INTRODUCTION

FINACIAL MARKETS

MEANING:-
A financial market is a market, in which people trade financial securities,
commodities, at low transaction costs and at price that reflect supply and demand.
Securities include stocks and bonds, and commodities include precious metals or
agricultural goods.

There are both general markets (where many commodities are traded) and
specialized markets (where only one commodity is traded). Markets work by
placing many interested buyers and sellers, including households, firms, and
government agencies, in one “place” , thus making it easier for them to find each
other.

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Definition:
Financial market refers to a marketplace, where trading of financial assets, such as
shares, debentures, bonds, bills of exchange currencies, etc. take place. It acts as an
intermediary between the savers and investors by mobilizing funds between them.

FUNCTIONS
Price Determination: Demand and supply of an asset in a financial

market help to determine their price. Investors are the supplier of the funds, while
the industries are in need of the funds. Thus, the interaction between these two
participants and other market forces helps to determine the price.

Mobilization of savings: For an economy to be successful it is crucial

that the money does not sit idle. Thus, a financial market helps in connecting those
with money with those who require money.

Ensures liquidity: Assets that buyers and sellers trade in the financial

market have high liquidity. It means that investors can easily sell those assets and
convert them into cash whenever they want. Liquidity is an important reason for
investors to participate in trade.

Saves time and money: Financial markets serve as a platform where

buyers and sellers can easily find each other without making too much efforts or
wasting time. Also, since these markets handle so many transactions it helps them
to achieve economies of scale. This results in lower transaction cost and fees for
the investors.

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Risk sharing
Financial market performs the function of the risk-sharing as the person who is
undertaking the investments are different from the persons who are investing their
fund in those investments. With the help of the financial market, the risk is
transferred from the person who undertakes the investments to those persons who
provide the funds for making those investments.

Easy Access
The industries require the investors for raising the funds and the investors require
the industries for investing its money and earning the returns from them. So the
financial market platform provides the potential buyer and seller easily, which
helps them in saving their time and money in finding the potential buyer and seller.

Reduction in transaction costs and provision of the

Information
The trader requires various types of information while doing the transaction of
buying and selling the securities. For obtaining the same time and money is
required

But the financial market helps in providing every type of information to the traders
without the requirement of spending any money by them. In this way, the financial
market reduces the cost of the transactions.

Capital Formation

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Financial markets provide the channel through which the new savings of the
investors flow in the country which aid in the capital formation of the country.

Example of the Functions of Financial Markets

Let’s consider an example of the company XYZ ltd, which requires the funds to
start a new project but at present, it doesn’t have such funds. On the other side,
there are investors who have spare money and want to invest in some areas where
they can get the required rate of expected returns.

So, in that case, the financial market will function where the company can raise
funds from the investors and the investors can invest their money through the help
of the financial market.

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 SEGMENTS OF

FINANCIAL MARKETS
MONEY MARKET

CAPITAL MARKET

FOREIGN EXCHANGE MARKET

GOVT.SECURITY MARKET

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 MONEY MARKET

INTRODUCTION
The money market is a component of the economy which provides short-term
funds. The money market deals in short-term loans, generally for a period of less
than or equal to 365 days.

As money became a commodity, the money market became a component of

the financial market for assets involved in short-term borrowing, lending, buying
and selling with original maturities of one year or less. Trading in money markets
is done over the counter and is wholesale.

There are several money market instruments including treasury bills, commercial
paper bankers' acceptances, deposits, certificates of deposit, bills of
exchange, repurchase agreements, and short-lived mortgage- and asset-backed
securities. The instruments bear differing maturities, currencies, credit risks, and
structures.

Definition: Money market basically refers to a section of the financial market

where financial instruments with high liquidity and short-term maturities are
traded. Money market has become a component of the financial market for buying

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and selling of securities of short-term maturities, of one year or less, such as
treasury bills and commercial papers.

Functions of a Money Market:

A money market performs a number of functions in an economy.

1.Provides Funds:
It provides short-term funds to the public and private institutions needing such
financing for their working capital requirements. It is done by discounting trade
bills through commercial banks, discount houses, brokers and acceptance houses.
Thus the money market helps the development of commerce, industry and trade
within and outside the country.

2. Use of Surplus Funds:

It provides and opportunity to banks and other institutions to use their surplus
funds profitably for a short period. These institutions include not only commercial
banks and other financial institutions but also large non-financial business
corporations, states and local governments.

