Economy of India

The economy of India is a developing mixed economy.[34] It is the world's fifth-

largest economy by nominal GDP and the third-largest by purchasing power
parity (PPP). The country ranks 139th in per capita GDP (nominal) with $2,134 and
122nd in per capita GDP (PPP) with $7,783 as of 2018.[35][36] After 1991 economic
liberalization, India achieved 6-7% average GDP growth annually. In FY 2015 and 2018
India's economy became the world's fastest growing major economy, surpassing China.
[37]

The long-term growth prospective of the Indian economy is positive due to its young
population, corresponding low dependency ratio, healthy savings[38] and investment
rates, and increasing integration into the global economy.[39] India topped the World
Bank's growth outlook for the first time in fiscal year 2015–16, during which the
economy grew 7.6%.[40] Despite previous reforms, economic growth is still significantly
slowed by bureaucracy, poor infrastructure, and inflexible labor laws (especially the
inability to lay off workers in a business slowdown).[41]
India has one of the fastest growing service sectors in the world with an annual growth
rate above 9% since 2001, which contributed to 57% of GDP in 2012–13.[42] India has
become a major exporter of IT services, Business Process Outsourcing(BPO) services,
and software services with $154 billion revenue in FY 2017.[43][42] This is the fastest-
growing part of the economy.[44] The IT industry continues to be the largest private-
sector employer in India.[45][46] India is the third-largest start-up hub in the world with over
3,100 technology start-ups in 2014–15[47] The agricultural sector is the largest employer
in India's economy but contributes to a declining share of its GDP (17% in 2013–14).
India ranks second worldwide in farm output.[48] The industry (manufacturing) sector has
held a steady share of its economic contribution (26% of GDP in 2013–14).[49] The
Indian automobile industry is one of the largest in the world with an annual production of
21.48 million vehicles (mostly two and three-wheelers) in 2013–14.[50] India had $600
billion worth of retail market in 2015 and one of world's fastest growing e-commerce
markets.
Currency Indian rupee (INR) ₹1 = 100 Paise
Fiscal year 1 April  – 31 March

Trade organisations WTO, WCO, WFTU, G-20, BIS, AIIB, ADB, WCO

Statistics

GDP $2.848 trillion (nominal; 2018 est)[3]

$10.385 trillion (PPP; 2018 est)[3]

5th (nominal)
GDP rank
3rd (PPP)
GDP growth  7.7% (Q4, 2017-18) (MOSPI)[4]
GDP per capita $2,134 (nominal; 2018 est)[3]

$7,783 (PPP; 2018 est)[3]

GDP per capita rank 139th (nominal)

122nd (PPP)
GDP by sector Agriculture: 17.32%

Industry: 29.02%

Services: 53.66% (2016 est.)[5]

Inflation (CPI)  4.28% (March 2018)[6]
Base borrowing rate  6.25% (as on 11 May 2018)[7]
Population below poverty line 21.2%[8]

58% live less than $3.10/day[9]

Gini coefficient
Human Development Index
Labour force
Labour force by occupation
(2011; World bank estimate)
33.9 (2013)[10]
 0.624 (2015) medium[11] (131st)
520.2 million (2017 est.)[12]
Agriculture: 47%

Industry: 22%

Services: 31% (FY 2014 est.)[13]

Unemployment  8.8% (2017 est.)[14]

Average net salary ₹82,269 / $1,284 annually (2016-17)[15]
Main industries Textiles

chemicals

food processing

steel
 cement

mining

petroleum

machinery

software

pharmaceuticals

transportation equipment[16][17]
Ease-of-doing-business rank  100 (2017)[18]

External

Exports $302.8 billion (2017)[19]

Export goods Agricultural products 13.2%

Fuels and mining products 15.7%

Manufacturers 68.4%

Others 2.7%[20]
Main export partners  European Union 17.6%

 United States 16.1%

 United Arab Emirates 11.5%

 Hong Kong 5.1%

 China 3.4%

Other 46.3%[20]

Imports $459.8 billion (2017)[19]

Import goods Agricultural products 7.1%

Fuels and mining products 33.1%

Manufacturers 47.8%

Other 12%[20]
Main import partners  China 17%

 European Union 11.3%

 United States 5.7%

 United Arab Emirates 5.4%

 Saudi Arabia 5.2%

Other 55.5%[20]
FDI stock Inward: $318.50 billion

Outward: $144.13 billion (2016)[21]

Current account  0.7% of GDP (2016–17)[22][23]
Gross external debt $471.9 billion (31 March 2017)[24][25]
 Net international investment position -$429.7 billion (Dec. 2017)[26]

Public finances
Public debt 67.7% of GDP (2017)[27]

Revenues ₹39.86 trillion (US$610 billion) (2018)[28]

Expenses ₹52.11 trillion (US$800 billion) (2018)[28]

Economic aid  $2.68 billion (2016)[29]

Credit rating  Standard & Poor's:[30]

BBB− (Domestic)

BBB− (Foreign)

BBB+ (T&C Assessment)

Outlook: Stable

 Moody's:[31]

Baa2

Outlook: Stable

 Fitch:[32]

BBB−

Outlook: Stable
Foreign reserves $426.082 billion ( 13 April 2018)[33](8th)

How exactly does the Indian economy work?

