Financial Innovation in Capital Market

Topics: Futures contract, Bond, Stock market Pages: 10 (3011 words) Published: June 24, 2011
Dr.C.Meera** Mr.R.S.Mohan ***T.Ramesh

Financial innovation has been a continuous and integral part of growth of the capital markets. Greater freedom and flexibility have enabled companies to reinvent and innovate financial instruments. Many factors such as increased interest rate, volatility, frequency of tax and regulatory changes etc. have stimulated the process of financial innovation. The deregulation of financial service industry and increased competition within investment banking also led to increased activities to design new products, develop better processes, and implement more effective solution for increasingly complex financial problems. Financial instrument is a combination of characteristics such as promised yield liquidity, maturity, security and risk. The process of financial innovation involves creating new instruments and technique by unpackaging and rebinding the same characteristics in different fashion to suit the constantly changing needs of the issuers and the investors. At times it leads to introduction of revolutionary new products such as swap, mortgage, and zero coupon bonds to finance leveraged buyouts. Sometimes it involves the piecing together of existing products and process to fit in a particular set of circumstances. Many companies consider the types of securities (debt and equity), and a handful of simple financial institutions (banks or exchanges). However, there is a range of financial products, types of financial institutions and a variety of processes that these institutions employ to do business.

'Financial innovation' is the act of creating and popularizing new financial instruments as well as new financial technologies, institutions and markets. The "innovations" are classified into •Product innovation- The product innovations may be represented by new derivative contracts, new corporate securities or new forms of investment products. •Process innovation- The process improvements can be represented by new means of distributing securities, processing transactions, or pricing transactions. In terms of financial innovations, securities innovations include instruments such as debt, preferred stock, convertible securities, and common equities. They help in reallocating risk, increasing liquidity, reducing agency costs, transactions costs, taxes and sometimes circumventing regulatory constraints.

Functions of Financial Innovation
The financial innovations help in moving funds across time and space; pooling of funds; managing or reallocating risk; extracting information to support decision-making; addressing asymmetric information problems; facilitating the sale or purchase of goods and services through a payment system; reducing agency cost, and enhancing liquidity Innovations in Financial Products

After the liberalization measures were announced in 1991, Indian Company under took issuance of new instruments seriously in order to attract large section of investors. Essar Steel used convertible debentures with warrants and loyalty coupons, Tata Iron and Steel Company Limited issued secured Premium Notes with warrants, Flex Industries issued partly convertible debentures and non-convertible debentures with warrant attached to each instrument DLF aments issued multiple option bonds, Essar oil issued optionally fully convertible debentures and Reliance Petroleum issued triple option convertible with equity warrant and Esab India issued partly convertible debenture. This burst of innovation has seen a typical shift in the design and development of new instrument. The classic conversion is that of debt in to equity. Offering the investor the option of conversion keeps the cost of his convertible debt lower than straight debt, thus minimizing the cash out flows during the gestation period. Once the project yields steady profits, the equity...
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