3. No Need to Borrow from Banks:

The existence of a developed money market removes the necessity of borrowing
by the commercial banks from the central bank. If the former find their reserves
short of cash requirements they can call in some of their loans from the money
market. The commercial banks prefer to recall their loans rather than borrow from
the central banks at a higher rate of interests.

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4. Helps Government:
The money market helps the government in borrowing short-term funds at low
interest rates on the basis of treasury bills. On the other hand, if the government
were to issue paper money or borrow from the central bank. It would lead to
inflationary pressures in the economy.

5. Helps in Monetary Policy:

A well-developed money market helps in the successful implementation of the
monetary policies of the central bank. It is through the money market that the
central banks are in a position to control the banking system and thereby influence
commerce and industry.

6. Helps in Financial Mobility:

By facilitating the transfer for funds from one sector to another, the money market
helps in financial mobility. Mobility in the flow of funds is essential for the
development of commerce and industry in an economy.

7. Promotes Liquidity and Safety:

One of the important functions of the money market is that it promotes liquidity
and safety of financial assets. It thus encourages savings and investments.

8. Equilibrium between Demand and Supply of Funds:

The money market brings equilibrium between the demand and supply of funds.
This it does by allocating saving into investment channels. In this way, it also helps
in rational allocation of resources.

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9. Central Bank Policies
The central bank is responsible for guiding the monetary policy of a country and
taking measures to ensure a healthy financial system. Through the money market,
the central bank can perform its policy-making function efficiently. For example,
the short-term interest rates in the money market represent the prevailing
conditions in the banking industry and can guide the central bank in developing an
appropriate interest rate policy. Also, the integrated money markets help the central
bank to influence the sub-markets and implement its monetary policy objectives.

10. Growth of Industries:

The money market provides an easy avenue where businesses can obtain short-
term loans to finance their working capital needs. Due to the large volume of
transactions, businesses may experience cash shortages related to buying raw
materials, paying employees, or meeting other short-term expenses. Through
commercial paper and finance bills, they can easily borrow money on a short-term
basis. Although the money market does not provide long-term loans, it influences
the capital market and can also help businesses obtain long-term financing. The
capital market benchmarks its interest rates based on the prevailing interest rate in
the money market.

11. Commercial Banks Self-Sufficiency

The money market provides commercial banks with a ready market where they can
invest their excess reserves and earn interest while maintaining liquidity. The
short-term investments such as bills of exchange can easily be converted to cash to
support customer withdrawals. Also, when faced with liquidity problems, they can

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borrow from the money market on a short-term basis as an alternative to borrowing
from the central bank. The advantage of this is that the money market may charge
lower interest rates on short-term loans than the central bank typically does.

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INSTRUMENTS OF MONEY
MARKET
TREASURY BILLS

CERTIFICTE OF DEPOSIT

COMMERCIAL PAPER

BANKER’S ACCEPTANCE

REPURCHASE AGREEMENTS

PROMISSORY NOTE

BILLS OF EXCHANGE

CALL AND NOTICE MONEY

INTER –BANK TERM MARKETLIQUID

MUTUAL FUNDS

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Several financial instruments are created for short-term lending and borrowing in
the money market, they include:

1 Treasury Bills
Treasury bills are considered the safest instruments since they are issued with a full
guarantee by the United States government. They are issued by the U.S. Treasury
regularly to refinance Treasury bills reaching maturity and to finance the federal
government’s deficits. They have a maturity of one, three, six, or twelve months.
Treasury bills are sold at a discount to their face value, and the difference between
the discounted purchases price and face value represents the interest rate. They are
purchased by banks, broker-dealers, individual investors, pension funds, insurance
companies, and other large institutions.

2 Certificate of Deposit
A certificate of deposit (CD) is issued directly by a commercial bank, but it can be
purchased through brokerage firms. It has a maturity date ranging from three
months to five years and can be issued in any denomination. Most CDs have a
fixed maturity date and interest rate, and they attract a penalty for withdrawing
prior the time of maturity. Just like a bank’s checking account, a certificate of
deposit is insured by the Federal Deposit Insurance Corporation (FDIC).