Let me start with an interesting example. In our economy we have three important
people :

 RBI (Reserve Bank Of India), similar to Grandfather.

 Commercial Banks, similar to Father.
 General Public, similar to Son.
Now if father wants the money, he will take it from grandfather.

Similarly, if son wants the money, he will take it from father.

Coming back to the point. Lets start with very basic questions.

What is the role of RBI?

RBI is the central bank of our country. It has the sole power to mint money of
denomination higher than one rupee notes and coins.
RBI has the total control over the money supply in our economy.

In simple words, RBI has a switch to on and off the inflation and growth factor.

RBI as said before is the grandfather. Hence if the commercial banks need money, then
RBI helps them by lending the money.

It also charges interest on such lending which is known as ‘repo rate’.

The money so minted is given as a loan from RBI (grandfather) to Commercial banks
(father).

What do commercial banks do of such money?

Commercial banks as the name suggests are commercial in nature. Which means they
are profit oriented.

They will lend the money to general public (son) for various purposes.

Hence if a random startup wants to have money for the business, it will approach bank
for the money.

In other words, banks help general public for promoting their business.

What do the businessman do after taking loan?

The businessman will invest the money in the business and therby earn profit.

Also he will have to spend money for running his business on various factors. These are
known as factors of production:

 Land (rent)
 Labour (wages)
 Capital (interest)
 Entrepreneur (profit)
Now you see that the cycle of money is completed this way:

Money minted by RBI — Commercial banks —Bussinessmen—and the same

businessmen will put their earned profit as a saving in banks.

Thus completing the money cycle.

How does RBI control growth?

Remember that RBI is the grandfather? Not just he is a grandfather, infact this
grandfather is a strict person.

When RBI wants to increase growth, the following will happen:

  RBI will mint more money.
 More money means more loan to Commercial banks.
 More loan to commercial banks means more loan to general public.
 Giving more money in the hands of public will cause increase in their
purchasing power.
 More purchasing power means more demand for goods and business will
flourish.
 But, Increase in demand of goods will cause rise in prices of the goods hence
causing inflation.
How does RBI control inflation?

It will simply reverse the above procedure.

 It will mint less money

 Less money means less amount to banks.
 Hence less money for general public.
 Hence lesser demand for goods and lesser the prices.
Note: You will now observe that growth and inflation go hand in hand.

If the economy grows, so will the inflation.

Hence expecting RBI to grow the economy without letting the prices
increase is like wanting to eat a lot of icecream without wanting to catch a
cold.

RBI is unfortunately not ajay devgan to ride both the horses

simultaneously. You get one, you sacrifice another.

What is the role of government then?

Well, the government also plays a special role of say grandmother here.

Finance ministry is responsible for the economy too.

The money earned by public is given back to the government in the form of taxes.

If the inflation rises, the grandmother will come to rescue too.

 Finance minister will increase the income tax.

 More income tax, means less money to spend in the hands of public.
 Less money will result into less demand and lesser prices of goods.

Note: These taxes are further used by the government on various infrastructural and
developmental projects. Sometimes there may be differences between RBI and
government as there can be between grandfather and grandmother.
This is how my friend the Indian economy works.

What's the difference between microeconomics and

macroeconomics?
Macroeconomics and microeconomics, and their wide array of underlying concepts, have been
the subject of a great deal of writings. The field of study is vast; so here is a brief summary of
what each covers. Microeconomics is generally the study of individuals and business decisions,
while  macroeconomics looks at higher up country and government decisions.

Microeconomics
Microeconomics is the study of decisions that people and businesses make regarding the
allocation of resources and prices of goods and services. This means also taking into account
taxes and regulations created by governments. Microeconomics focuses on supply and
demand and other forces that determine the price levels seen in the economy. For example,
microeconomics would look at how a specific company could maximize its production and
capacity, so that it could lower prices and better compete in its industry. (Find out more about
microeconomics in How does government policy impact microeconomics?

