Capital Markets: Challenges and Developments

What are Interest Rate Derivatives (IRDs)?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Foreign portfolio investment (FPI)

Mains level : Not Much

The RBI has proposed allowing foreign portfolio investors (FPIs) to undertake exchange-traded rupee interest rate derivatives transactions subject to an overall ceiling of ₹5,000 crores.

Every year, there is a question on a capital market instruments. Make note of all such separately. Also, try this PYQ:

Q. Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly? (CSP 2019)

(a) Certificate of Deposit

(b) Commercial Paper

(c) Promissory Note

(d) Participatory Note

Interest Rate Derivatives (IRDs)

  • An IDR is a financial instrument with a value that is linked to the movements of an interest rate or rates.
  • These may include futures, options, or swaps contracts.
  • They are often used by institutional investors, banks, companies, and individuals to protect themselves against changes in market interest rates.
  • The proposed directions by RBI are aimed at encouraging higher non-resident participation, enhance the role of domestic market makers in the offshore market, improve transparency, and achieve better regulatory oversight, according to the central bank.

Back2Basics: Foreign portfolio investment (FPI)

  • FPI involves holding financial assets from a country outside of the investor’s own.
  • FPI holdings can include stocks, ADRs, GDRs, bonds, mutual funds, and exchange-traded funds.
  • Along with foreign direct investment (FDI), FPI is one of the common ways for investors to participate in an overseas economy, especially retail investors.
  • Unlike FDI, FPI consists of passive ownership; investors have no control over ventures or direct ownership of property or a stake in a company.

FPI vs FDI

  • With FPI—as with portfolio investment in general—an investor does not actively manage the investments or the companies that issue the investments.
  • They do not have direct control over the assets or the businesses.
  • In contrast, foreign direct investment (FDI) lets an investor purchase a direct business interest in a foreign country.
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