chinese economy. Bank of America Merrill Lynch estimates China’s GDP increases by about 0.15 percent for every 10 percent drop in the oil price, with its current account balance growing by 0.2 percent of GDP and consumer inflation declining by 0.25 percentage point.
International Monetary Fund researchers have estimated that falling oil prices could boost China’s GDP by 0.4 to 0.7 percent 2015 and by 0.5 to 0.9 percent in 2016.

Japan
Japan imports almost all of its oil, Imported USD 150 bn in oil last year, so it should reap large benefits of cheaper prices. But the effects might also hurt the country’s economy. The higher energy prices have actually been pushing inflation higher and have been a part of the country’s economic growth strategy.

Japan has been suffering from a trade deficit, which stood at US $6.8bn in October, and was the highest on record last year at JPY11.5tn (US $120bn). An important driver has been the cost of oil and gas (34% of all imports), due to their shutting down all of their nuclear reactors Fukushima in 2011. Plummeting oil prices is a huge positive for them. The lower oil price will also be offset by the weaker yen, since the end of September, the yen has fallen by 8% against the dollar while crude oil prices have plunged by 60%.

The fall has became great challenge to the Bank of Japan due to the latest fall in inflation to 0.9%. The fall in the oil price will have a significant dis-inflationary impact, which is currently estimated at -0.4% on CPI.

India
India is one of the top oil importers, importing nearly 75% of its oil. Falling oil prices will will reduced India’s import bill, oil accounts for 37 per cent of its total imports. India, which is the fourth largest consumer of oil, is a big beneficiary of falling oil prices. The reduced prices will not only lower the import bill but also help save foreign exchange. As per Bank of America Merrill Lynch estimates, every $10 fall in crude could reduce the current account deficit by approximately 0.5% of GDP and the fiscal deficit by around 0.1% of GDP.

India had fuel subsidies of almost $22 billion for consumers, though much of that has gradually been cut, the cost of India’s fuel subsidies could fall by $2.5bn this year and the country is planning to deregulate fuel prices completely if oil continues its fall. The Indian government has increased the excise duty on petrol and diesel thrice since October 2014, in order to shore up its revenues.

Falling oil prices is not enough for Europe
Europe, meanwhile, is only partially benefiting from the decline in prices because the euro has been weakening, making it relatively more expensive for Europeans to purchase oil, which is priced in dollars. Falling oil prices has been welcomed by oil importing countries but European economy showed its mixed reaction on it. Lower oil prices will be welcomed by consumers who will see a rise in discretionary income, after years of a real wage squeeze this will help strengthen the economy. But the problem is that, looking at the wider economic situation it is hard to get too optimistic. The overwhelming impression is of a very weak European economy, which is struggling with a dangerous mix of austerity, deflation, weak growth and debt. Falling oil prices rather than helping increase spending is pushing down the headline inflation rate and making actual deflation a real possibility.

In the US
Most American consumers are delighted with the recent slide in the price of crude oil, which has lowered gasoline prices significantly,which have fallen to $2.47 per gallon, the lowest since 2009. Falling gas prices have an effect on consumer prices. The most recent CPI report was released on Jan.16 and consumer prices had fallen by 0.4% in Dec 2014. The core CPI, which excludes the volatile food and energy groups, rose by a mere 0.1%. The CPI rose 0.8 percent in 2014 after a 1.5 percent increase in 2013. This is the second-smallest December-December increase in the last 50 years, trailing only the 0.1 percent increase in 2008. It is considerably lower than the 2.1 percent average annual increase over the last ten years. The energy index, which rose slightly in both 2012 and 2013, declined sharply in 2014, falling 10.6 percent, the largest decline since 2008. According to Swiss investment bank UBS, US alone, boosts GDP by 0.1%, each $10-per-barrel drop in the price of oil. In US oil-producing states like Texas and North Dakota are likely to see a drop in revenues and economic activity. The falling price of oil is also putting severe pressure on Alaska’s state budget.