Microeconomics' rules flow from a set of compatible laws and theorems, rather than beginning
with empirical study.

Macroeconomics
Macroeconomics, on the other hand, is the field of economics that studies the behavior of the
economy as a whole, not just of specific companies, but entire industries and economies. It looks
at economy-wide phenomena, such as Gross Domestic Product (GDP) and how it is affected by
changes in unemployment, national income, rate of growth, and price levels. For example,
macroeconomics would look at how an increase/decrease in net exports would affect a
nation's capital account or how GDP would be affected by the unemployment rate. (To keep
reading on this subject, see Macroeconomic Analysis.)

John Maynard Keynes is often credited with founding macroeconomics, when he initiated the
use of monetary aggregates to study broad phenomena. Some economists reject his theory and
many of those who use it disagree on how to interpret it.

Micro and Macro

While these two studies of economics appear to be different, they are actually interdependent and
complement one another since there are many overlapping issues between the two fields. For
example, increased inflation (macro effect) would cause the price of raw materials to increase for
companies and in turn affect the end product's price charged to the public.
Microeconomics takes what is referred to as a bottoms-up approach to analyzing the economy
while macroeconomics takes a top-down approach. In other words, microeconomics tries to
understand human choices and resource allocation, while macroeconomics tries to answer such
questions as "What should the rate of inflation be?" or "What stimulates economic growth?"

Regardless, both micro- and macroeconomics provide fundamental tools for any finance
professional and should be studied together in order to fully understand how companies operate
and earn revenues and thus, how an entire economy is managed and sustained.

What Should Individual Investors Look At?

Individual investors are probably better off focusing on microeconomics than macroeconomics.
There may be some disagreement between fundamental (particularly value) investors and
technical investors about the proper role of economic analysis, but it is more likely that
microeconomics will affect an individual investment proposal.

Warren Buffett has famously stated that macroeconomic forecasts don't influence his investing
decisions. When asked about how he and Charlie Munger, his business partner, choose
investments, Buffett responded, "Charlie and I don't pay attention to macro forecasts. We've
worked together for 50+ years, and I can't think of a time when they influenced a decision about
stock or a company." Buffett has also referred to macroeconomic literature as "the funny papers."

John Templeton, another famously successful value investor, shared a similar sentiment. "I never
ask if the market is going to go up or down, because I don't know. It doesn't matter. I search
nation after nation for stocks, asking: 'where is the one that is lowest priced in relation to what I
believe it's worth?'" said Templeton.

The Divide Between Microeconomics and Macroeconomics

Microeconomics concerns itself with the small details that make a difference when evaluating
individual companies. This includes production costs and market prices for goods and services.
A lot of microeconomic information can be gleaned from the financial statements.

Macroeconomics focuses on aggregates and econometric correlations. Investors of mutual funds

or interest rate-sensitive securities should keep an eye toward monetary and fiscal policy.
Outside of a few meaningful and measurable impacts, macroeconomics doesn't offer much for
specific investments.

Moreover, economists generally agree on the principles of microeconomics. As the International

Monetary Fund (IMF) website states, "There are no competing schools of thought in
microeconomics." This is not true with macroeconomics. Macroeconomic forecasting has a very
poor track record, and the accepted version of macroeconomics has changed several times since
its inception.
ECONOMY INDICATORS
Basic Indicators
The following basic economic indicators are important to understand:

 Gross Domestic Product (GDP) - is the total amount of all goods and services produced
in the country. This includes consumer spending, government spending and business
inventories. Real GDP is a variant that takes out the impact of inflation, so that GDP can
be compared over time. Real GDP is the basic measure of business activity and tracks the
business cycle. 

 Consumer Price Index (CPI) -is a measure of the price of a basket of goods and
services; increases to this index indicate an increase in inflation. 

 Producer Price Index (PPI) -is a measure of the price of commercial items, such as
farm products and industrial commodities. PPI indicates the cost to produce items and is
the leading indicator of inflation. 

 Trade deficit - resultswhen a country's imports exceed its exports. The United

States usually has a trade deficit. 

 Trade surplus - resultswhen a country's exports exceed its imports. 

 Balance of payments (BOP) - is the amount of foreign currency taken in minus the

amount of domestic currency paid out; the United States usually has a balance of
payments deficit. 

 Unemployment rate - the Bureau of Labor Statistics releases employment numbers each

month that note the number of employed and unemployed people in the United States, as
well as the percentage of unemployed. Increases in the unemployment rate tend to occur
when the economy declines and vice versa.

Leading, coincident and lagging indicators

Certain economic indicators serve as barometers of economic activity. These are divided into
three categories: leading indicators, coincident (or current) indicators and lagging indicators.