3 Commercial Paper
Commercial paper is an unsecured loan issued by large institutions or corporations
to finance short-term cash flow needs such as inventory and accounts payables. It

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is issued at a discount, with the difference between the price and face value of the
commercial paper being the profit to the investor. Only institutions with a high
credit rating can issue commercial paper, and it is therefore considered a safe
investment. Commercial paper is issued in denominations of $100,000 and above.
Individual investors can invest in the commercial paper market indirectly through
money market funds. Commercial paper has a maturity date between one month
and nine months.

4 Banker’s Acceptance
A banker’s acceptance is a form of short-term debt that is issued by a firm but
guaranteed by a bank. It is created by a drawer, providing the bearer the rights to
the money indicated on its face at a specified date. It is often used in international
trade because of the benefits to both the drawer and bearer. The holder of the
acceptance may decide to sell it on a secondary market, and investors can profit
from the short-term investment. The maturity date usually lies between one month
and six months from the issuing date.

5 Repurchase Agreements
A repurchase agreement (repo) is a short-term form of borrowing that involves
selling a security with an agreement to repurchase it at a higher price at a later date.
It commonly used by dealers in government securities who sell Treasury bills to a
lender and agree to repurchase them at an agreed price at a later date. The Federal
Reserve buys repurchase agreements as a way of regulating the money supply and
bank reserves. Their date of maturity ranges from overnight to 30 days or more.

6. Promissory Note:

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A promissory note is one of the earliest type of bills. It is a financial instrument
with a written promise by one party, to pay to another party, a definite sum of
money by demand or at a specified future date, although it falls in due for payment
after 90 days within three days of grace. However, Promissory notes are usually
not used in the business, but USA is an exception.

7. Bills of exchange or commercial bills

The bills of exchange can be compared to the promissory note; besides it is drawn
by the creditor and is accepted by the bank of the debater. The bill of exchange can
be discounted by the creditor with a bank or a broker. Additionally, there is a
foreign bill of exchange which becomes due for payment from the date of
acceptance. However, the remaining procedure is the same for the internal bills of
exchange.

8. Call and Notice Money

Call and Notice Money exist in the market. With respect to Call Money, the funds
are borrowed and lent for one day, whereas in the Notice Market, they are
borrowed and lent up to 14 days, without any collateral security. The commercial
banks and cooperative banks borrow and lend funds in this market. However, the
all-India financial institutions and mutual funds only participate as lenders of
funds.

9.Inter-bank Term Market

The inter-bank term market is for the cooperative and commercial banks in India
who borrow and lend funds for a period of over 14 days and up to 90 days. This is
done without any collateral security at the rates determined by markets.

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10. Liquid Mutual Funds:
This particular mode is meant for those who have large surplus funds whether
individuals or institutions. Basically this is unsecured money market instrument
and funds are invested for a very short period say 7 -20 days. After having invested
in these instruments withdrawals can be allowed only on the notice of at least 24
hours.

STRUCTURE OF INDIA MONEY MARKET

Indian money market consist of financial institution and financial instruments

Financial institutions
Financial institutions of money market are those which deal in lending and
borrowing of short term funds. The financial institutions differ from the country to
country.

Broadly speaking, the money market in India comprises two sectors- (a)
Organized sector, and (b) Unorganized sector.

(a) Organized sector: organized sector of India money market is that

sector whose roles and activities are systematically co-ordinate by the
monetary authority. The organized sector of Indian money market
comprises the following institutions.
 Reserve bank of India: RBI is regarded as an apex institution of money
market. It is the monitory authority. RBI is the lender of the last resort of the
money market. It is the controller and guardian of money market .no money
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 can exist without the central bank of the country .RBI is the central bank of
country which controls and guides the institutions working in the money
market. RBI increase and reduced the money supply and credit to ensure the
economic stability in the country.
 Commercial banks: commercial banks are the back –bone of India Money
market. The commercial banks dominate the organized sector of money
market. The commercial banks use their short term deposits for financial
trade, commerce and industry for short periods. The commercial banks
invest their funds in discounting commercial bills, treasury bills or govt. bills
to facilitate trade and commerce by mobilizing the flow of money.
Commercial banks includes
 Public sector banks : public sector commercial banks are state banks
of India and its subsidiaries banks ,nationalized banks and regional
rural banks.
 Private sector banks :private sector commercial banks include
private scheduled banks or non scheduled banks and foreign banks
 Co-operative banks: Another important financial institution of
Indian money market are co-operative banks .the co-operative banks
are a part of co –operative credit institutions which have a three tier
structure. At the top, there are co-operative banks at state level, co-
operative banks at district level and national co-operative banks.
These are also deal in short term credit in money market

(B) Unorganized sector: The unorganized financial institution of

money market is that institution whose activities are not systematically co-ordinate

by the monetary authority, unorganized sector included:

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 Indigenous banks : These banks found their origin in India .These banks
made a significant contribution to the development of money market .these
agencies do their banking business with their own funds.
 Money lenders: Money lenders include Mahajans, commission agents,
jewelers who are the runners of indigenous banks of India. These money
lenders also participate in the activities of Indian money market.