Crude Conspiracy: A Secret war on Russia and Iran
If we take it to other side, many believes that recent drop in the oil prices is the secret economic war on Russia and Iran by the US Saudi alliance. The US-Saudi oil price manipulation is aimed at destabilizing several strong opponents of US globalist policies. The alliance is trying to instill an economic collapse upon Moscow and Tehran, almost similar to what the US and Saudis did to the leaders of the Soviet Union in 1986. According to Article on WSJ , September meeting between US Secretary of State John Kerry and Saudi King Abdullah at his palace on the Red Sea arrived at a deal that the Saudis would support Syrian airstrikes against Islamic State (ISIS), in exchange for Washington backing the Saudis in toppling Assad.

Now, Saudi has used its oil weapon for proxy war against Iran to limit its nuclear energy expansion, and to make Russia change its position of support for the Assad Regime in Syria, Russia have provided the weapons and funding to keep Assad in power. While the US wants its Ukraine-related sanctions against Russia to have more bite. Sanctions imposed on Moscow over Ukraine and the low oil prices together will send the Russian economy into recession next year.

US Saudi alliance focusing to Squeeze them to the last drop and bankrupt them by bringing down the price of oil to levels below what is required for both Moscow and Tehran to finance their budgets with ease and control. Economy of both countries is highly reliable on revenue from oil exports, Iran need oil price to $140 to balance its budget favorable while Russia requires $100. The impact of lower prices strikes rouble badly as it already fallen over 14 percent since July against the US dollar, which puts Russian economy under more pressure as oil price quotes on US Dollar.

However, it is a conspiracy theory, use of oil weapon also hurts Saudi on its revenue in the longer term while in US, shale oil much expensive to extract surely it will hurts US producers as price are lower than the cost.

Financial Market

Financial market deals in financial securities or instruments and financial services. It may be variously classified as primary and secondary, money markets and capital markets, organised and unorganised markets official and parallel markets, and foreign and domestic markets. Financial market provides money and capital supply to the industrial concern as well as promote the savings and investments habits of the public. In simple censes financial market is a market which deals with various financial instruments (share, debenture, bonds, treasury bills, commercial bills etc.) and financial services (merchant banking, underwriting etc).

Money Market

Money market is one of the part of Indian financial market which provides short-term financial requirements of the industrial and business concern. Money market again subdivided into the following categories on the basis of the instruments used in the money market.

A well-organised money market is the basis for an effective monetary policy. A money market may be defined as the market for lending and borrowing of short-term funds. It is the place where the short-term surplus investable funds at the disposal of banks and other financial institutions are bid by borrowers comprising companies, individuals and the government. The RBI in India occupies a pivotal position in the money market as it controls the flow of currency and credit into the market.

Some important money market instruments are:

Call Money

Call money is short-term finance repayable on demand, with a maturity period of one to fifteen days, used for inter-bank transactions. The money that is lent for one day in this market is known as “call money” and, if it exceeds one day, is referred to as “notice money.”

Call money is a method by which banks lend to each other to be able to maintain the cash reserve ratio. The interest rate paid on call money is known as the call rate. It is a highly volatile rate that varies from day to day and sometimes even from hour to hour. There is an inverse relationship between call rates and other short-term money market instruments such as certificates of deposit and commercial paper. A rise in call money rates makes other sources of finance, such as commercial paper and certificates of deposit, cheaper in comparison for banks to raise funds from these sources.

The term, in the international market, usually refers to the short term financing by banking institutions to brokers for maintaining the margin account. It is different from the term ‘loan’ as the schedule for the payment of interest and principal is not fixed. Since, the loan can be called at any time, it is riskier than other forms of loans. It helps in meeting liquidity needs at short notice.

Treasury Bills

Short-term (usually less than one year, typically three months) maturity promissory note issued by a national (federal) government as a primary instrument for regulating money supply and raising funds via open market operations. Issued through the country’s central bank, T-bills commonly pay no explicit interest but are sold at a discount, their yield being the difference between the purchase price and the par-value (also called redemption value). This yield is closely watched by financial markets and affects the yield on municipal and corporate bonds and bank interest rates. Although their yield is lower than on other securities with similar maturities, T-bills are very popular with institutional investors because, being backed by the government’s full faith and credit, they come closest to a risk free investment. Issued first time in 1877 in the UK and in 1929 in the US.