Leading indicators preview signs of improvement or decline in economic conditions. Some of

these leading indicators include plant and equipment orders, money supply, stock prices,
consumer expectations, average work week for production workers and average weekly claims
for unemployment insurance. 

Coincident indicators coincide with current economic activity. Examples include nonfarm
employment, industrial production, manufacturing and trade sales, and personal income minus
transfer payments such as Social Security, disability benefits and unemployment compensation.
Lagging indicators are signs that do not emerge until after a change in economic conditions.
They include the unemployment rate, business spending, labor costs, bank loans outstanding and
bank interest rates.

Here are some factors that can impact the growth rate of the economy:

 Fiscal policy - this refers to government actions (approved by Congress) that may

influence economic activity. These would include changing tax rates, increasing Social
Security payments, and increasing or decreasing government spending.

Learn how governments adjust taxes and government spending to moderate the economy within
the article What is Fiscal Policy?

 Monetary policy - this refers to actions taken by the Federal Reserve to either increase or
decrease the money supply in the economy. The Fed uses the following strategies to
expand or contract funds in the banking system: 

o Buying or selling government securities in the open market. Buying government

securities increases the money supply by injecting cash into the economy and
helps lead to lower interest rates; selling securities decreases the money supply by
removing cash from the economy and helps to raise interest rates. 

o Increasing or decreasing member bank reserve requirements. Higher reserve

requirements tighten the money supply; lower reserve requirements loosen the
money supply. 

o Increasing or decreasing the discount rate to member banks who borrow reserves
from the Fed. A higher discount rate tightens money supply; a lower discount rate
loosens money supply.

Typically, when the supply of money increases, interest rates fall. And when the supply of
money tightens, interest rates increase. So, the Fed actions discussed earlier have an impact on
the following:

 Consumer spending
 Interest rates on newly issued bonds
 Market prices of existing bonds: when interest rates rise, the prices of bonds with lower
coupon rates decrease and vice versa
Fed actions can also indirectly impact stocks:

 When monetary policy expands credit, lower interest rates make bonds less appealing as
investments, and stocks more appealing. 

 From the corporate perspective, company earnings may rise because of lower interest
expense, which may cause the market price of the stock to rise. 

 Of course, when the opposite occurs and monetary policy tightens credit, interest rates
will rise, earnings will decrease, and the market price of the stock is likely to decrease as
well. As interest rates rise, bonds become more attractive to investors.

Consider these sample exam questions:

1. Which of the following short-term effects could result from increases in the money
supply?
I. Interest rate increases
II. Bond price decreases
III. Stock price increases
IV. Inflation

I. I & II
II. I & IV
III. III & IV
IV. I, III, & IV

The correct answer is "c": increases in the money supply would decrease interest rates, not
increase them, and bond and stock prices would both increase. Inflation does not always follow
an increase in the money supply, but it usually does if the increase in the money supply is not
accompanied by an increase in real output.

2. All of the following are tools used by the Federal Reserve to control the money
supply EXCEPT:
a. Setting the Fed funds rate
b. Setting the discount rate
c. Changing reserve requirements
d. Buying and selling government securities in the open market

The correct answer is "a". All the other actions are tools used by the Federal Reserve, but it
does not have the ability to set the Fed funds rate. That rate responds to Fed actions but is not
directly set by the Fed.
Central Bank
What is a 'Central Bank'
A central bank or monetary authority is a monopolized and often nationalized institution given
privileged control over the production and distribution of money and credit. In modern
economies, the central bank is usually responsible for the formulation of monetary policy and the
regulation of member banks.

central banks are inherently non-market-based or even anticompetitive institutions. Many central
banks, including the Fed, are not government agencies, and so are often touted as being
politically independent. However, even if a central bank is not legally owned by the government,
its privileges are established and protected by law.

The critical feature of a central bank — distinguishing it from other banks — is it legal
monopoly status, which gives it the privilege to issue bank notes and cash. Privately
owned commercial banks are only permitted to issue demand liabilities, such as checking
deposits.

Functions of Central Banks

Although their responsibilities range widely, depending on their country, central banks' duties
(and the justification for their existence) usually fall into three areas. 

First, central banks control and manipulate the money supply: issuing currency and
setting interest rates on loans and bonds. (Typically, central banks raise interest rates to slow
growth and avoid inflation; they lower them to spur growth, industrial activity and consumer
spending.) In this way, they manage monetary policy to guide the economy and achieve
economic goals, such as full employment.