Financial instruments
 Call money market: The call money market is an essential part of the Indian
Money Market, where the day-to-day surplus funds (mostly of banks) are
traded. The money market is a market for short-term financial assets that are
close substitutes of money. The most important feature of a money market
instrument is that it is liquid and can be turned into money quickly at low
cost and provides an avenue for equilibrating the short-term surplus funds of
lenders and the requirements of borrowers. The loans are of short-term
duration varying from 1 to 14 days, are traded in call money market.
 Collateral Loan Market: Collateral loan market deals with collateral loans
i.e., loans backed by security. In the Indian collateral loan market, the
commercial banks provide short- term loans against government securities,
shares and debentures of the government, etc.
 Certificate of Deposit and Commercial Paper Markets: Certificate of
Deposit (CD) and Commercial Paper (CP) markets deal with certificates of
deposit and commercial papers. These two instruments (CD and CP) were
introduced by Reserve Bank of India in March 1989 in order to widen the
range of money market instruments and give investors greater flexibility in
the deployment of their short-term surplus funds.

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 Bill market: Bill Market refers to the market for short-term bills generally of
three months maturity. A bill is a promise to pay a specified amount by the
borrower (drawer) to the creditor (drawee). Bills are of three types- (a) bills
of exchange or commercial bills used to finance trade; (b) finance bills or
promissory notes; and (c) treasury bills used to meet temporary financial
needs to the government. These bills may be bought and sold in the discount
market which consists of commercial banks, discount houses and other
institutions.
 Treasury Bills (T. Bills):
Treasury bills are issued by Reserve Bank of India on behalf of the
Government of India. These bills enable government to get short term
borrowings as these bills are sold to banks and general public. These bills are
negotiable instruments and are freely transferable. These are issued at a
discount. These are considered safest investment as these are issued by R.B.I.
The maturity period of Treasury Bills varies from 14 to 364 days.

 General bill: bills of exchange are commercial papers which are known as
general bills. Commercial is written unconditional order which is signed by

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 the drawer requiring the drawer to pay on demand or fixed future time, a
definite sum of money.

Drawbacks

Defects of Indian Money Market:

The Indian money market is not well developed. Compared to the growth in the
economy, the growth of the money market has been slow and the influence of the
money market in the economy has been quite limited.

(i) Dual Character:

The Indian economy has dichotomy money markets with an organized sector and
an unorganized sector. The organized sector consists of specialized banking and
financial institutions like the RBI, SBI, commercial banks, cooperative banks, LIC,
UTI, GIC, etc. which operate in the money market in accordance with rules laid
down.

On the other hand, the unorganized sector includes indigenous bankers,

moneylenders, traders, merchants, landlords, brokers, chit funds, etc. which do not
follow any set rules in loan operations. The two sectors do not have any contact
with each other and lack coordination or cooperation. In fact, the unorganized
sector reduces the effectiveness of monetary policy measures because it does not
fall under the jurisdiction of the RBI.

(ii) Captive Market:

The Indian money market is captive. It is governed by a few institutions which

participate in it. The participants in the organized money market are limited to

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banks and a few all-India financial institutions like UTI, GIC, LIC, etc., while in
the unorganized market the principal participants are moneylenders and indigenous
bankers.

(iii) Narrow Based:

The Indian money market is narrow based and is functioning with limited number
of instruments. The main instruments are inter-bank call money, treasury bills,
commercial bills, inter-corporate funds, certificates of deposit and commercial
paper.

The last two have just been started and others have made Little impact on the
working of the money market. In fact, only few instruments are being used in
practice and others remain only in paper. Moreover, these instruments do not serve
those institutions which can deal in the money market whenever they have excess
funds or paucity of funds.