In India, the Reserve Bank of India has been issuing 91-day, 182-day and 364-day treasury bills. the auction format of 91-day treasury bill has changed from uniform price to multiple price to encourage more responsible bidding from the market players.

Commercial Papers

Commercial paper, in the global financial market, is an unsecured promissory note with a fixed maturity of no more than 270 days. Commercial paper is a money-market security issued (sold) by large corporations to obtain funds to meet short-term debt obligations (for example, payroll), and is backed only by an issuing bank or corporation’s promise to pay the face amount on the maturity date specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings from a recognized credit rating agency will be able to sell their commercial paper at a reasonable price. Commercial paper is usually sold at a discount from face value, and carries higher interest repayment rates than bonds. Typically, the longer the maturity on a note, the higher the interest rate the issuing institution pays. Interest rates fluctuate with market conditions, but are typically lower than banks’ rates.

Certificate of Deposits

Certificate of Deposit (CD) is a negotiable money market instrument and issued in dematerialized form or as a Issuance Promissory Note against funds deposited at a bank or other eligible financial institution for a specified time period. CD refers to instruments of relatively short duration or savings accounts that pay a fixed rate of interest until a given maturity date. Also, funds placed in a Certificate of Deposit usually cannot be withdrawn prior to maturity or they can perhaps only be withdrawn with advanced notice and/or by having a penalty assessed. The maturity period of CDs issued by banks should not be less than 7 days and not more than one year, from the date of issue. CDs will often be used by individuals, businesses and financial institutions around the world as a means of storing their liquid funds for a fixed period of time for future use. In the retail market, a Certificate of Deposit is a relatively safe investment when provided by insured financial institutions such as banks, savings and loan corporations and credit unions that are usually regulated within the country in which they operate.

Repurchase Agreement

A form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day. For the party selling the security (and agreeing to repurchase it in the future) it is a repo; for the party on the other end of the transaction, (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest. The repurchase price should be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate.

Central banks often use repos to boost money supply, buying Treasury bills or other government paper from commercial banks so the banks can boost their reserves, and selling the paper back at a later date. When the central bank wants to tighten money supply, it sells the paper first, and buys it back later – this is called a reverse repo, an agreement to lend securities rather than funds.

Capital Market

Capital markets help channelise surplus funds from savers to institutions which then invest them into productive use. Generally, this market trades mostly in long-term securities. It is a market where buyers and sellers engage in trade of financial securities like bonds, stocks, etc. The buying/selling is undertaken by participants such as individuals and institutions. Securities Exchange Board of India (SEBI)  is the Regulator of Capital Market  in India.

Capital market consists of primary markets and secondary markets. Primary markets deal with trade of new issues of stocks and other securities, whereas secondary market deals with the exchange of existing or previously-issued securities.

Equity Market

Equity market that gives companies a way to raise needed capital and gives investors an opportunity for gain by allowing those companies’ stock shares to be traded. In this market shares are issued and traded, either through exchanges or over-the-counter markets. It is also known as the stock market, it is one of the most vital areas of a market economy because it gives companies access to capital and investors a slice of ownership in a company with the potential to realize gains based on its future performance. This market can be split into two main sectors: the primary and secondary market. The primary market is where new issues are first offered. Any subsequent trading takes place in the secondary market.

Equities (Shares)

It is an instrument that signifies an ownership position, or equity, in a corporation, and represents a claim on its proportionate share in the corporation’s assets and profits. A person holding such an ownership in the company does not enjoy the highest claim on the company’s earnings. Instead, an equity holder’s claim is subordinated to creditor’s claims, and the equity holder will only enjoy distributions from earnings after these higher priority claims are satisfied.

It may comprise ordinary shares and preference shares. Companies issues their shares electroniclly through stock exchanges on which investor can trade with the help of members of strock exchange.