Second, they regulate member banks through capital requirements, reserve requirements (which

dictate how much banks can loan to customers, and how much capital they must keep on hand)
and deposit guarantees, among other tools. They also provide loans and services for a nation’s
banks and its government, and manage foreign exchange reserves.

Finally, a central bank also acts as an emergency lender to distressed commercial banks and
other institutions, and sometimes even a government. By purchasing government debt
obligations, for example, the central bank provides a politically attractive alternative
to taxation when a government needs to increase revenue.
How Do Central Banks Inject Money into The Economy?
Along with the measures mentioned above, central banks have other actions at their disposal. In
the U.S., for example, the Federal Reserve Board (the governing body of the Fed) can affect the
national money supply by changing reserve requirements, the minimum amounts of cash that
banks must hold in reserve against their deposits. When reserve requirements fall, banks can loan
more money, and the economy’s money supply climbs. Raising reserve requirements decreases
the money supply.

When the Fed lowers the discount rate that banks pay on short-term loans, it also
increases liquidity. Lower rates increase the money supply, which in turn boosts economic
activity.  But decreasing interest rates can fuel inflation, so the Fed must be careful.

And the Fed can conduct open market operations to change the federal funds rate. The Fed buys
government securities from securities dealers, supplying them with cash, thereby increasing the
money supply. The Fed sells securities to move the cash into its pockets and out of the system.

Central Banks and Deflation

What can central banks do to fight the pernicious and devastating effects of deflation, a sustained
and broad decline in price levels in an economy over a period of time?

Over the past quarter-century, concerns about deflation have spiked after big financial crises
and/or the bursting of stock market bubbles, such as the Asian crisis of 1997, the "tech wreck" of
2000-02, and the Great Recession of 2008-09. These concerns have assumed center stage in
recent years because of Japan's experience after its asset bubble burst in 1990, causing
the Nikkei index to lose one-third of its value within a year. As deflation became entrenched, the
Japanese economy – which had been one of the fastest-growing in the world from the 1960s to
the 1980s – slowed dramatically. Real GDP growth averaged only 1.1% annually from 1990
onward. In 2013, Japan's nominal GDP was about 6%  below its level in the mid-1990s. (For
more on the Japanese economy, see From Mrs. Watanabe to Abenomics – the Yen's wild ride).

The Great Recession sparked fears of a similar period of prolonged deflation in the United States
and elsewhere, because of the catastrophic collapse in prices of a wide range of assets –
stocks, mortgage-backed securities (MBS), real estate, and commodities. The global financial
system was also thrown into turmoil by the insolvency of a number of major banks and financial
institutions in the United States and Europe, exemplified by the bankruptcy of Lehman Brothers
in September 2008 (see Case Study – The Collapse of Lehman Brothers). There were widespread
concerns that scores of banks and financial institutions that were on the verge of going under
would do so in a domino effect, leading to a collapse of the financial system, a shattering of
consumer confidence, and outright deflation.

The Federal Reserve's Approach to Deflation

In December 2008, the Federal Open Market Committee (FOMC, the Federal Reserve's
monetary policy body) cut the target federal funds rate essentially to zero. The fed funds rate is
the Federal Reserve's conventional instrument of monetary policy, but with that rate now at the
"zero lower bound" – so called because nominal interest rates cannot go below zero – the Federal
Reserve had to resort to unconventional monetary policies to ease credit conditions and stimulate
the economy.

The Federal Reserve turned to two main types of unconventional monetary policy tools:
(1) forward policy guidance and (2) large-scale asset purchases, aka quantitative easing (QE).

The Federal Reserve introduced explicit forward policy guidance in the August 2011 FOMC
statement, in order to influence longer-term interest rates and financial market conditions. The
Fed specifically said then that it expected economic conditions to warrant exceptionally low
levels for the federal funds rate at least through mid-2103. This guidance led to a drop in
Treasury yields, as investors grew comfortable that the Fed would hold off on raising rates for
the next two years. The Fed subsequently extended its forward guidance twice in 2012, as a tepid
recovery caused it to push out the horizon for keeping rates low.

But it's the other tool, quantitative easing, that has hogged the headlines and become
synonymous with the Fed's easy-money policies. QE essentially involves a central bank creating
new money and using it to buy securities from the nation's banks so as to pump liquidity into the
economy and drive down long-term interest rates. In this case, it allowed the Fed to purchase
riskier assets, including mortgage-backed securities and other non-government debt. This ripples
through to other interest rates across the economy, and the broad decline in interest rates
stimulates demand for loans from consumers and businesses. Banks are able to meet this higher
demand for loans because of the funds they have received from the central bank in exchange for
their securities holdings.

Other Deflation-Fighting Measures

Other central banks have also resorted to unconventional monetary policies to stimulate their
economies and stave off deflation.