(iv) Small Geographical Area:

The Indian money market is confined to a small geographical area comprising four
capital cities of India, viz., Delhi, Mumbai, Kolkata and Chennai. This inhibits the
growth of the money market. A large segment of rural, semi-urban, and urban
India is out of the purview of the organized money market.

(v) Slow Rate of Monetization:

The slow rate of monetization is another factor which has kept the Indian money
market under-developed. There are still large backward areas in rural India in
which monetization is taking place at a very slow pace. They fall in the
unorganized sector of the money market and get loans from the merchant-
moneylenders.

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(vi) Shortage of Capital:

There is shortage of capital in the Indian money market which fails to meet the
requirements of the trade and industry.

The main reasons for the insufficiency of funds are:

(i) Low saving capacity of the people due to low levels of income;

(ii) Inadequate banking facilities in the rural areas;

(iii) Preferences of savers to invest in physical assets like land, real estate, gold,
etc. than in financial savings.

(vii) Defects in the Call Money Market:

(viii) Defects in the Bill Market:

Despite the introduction of the Bill Market Scheme in 1952 and the Bill
Rediscounting Scheme in 1970, the bill market in India continues to remain
underdeveloped. In fact, bill culture has not been developed properly because
preference for cash credit type of financing still continues.

The bill rediscounting business constitutes a very small part of the total lending
activities of the banks in India.

(ix) Large Unorganized Sector:

A major defect of the Indian money market is the existence of a large unorganized
sector. This sector is dominated by indigenous bankers and money-lenders. They
are neither under the control of the RBI nor are they influenced by market rates of
interest. There is also no clear demarcating line for short-term and long-term
finance in this sector.

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(x) No Relation between Organized and Unorganized Sectors:

In India the organized and the unorganized sector of the money market do not have
any relation with each other. The moneylenders and indigenous bankers work
independently and they fail to get funds from commercial banks except like other
customers. Rather, they prefer to borrow from each other because the commercial
banks insist on observance of formal rules and procedures.

Suggestions to Improve the Indian Money Market

The following suggestions are made to further improve the Indian money
markets:

(i) Control over Indigenous Bankers:

After nationalization of banks in 1969, banking facilities have considerably

expanded in rural India under the branch expansion scheme of commercial banks,
lead bank scheme, regional rural banks, cooperative banks, etc. But the hold of the
indigenous bankers still continues over the majority of villagers.

As recommended by the Banking Commission, 1972, the activities of the

indigenous bankers should be controlled through the commercial banks and they
should encourage the former to transform themselves into corporate bodies. The
RBI should lay down guidelines for commercial banks in dealing with indigenous
bankers.

(ii) Control over Chit Funds:

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To control the activities of chit funds which exploit and cheat their members of
their hard-earned savings, the Banking Commission suggested that there should be
a uniform legislation for chit funds throughout the country and that only public
limited companies with a minimum paid-up capital should be allowed to run chit
funds.

(iii)Development of Bill Market:

In the organized sector of the money market, a properly developed bill market is
essential for the growth of money market in India. For this purpose, the
Government should direct departmental undertakings and public sector
organizations that payments for all credit purchases should be in the form of bills
which should be strictly honored on due dates.

(iv) Growth of Money Market in Other Centers:

The money market is restricted to four major cities in India. To expand the money
market in other cities, banking and clearing house facilities should be provided on
a larger scale. Discount houses and acceptance houses should be established.
Cheap remittance facilities should be extended throughout the country to increase
the mobility of funds. These measures will go a long way in the growth of the
money market in other cities.

(v) Creation of Secondary Market:

For the smooth functioning and growth of the money market, an active secondary
market should be created by establishing new sets of institutions which should
impart sufficient liquidity in the Indian money market.

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 Capital market

A capital market is a financial market in which long-term debt (over a

year) or equity-backed securities are bought and sold. Capital
markets channel the wealth of savers to those who can put it to long-term
productive use, such as companies or governments making long-term
investments.

STRUCTURE OF CAPITAL MARKET

Capital market is classified in two ways

1)CAPITAL MARKET IN INDIA

GILD-Edged Industrial Development Financial

Market Securities Financial Intermediaries

Market Institutions (DFIs)

GILT-Edged Market

GILT-Edged Market refers to the government and semi-government securities , which carry
fixed rates of interest . RBI plays an important role in this market.

Industrial Securities Market

It deals with

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