Ordinary Shares: An ordinary share represents equity ownership in a company. It entitles the owner to a vote in matters put before shareholders in proportion to their percentage ownership in the company. Shareholders are entitled to receive dividends if any are available after dividends on preferred shares are paid. If the company does badly, it is also the ordinary shareholders that will suffer.  The true value of an ordinary share is based on the price obtained through market forces, the value of the underlying business and investor sentiment toward the company.

Preference Shares: Preference shares are a hybrid security with elements of both debt and equity. It  have legal priority over ordinary shareholders in respect of earnings and in the event of bankruptcy, in respect of assets. Fixed dividend is paid  each year. Shareholders have no voting rights, except in certain circumstances such as when their dividends have not been paid.

Types of Preference Shares

Cumulative: dividend is accumulated if the company does not earn sufficient profit to pay the dividend i.e., if the dividend is not paid in one year it will be carried forward to successive years;

Non-cumulative: if the company is unable to pay the dividend on preference shares because of insufficient profits, the dividend is not accumulated. Preference shares are cumulative unless expressly stated otherwise;

Participating: participating preference shares, in addition to their fixed dividend, share in the profits of a company at a certain rate;

Convertible: apart from earning a fixed dividend, convertible preference shares can be converted into ordinary shares on specified terms;

Redeemable: redeemable preference shares can be redeemed at the option of the company either at a fixed rate on a specified date or over a certain period of time.

Primary Market

The Primary Market is, hence, the market that provides a channel for the issuance of new securities by issuers (Government companies or corporates) to raise capital. The securities (financial instruments) may be issued at face value, or at a discount / premium in various forms such as equity, debt etc. They may be issued in the domestic and / or international market.

Features of primary markets include:

• The securities are issued by the company directly to the investors.
• The company receives the money and issues new securities to the investors.
• The primary markets are used by companies for the purpose of setting up new ventures/ business or for expanding or modernizing the existing business
• Primary market performs the crucial function of facilitating capital formation in the economy

A primary market is not inclusive of sources, from where companies can generate external finance over a long term, such as loans provided by financial organizations. Through these markets, companies can also go public, which means changing private capital to public capital. The primary market accelerates the process of capital formation in a country’s economy.

Many companies have entered the primary market to earn profit by converting their capital, which is basically a private capital, into a public one, releasing securities to the public. This phenomena is known as “public issue” or “going public”.

Investors can obtain news of upcoming shares only in the primary market. The issuing firm collects money, which is then used to finance its operations or expand business, by selling its shares. Before selling a security on the primary market, the firm must fulfill all the requirements regarding the exchange.

Participants in the Primary Markets

Merchant Banks:

Merchant Banking is a combination of Banking and consultancy services. It provides consultancy to its clients for financial, marketing, managerial and legal matters. Consultancy means to provide advice, guidance and service for a fee. It helps a businessman to start a business. It helps to raise (collect) finance. It helps to expand and modernize the business. It helps in restructuring of a business. It helps to revive sick business units. It also helps companies to register, buy and sell shares at the stock exchange. It deals mostly in international finance, long-term loans for companies and underwriting. Merchant banks do not provide regular banking services to the general public. merchant banking provides a wide range of services for starting until running a business. It acts as Financial Engineer for a business. Major operations performed by the merchant banks are:

• Management of Debt and Equity Offerings
• Placement and Distribution,
• Rights Issues of Shares,
• Corporate Advisory Services,
• Project Advisory,
• Loan Syndication,
• Venture Capital & Mezzanine Financing,
• Mergers & Acquisitions,
• Takeover Defense.

Primary Market Underwriters:

Investment banks are the main underwriters in the primary markets and thus are the major facilitators of these types of markets. They normally decide the base price of the securities on sale and then administer the entire process of its sale to the investors. The underwriters also play the important role of safeguarding the issue related risks for the companies that are offering the shares for sale.

Underwriters generally receive underwriting fees from their issuing clients, but they also usually earn profits when selling the underwritten shares to investors. However, underwriters have the responsibility of distributing a securities issue to the public. If they can’t sell all of the securities at the specified offering price, they may be forced to sell the securities for less than they paid for them, or retain the securities themselves.