In December 2012, Japanese Prime Minister Shinzo Abe launched an ambitious policy
framework to end deflation and revitalize the economy. Dubbed “Abenomics," the program has
three main arrows or elements – (1) monetary easing, (2) flexible fiscal policy, and (3) structural
reforms. In April 2013, the Bank of Japan announced a record QE program, saying it would buy
Japanese government bonds and double the monetary base to 270 trillion yen by the end of 2014,
with the objective of ending deflation and achieving inflation of 2% by 2015. The policy
objective of slashing the fiscal deficit in half by 2015, from its 2010 level of 6.6 % of GDP, and
achieving a surplus by 2020, commenced with an increase in Japan's sales tax to 8 % from April
2014, from 5 % earlier. The structural reforms element may be the hardest to get going, as it
needs bold measures to offset the effects of an aging population, such as allowing foreign labor
and employing women and older workers. 
In January 2015, the European Central Bank (ECB) embarked on its own version of QE, by
pledging to buy at least 1.1 trillion euros' worth of bonds, at a monthly pace of 60 billion euros,
through to September 2016. The ECB launched its QE program six years after the Federal
Reserve did so, in a bid to support the fragile recovery in Europe and ward off deflation, after its
unprecedented move to cut the benchmark lending rate below 0% in late-2014 met with only
limited success.

While the ECB was the first major central bank to experiment with negative interest rates, a
number of central banks in Europe, including those of Sweden, Denmark and Switzerland, have
pushed their benchmark interest rates below the zero bound.

Results of Deflation-Fighting Efforts

The measures taken by central banks seem to be winning the battle against deflation, but it is too
early to tell if they have won the war. Meanwhile, the concerted moves to fend off deflation
globally have had some strange consequences:  

 QE could lead to a covert currency war: QE programs have led to major currencies
plunging across the board against the U.S. dollar. With most nations having exhausted
almost all their options to stimulate growth, currency depreciation may be the only tool
remaining to boost economic growth, which could lead to a covert currency war
(see What is a currency war and how does it work?).
 European bond yields have turned negative: More than a quarter of debt issued by
European governments, or an estimated $1.5 trillion, currently has negative yields. This
may be a result of the ECB's bond-buying program, but it could also be signaling a sharp
economic slowdown in future.
 Central bank balance sheets are bloating: Large-scale asset purchases by the Federal
Reserve, Bank of Japan, and the ECB are swelling up  balance sheets to record levels.
Shrinking these central bank balance sheets may have negative consequences down the
road.

MARKET SECURITIES
CHARACTERISTICS
The characteristics of a well-functioning securities market are:

 Efficient - Internal - Markets must be efficient internally.

 Efficient - External - Markets react quickly to new news; existing prices reflect all
available information.
 Liquidity - Markets are liquid and as such, assets can be bought or sold easily. There are
numerous buyers and sellers giving depth to the market.
 Continuity - In the context of liquidity, prices do not change substantially from one
transaction to another unless significant new news arises.
  Marketability - In the context of liquidity, marketability is the ability to sell an asset
quickly.
 Timely and accurate information - New information is brought to the market in a
timely and accurate way.

How Do Investment Banks Issue Bonds?

In the new issuance of bonds, an investment bank has options with respect to how to place the bonds in
the market. These options are as follows:

1. Competitive Bids 
Competitive bids are the process in which the bond issuer solicits bids from the underwriting of various
investment banks. This is typically used in dealing with municipal bonds.

2. Negotiated Sales
A negotiated sale is the process whereby a bond issuer negotiates with the investment bank with respect
to the pricing of underwriting services. 

3. Private Placements
A private placement is the process whereby an investment bank "places" the new bond issue with a small
number of buyers, typically large institutions. Private placements are not registered with the SEC for
public sale.

The Primary Market 

The primary market refers to the market where new issues (stocks and bonds not sold before) are sold.
Investment bankers, acting as underwriters, bring new issues to the market through the primary market.
This can be done as either an Initial Public Offering (IPO), when the stock has not previously traded, or as
a seasoned offering once the stock has traded but new shares are being added to the market. 

The Secondary Market

A secondary market is the market in which assets are traded after they have been sold through the primary
market. In this market, investors trade directly with each other through an exchange. 

If the secondary market for a stock follows the characteristics we discussed previously, such as liquidity
and marketability, and the issuer would like to issue more shares through a seasoned offering, the issuer
would have a much easier time selling the new shares in the primary market.