The Bankers to an issue:

The Bankers to an issue are scheduled banks which engaged in activities such as acceptance of applications along with application money from investors in respect if issues of capital and refund of application money. Banker to an issue has to obtain a certificate of registration granted by the regulator of the country. Every banker to an issue enters into an agreement with the issuing company.

Activities related to bankers to an issue are:

• acceptance of application
• acceptance of allotment
• refund of application
• payment of dividend or interest warrants.

Brokers to an Issue

Companies making public issues appoint brokers to procure subscription. The managers to the issue distribute prospectuses and application forms to the brokers. A broker that sells shares that are being made available for the first time in a share issue. Broker are responsible for procuring the subscription to the issue from the prospective investors. They provide a vital connecting link between the prospective investors and the issuer, thus, assisting in speedy subscription of issue by the public. Broker has to obtain membership cerificate from the stock exchange to act as a broker to the issuer company.

Registrar to an Issue & Share Transfer Agents

Registrar to an Issue is the person appointed by a body corporate or any person or group of persons to carry on the activities like:

• collecting applications from investors in respect of an issue;
• keeping a proper record of applications and monies received from investors or paid to the seller of the securities. and
• assisting body corporate or person or group of persons in-
  • determining the basis of allotment of securities in consultation with the stock exchange;
  • finalising of the list of persons entitled to allotment of securities;
  • processing and despatching allotment letters, refund orders or certificates and other related documents in respect of the issue.

Share Transfer Agent is any person, who on behalf of any body corporate maintains the record of holders of securities issued by such body corporate and deals with all matters connected with the transfer and redemption of its securities. A department or division (by whatever name called) of a body corporate performing the activities referred in sub-clause (i) if, at any time the total number of the holders of securities issued exceed one lakh.

Different types of issues:

Primary markets are basically the platform where an investor gets the first opportunity to purchase a new security. The group or company that issues the security gets the money by selling a certain amount of securities.  Normally, the entire process of buying a primary market security involves several rules and regulations that have to be properly adhered to before a security can change hands.

Methods of Issuing Securities in the Primary Market:

There are three methods through which securities can be issued in the primary market:

• Public Issue
  • Initial Public Offer (IPO)
  • Follow-on Public Offer (FPO)
  • Rights Issue
  • Private Placement

Initial Public Offer (IPO)

The most common primary mechanism for raising capital is an Initial Public Offer (IPO), under which shares are offered to the public as a precursor to trading in the secondary market of an exchange. In this method shares are issued to the underwriter after the issue of prospectus which provides details of financial and business information as regards the issuer. Shares are then released to the underwriter and the underwriter releases the share to the public as per their application. The price at which the shares are to be issued is decided with the help of the book building mechanism; in the case of over subscription, the shares are allotted on a pro rata basis.

Essential steps involved in the IPO method are as follows:

Order: Broker receives order from the client and places orders on behalf of the client with the issuer.

Share Allocation: The issuer finalizes share allocation and informs the broker of the same.

Client: Broker advises the successful clients of the share allocation. Clients then submit the application forms for shares and make payment to the issuer through the broker.

Primary Issue Account: Issuer opens a separate escrow account (primary issue account) for the primary market issue. Clearing house of the exchange debits this account of the broker and credits the issuer’s account.

Certificates: Certificates are then delivered to investors. Otherwise depository account may be credited.

Follow-on Public  Issue (FPO)

FPOs are popular methods for companies to raise additional equity capital in the capital markets through a stock issue. Public companies can also take advantage of an FPO issuing an offer for sale to investors, which is made through an offer document. FPOs should not be confused with IPOs, as IPOs are the initial public offering of equity to the public while FPOs are supplemantary issues made after a company has been established on an exchange.

Right Issue

This method is used by those companies who have already issued their shares. When an existing company issues new shares, first of all it invites its existing shareholders. This issue is called the right issue. In this case, the shareholder has the right either to accept the offer for himself or assign a part or all of his right in favour of another person.

Private Placement

Private Placement of shares means the company sells its shares to a small group of investors at a higher price. In this method, securities are placed to a select group of persons not exceeding 49, and it is neither a rights issue nor a public issue. It can sell to banks, insurance companies, financial institutions, etc. It is an economical and quick method of selling securities. The company does not sell its shares to the public.

What is Prospectus?

An offer document through which public are solicited to subscribe to the share capital of a corporate entity is called ‘prospectus’. Its purpose is to invite the public for the subscription/purchase of securities of a company. As per the guidelines of regulator of stock market it is nessesary to disclose all information like the reason for raising the money, the way money is proposed to be spent, the return expected on the money to public while coming with new issue, these information are disclose by the company through Prospectus, which also includes information regarding the size of the issue, the current status of the company, its equity capital, its current and past performance, the promoters, the project, cost of the project, means of financing, product and capacity etc. It also contains lot of mandatory information regarding underwriting and statutory compliances. This helps investors to evaluate short term and long term prospects of the company.

Deemed prospectus: a prospectus that is deemed to have been made by the issuer, though it is actually offered to the public by a third party or the so-called issue house (Indian terminology). The issuer saves the underwriting expenses in selling its securities.

Statement in Lieu of Prospectus: A public document prepared in the second schedule of company’s ordinance by every such public company which doesn’t issue a prospectus on its formation with the registrar before allotment or shares of debentures, and signed by every person who is named therein. A statement in lieu of prospectus gives practically the same information as a prospectus and is signed by all the directors or proposed directors. In case, the company has not filed a statement in lieu of prospectus with the registrar, it is then not allowed to allot any of its shares or debentures. An offer document (filed with the RoC at least three days before making allotment of shares or debentures) may be considered to be a ‘statement in lieu of prospectus’ under any of the following circumstances:

• Where a company could raise the necessary capital without any public subscription, or
• Where a company could not make any allotment on account of the minimum subscription not being obtained.

A statement in lieu of the prospectus contains the information as described below:-

1- Name of the company

2- Statement of capital

3- Description of the business

4- Names, addresses, and occupation of directors

5- Estimated initial expenses

6- Names of vendors and details of property

7- Material contracts

8- Director’s interest

9- Minimum subscription

Red-herring prospectus: a prospectus that contains most of the information that will be presented in the final prospectus but often does not mention a price and/or the number of securities. A red-herring prospectus is alternatively known as a preliminary prospectus. It is issued where a company offers its securities through the “book-building issue”. In case of book-build issues, there is a process of price discovery and the price cannot be determined, until the bidding process is complete. Once the bidding process is complete, the details of the final price are included in the offer document. The offer document filed thereafter with RoC is called a prospectus. It shall be filed with the RoC at least three days before the opening of the offer. A copy of the same must be filed with the regulator (SEBI) also. It carries the same obligations and liabilities as are applicable to an ordinary prospectus.

Public Issue  Pricing

An Initial Public Offer (IPO) is the selling of securities to the public in the primary market. This Initial Public Offering can be made through the fixed price method, book building method or a combination of both.

Fixed Price Issue: In the fixed price issue the price at which the securities are offered and would be allotted is made known in advance to the investors. Demand for the securities offered is known only after the closure of the issue. This method serves as an excellent mode of disclosure of all the information pertaining to the issue. Besides disclosure of information, this method also facilitates satisfactory compliance with the legal requirements of transparency. The method promotes confidence of investors through transparency and non-discriminatory basis of allotment. It prevents artificial jacking up of prices as the issue is made public. In this 100% advance payment is required to be made by the investors at the time of application. 50% of the shares offered are reserved for applications below Rs. 1 lakh and the balance for higher amount applications. It is a time consuming process as it needs the due compliance with various formalities before being placed. Issuing through fixed price it inccured high costs such as underwriting expenses, brokerage, administrative costs, publicity costs, legal costs etc.

Book Building Isuue: Book Building is essentially a process used by companies raising capital through Public Offerings-both Initial Public Offers (IPOs) or Follow-on Public Offers ( FPOs) to aid price and demand discovery. It is a mechanism where, during the period for which the book for the offer is open, the bids are collected from investors at various prices, which are within the price band specified by the issuer. The process is directed towards both the institutional as well as the retail investors. The issue price is determined after the bid closure based on the demand generated in the process. In this issue 10% advance payment is required to be made by the QIBs along with the application, while other categories of investors have to pay 100% advance along with the application. 50% of shares offered are reserved for QIBS, 35% for small investors and the balance for all other investors.