For more on the markets where securities are traded, check out the article, Markets Demystified

Secondary markets for U.S. government/municipal bonds are traded primarily through banks, including
investment banks. Treasuries, however, are traded through treasury dealers. Secondary markets for
corporate bonds are primarily through the OTC market. In addition to the OTC market, secondary trading
for corporate bonds also takes place on the New York Stock Exchange and the American Stock
Exchange.

 Call vs. Continuous Markets

There are two typical structures of a securities exchange. They are:
  Call Markets 
A call market is a market where a stock can only trade at a specific time. Bids for the
stock are collected and then traded at a specific time and at one price. Because this
market trades only at specific times and at one negotiated price, it is typically only used
for smaller markets.

 Continuous Markets
A continuous market can occur at any time as long as the market is open. Buyers and
sellers are matched up on a continuous basis and the price is determined through an
auction or through bid-ask quotes.

Structural Differences Among the Different Markets

While markets and exchanges facilitate the buying and selling of securities, there are some
structural differences among them.

 National Stock Exchanges

These exchanges trade numerous issues of diverse shares to a wide number of investors.
A national stock exchange operates as an auction market where buyers and sellers are
driven by price. The New York Stock Exchange (NYSE) and the American Stock
Exchange (AMEX) are examples of national stock exchanges in the U.S. The London
Stock Exchange (LSE) is an example of a national stock exchange outside of the U.S. A
national stock exchange typically has stringent qualifications a stock must meet in order
to be listed.

 Regional Exchanges
A regional exchange is similar to the national stock exchanges except regional exchanges
serve smaller markets and typically trade smaller issues. A company that cannot list its
shares on a national stock exchange because it does not meet the requirements may
choose to list its share on a regional exchange. The Boston exchange is an example of a
regional exchange in the U.S.

 Over-the-Counter Markets (OTC)

An OTC market is a less formal exchange. Both listed stocks and unlisted stocks can
trade in the OTC market. The OTC market operates as an order-driven market where
buyers and sellers submit bids and a dealer buys or sells the stock from his own
inventory. Unlike a national exchange where a broker matches buyers and sellers, an
OTC market comprises any securities for which there is a market. As a result, the OTC
market is also referred to as a negotiated market. In the U.S., the Nasdaq system is used
as the quotation system for the OTC market.

The main characteristics of exchange markets can be classified into:

1. Exchange Membership
In the U.S., the listed securities exchanges classify memberships as:
  Specialists: Specialists are the market makers for stocks, controlling the limit book and
posting bid and ask prices.
 Commission Brokers: Commission brokers are employees of a firm that is a member of
the exchange. The commission broker buys and sells shares for the clients of its firm.
 Floor Brokers: Floor brokers function much like commission brokers buying and selling
shares. Unlike commission brokers who are employees of member firms however, floor
brokers are independent and aid commission brokers when they become too busy.
 Registered Traders: Registered traders are members that buy and sell for their own
account. They help to provide liquidity. Because they are independent, however, the
exchange places limits on how they trade.

 
2. Types of Orders
An order on an exchange can be classified as follows:

 Market Order: A market order is a basic order to buy or sell a security at the best
available price. For example, a client places an order to buy 100 shares of Newco; the
client expects/wants the best available price for buying those shares.
 Limit Order: A limit order places a specific price at which a transaction is executed.
These orders typically have a set time horizon in which the limit order can be executed.
For example, Newco's stock is trading at $50. A client places a buy limit order to
purchase shares at $45. The transaction will thus be executed when the shares reach $45,
if they do. Otherwise, the order will expire in the allotted time.
 Short Sale Order: A short sale order is an order to sell shares that a client does not own.
As a result, the trader must borrow the stock, sell it, and then buy the stock again to
replace the shares he borrowed. For example, a client wants to sell 100 shares of Newco
short at $45. The trader must borrow 100 shares, sell the 100 shares and then purchases
the shares to replace the ones he borrowed. A client may do this if he believes shares of
the respective company will decline below the price at which the shares were sold short.
 Stop Loss Orders: Stop loss orders are placed in order to prevent losses on shares below
a specified share price. For example, an investor bought shares of Newco at $50. The
shares appreciated to $100. The investor is interested in protecting some profit on the
shares of Newco in case the price starts declining. This investor may place a stop loss
order on the shares of Newco at $80. If Newco's shares decline to $80, the stop loss order
would be executed, protecting some of the investor's profit. Whether you use this strategy
for your own or for a client's portfolio, stop loss orders are essentially a simple but
powerful tool to help implement a stock-investment strategy. Find out more in the article
called The Stop-Loss Order, Make Sure You Use It