The Process:

• The Issuer who is planning an offer nominates lead merchant banker(s) as ‘book runners’.
• The Issuer specifies the number of securities to be issued and the price band for the bids.
• The Issuer also appoints syndicate members with whom orders are to be placed by the investors.
• The syndicate members input the orders into an ‘electronic book’. This process is called ‘bidding’ and is similar to open auction.
• The book normally remains open for a period of 5 days.
• Bids have to be entered within the specified price band.
• Bids can be revised by the bidders before the book closes.
• On the close of the book building period, the book runners evaluate the bids on the basis of the demand at various price levels.
• The book runners and the Issuer decide the final price at which the securities shall be issued.
• Generally, the number of shares are fixed, the issue size gets frozen based on the final price per share.
• Allocation of securities is made to the successful bidders. The rest get refund orders

Based on the total demand the cut off price is then decided by the issuer and merchant banker. The cut off price is the price at which the cumulative demand for shares, equals or exceeds the offer size.

Secondary Market

Securities issued by a company for the first time are offered to the public in the primary market. Once the IPO is done and the stock is listed, they are traded in the secondary market. This is the market wherein the trading of securities is done.  It is also called aftermarket where buyer or seller can trade on securities between them on stock exchange rather than from issuing companies. Secondary market consists of both equity as well as debt markets. For the general investor, the secondary market provides an efficient platform for trading of his securities.

The capital of a company is made up of a combination of borrowing and the money invested by its owners. The long-term borrowings, or debt, of a company are usually referred to as bonds, and the money invested by its owners as shares, stocks or equity.

Debt Market (Bond Market)

It is a market meant for trading (i.e. buying or selling) fixed income instruments. Fixed income instruments could be securities issued by Central and State Governments, Municipal Corporations, Govt. Bodies or by private entities like financial institutions, banks, corporates, etc. Its primary goal is to provide long-term funding for public and private expenditures. The bond market has largely been dominated by the United States, which accounts for about 44% of the market.  Debt Markets in India and all around the world are dominated by Government securities, which account for between 50 – 75% of the trading volumes and the market capitalization in all markets. Government securities (G-Secs) account for 70 – 75% of the outstanding value of issued securities and 90-95% of the trading volumes in the Indian Debt Markets.

Fixed Income securities offer a predictable stream of payments by way of interest and repayment of principal at the maturity of the instrument. The debt securities are issued by the eligible entities against the moneys borrowed by them from the investors in these instruments. Therefore, most debt securities carry a fixed charge on the assets of the entity and generally enjoy a reasonable degree of safety by way of the security of the fixed and/or movable assets of the company. The investors benefit by investing in fixed income securities as they preserve and increase their invested capital or also ensure the receipt of dependable interest income. The investors can even neutralize the default risk on their investments by investing in Govt. securities, which are normally referred to as risk-free investments due to the sovereign guarantee on these instruments

Derivatives Market

The derivatives market is the financial market for derivatives security, generally referred to a financial contract whose value is derived from the value of an underlying asset or simply underlying. There are a wide range of financial assets that have been used as underlying, including equities or equity index, fixed-income instruments, foreign currencies, commodities, credit events and even other derivative securities. Depending on the types of underlying, the values of the derivative contracts can be derived from the corresponding equity prices, interest rates, exchange rates, commodity prices and the probabilities of certain credit events.

The market can be divided into two, that for exchange-traded derivatives and that for over-the-counter derivatives. According to BIS, outstanding amount for future contracts traded on orgainsed exchanges globally is  USD 30,149.9 billion till September 2014 & for options USD 47,719.9 billion. In OTC market outstanding amount is USD 766,274 billion at the end of June 2014.

Participants of Derivatives Market

The derivatives market is similar to any other financial market and has following three broad categories of participants:

Hedgers: These are investors with a present or anticipated exposure to the underlying asset which is subject to price risks. Hedgers use the derivatives markets primarily for price risk management of assets and portfolios.

Speculators: These are individuals who take a view on the future direction of the markets. They take a view whether prices would rise or fall in future and accordingly buy or sell futures and options to try and make a profit from the future price movements of the underlying asset.

Arbitrageurs: They take positions in financial markets to earn risk less profits. The arbitrageurs take short and long positions in the same or different contracts at the same time to create a position which can generate a risk less profit.

 

 

Types of Derivative Contracts

Derivatives comprise four basic contracts namely Forwards, Futures, Options and Swaps. Over the past couple of decades several exotic contracts have also emerged but these are largely the variants of these basic contracts.

Forward Contracts: These are promises to deliver an asset at a pre- determined date in future at a predetermined price. Forwards are highly popular on currencies and interest rates. The contracts are traded over the counter (i.e. outside the stock exchanges, directly between the two parties) and are customized according to the needs of the parties. Since these contracts do not fall under the purview of rules and regulations of an exchange, they generally suffer from counter party risk i.e. the risk that one of the parties to the contract may not fulfill his or her obligation.

Futures Contracts: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in future at a certain price. These are basically exchange traded, standardized contracts. The exchange stands guarantee to all transactions and counterparty risk is largely eliminated. The buyers of futures contracts are considered having a long position whereas the sellers are considered to be having a short position. It should be noted that this is similar to any asset market where anybody who buys is long and the one who sells in short. Futures contracts are available on variety of commodities, currencies, interest rates, stocks and other tradable assets. They are highly popular on stock indices, interest rates and foreign exchange.

Options Contracts: Options give the buyer  a right but not an obligation to buy or sell an asset in future. Options are of two types – calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. One can buy and sell each of the contracts. When one buys an option he is said to be having a long position and when one sells he is said to be having a short position. In case of options only the seller (also called option writer) is under an obligation and not the buyer (also called option purchaser). The buyer has a right to buy (call options) or sell (put options) the asset from / to the seller of the option but he may or may not exercise this right. In case the buyer of the option does exercise his right, the seller of the option must fulfill whatever is his obligation (for a call option the seller has to deliver the asset to the buyer of the option and for a put option the seller has to receive the asset from the buyer of the option). An option can be exercised at the expiry of the contract period (which is known as European option contract) or anytime up to the expiry of the contract period (termed as American option contract).

Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are:

• Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency.
• Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.

Forex Market (Currency Market)

The foreign exchange market  is a global decentralized market for the trading of currencies. In terms of volume of trading, it is by far the largest market in the world. The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock. The foreign exchange market determines the relative values of different currencies. RBI regulates the forex market in India.

The foreign exchange market works through financial institutions, and it operates on several levels. Behind the scenes banks turn to a smaller number of financial firms known as “dealers,” who are actively involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the “interbank market”, although a few insurance companies and other kinds of financial firms are involved. Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little (if any) supervisory entity regulating its actions. The foreign exchange market assists international trade and investments by enabling currency conversion.

The currency market is considered to be the largest financial market in the world, processing 5.3 trillions of US dollars worth of transactions each day. The foreign exchange markets isn’t dominated by a single market exchange, but involves a global network of computers and brokers from around the world. As the most traded currency, the US dollar makes up 85% of Forex trading volume. At nearly 40% of trading volume, the euro is ahead of the third place Japanese yen that takes almost 20%.

Commodities Market

A physical or virtual marketplace for buying, selling and trading raw or primary products. For investors’ purposes there are currently about 50 major commodity markets worldwide that facilitate investment trade in nearly 100 primary commodities.  Commodities are split into two types: hard and soft commodities. Hard commodities are typically natural resources that must be mined or extracted (gold, rubber, oil, etc.), whereas soft commodities are agricultural products or livestock (corn, wheat, coffee, sugar, soybeans, pork, etc.) Forward Market Commission (FMC) is the regulator of Commodity market in India.

The highest volume of trading occurs in oil, gold and agricultural products. Since no one really wants to transport all those heavy materials, what is actually traded are futures contracts. These are agreements to buy or sell at an agreed upon price on a specific date.