 
3. Market Makers
Market makers facilitate the trading in a stock, buying and selling stock from their own accounts
in order to maintain orderly trading and provide liquidity in a stock if it is needed. Additionally,
the market maker manages the limit order book where both limit and stop orders are recorded. In
the U.S. exchanges, the market maker is known as a specialist.
The Process of Shorting Stock
A short sale order, or a stock sold short, is an order to sell shares that a client does not own. As a
result, the trader must borrow the stock from an existing client, sell the shares of the security and
then buy the stock again to replace the shares he borrowed. In doing this, there are three rules
that must be followed:

1. A short sale order can only be done in what is known as an "up market" where the market
is appreciating, not declining. This is known as the uptick rule.
2. If a dividend is paid on the shares, the investor selling the shares short pays the dividend
to the investor he borrowed the shares from.
3. An investor cannot borrow shares to sell short without providing some sort of collateral.

An investor may want to sell a stock short if the investor believes that stock is going to decline.
For example, a client wants to sell 100 shares of Newco short at $45. The trader sells 100 shares
he borrowed from another investor at $45. The amount from the sale goes to the investor selling
the shares short. The investor is hoping the shares go below the $45. If, for example, the shares
decline to $35, the investor already sold the shares at $45. The investor can thus repurchase the
shares at $35 and replace the shares he borrowed. Excluding transaction costs, the investor had
made $10 per share on the transaction.

s trading has grown and globalization of the capital markets has occurred over the years,
institutionalization of securities markets transpired. The effects of the institutionalization of
securities markets are as follows:

1. Commissions
Commissions are defined as the explicit fee to trade a security. Given the institutionalization of
securities markets, commissions were structured by the SEC and work to limit unfair practices
with respect to how firms charge commissions for trading.

2. Block Trades
Block trades are large trades that are primarily done through institutions. Given the growth of the
financial markets, block trades have increased in frequency. As a result, block trading houses
were developed to handle these trades in an organized and efficient manner so as not to disrupt
the securities market and cause large-scale volatility.

3. National Market System

The National Market System (NMS) has been proposed; it would provide even greater efficiency
with lower transaction costs. In proposals, the NMS would contain a centralized reporting
system, a centralized quotation system, centralized limit order book and increased competition
among all market makers. 

4. Stock Price Volatility Impact

One theory of the institutionalization of securities markets is that volatility is increased given the
increased institutional trading, typically done in block trades. The counter-argument to the theory
is that institutional trading will decrease volatility because it will make the markets more liquid.
As such, there is no empirical evidence that the institutionalization of securities markets has
impacted stock price volatility.

Inflation occurs when an economy grows due to increased spending. When this happens, prices
rise and the currency within the economy is worth less than it was before; the currency
essentially won’t buy as much as it would before. When a currency is worth less, its exchange
rate weakens when compared to other currencies.

There are many methods used to control inflation; some work well while others may have
damaging effects. For example, controlling inflation through wage and price controls can cause
a recession and cause job losses.

What methods can the government use to

control inflation?
Contractionary Monetary Policy
One popular method of controlling inflation is through a contractionary monetary policy. The
goal of a contractionary policy is to reduce the money supply within an economy by decreasing
bond prices and increasing interest rates. This helps reduce spending because when there is less
money to go around, those who have money want to keep it and save it, instead of spending it. It
also means that there is less available credit, which can also reduces spending. Reducing
spending is important during inflation, because it helps halt economic growth and, in turn, the
rate of inflation.

There are three main tools to carry out a contractionary policy. The first is to increase interest
rates through the central bank, in the case of the U.S., that's the Federal Reserve. The Fed Funds
Rate is the rate at which banks borrow money from the government, but, in order to make
money, they must lend it at higher rates. So, when the Federal Reserve increases its interest rate,
banks have no choice but to increase their rates as well. When banks increase their rates, fewer
people want to borrow money because it costs more to do so while that money accrues at a
higher interest. So, spending drops, prices drop and inflation slows.

Reserve Requirments 
The second tool is to increase reserve requirements on the amount of money banks are legally
required to keep on hand to cover withdrawals. The more money banks are required to hold back,
the less they have to lend to consumers. If they have less to lend, consumers will borrow less,
which will decrease spending.

Reducing the Money Supply

The third method is to directly or indirectly reduce the money supply by enacting policies that
encourage reduction of the money supply. Two examples of this include calling in debts that are
owed to the government and increasing the interest paid on bonds so that more investors will buy
them. The latter policy raises the exchange rate of the currency due to higher demand and, in
turn, increases imports and decreases exports. Both of these policies will reduce the amount of
money in circulation because the money will be going from banks, companies and investors
pockets and into the government’s pocket where it can control what happens to it.