INTRODUCTION

The economic development of any country depends upon the existence of a well-organized
financial system which promotes the well-being and standard of living of the people of a
country. Thus, the ‘financial system’ is a broader term which brings under its fold the
financial markets and the financial institutions which support the system.
A financial system could be defined at an international, regional or organization level. A
financial system refers to a system which enables the transfer of money between investors
and borrowers. The term “system” in “Financial System” indicates a group of complex and
closely linked institutions, agents, procedures, markets, transactions, claims and liabilities
within an economy.
The responsibility of the financial system is to mobilize the savings in the form of money
and monetary assets and invest them to productive ventures. An efficient functioning of the
financial system facilitates the free flow of funds to more productive activities and promotes
investment. Thus, the financial system provides the intermediation between savers and
investors which in turn promotes faster economic development.

FINANCIAL MARKETS:
A financial market is the place where financial assets are created or transferred. It can be
broadly categorized into money markets and capital markets on the basis of the maturity of
financial instruments. Money market handles short-term financial assets (less than a year)
whereas capital markets take care of those financial assets that have maturity period of more
than a year.
Without financial markets, borrowers would have problems finding lenders. Intermediaries
like banks assist in this procedure. Banks take deposits from investors and lend money from
this pool of deposited money to people who need loan. Banks commonly provide money in
the form of loans.

FIVE BASIC COMPONENTS OF FINANCIAL SYSTEM:

 Financial Institutions
 Financial Markets
 Financial Instruments (Assets or Securities)
 Financial Services
 Money
TYPES OF FINANCIAL MARKETS:
 Capital markets, which provide long term debt financing and investment.
 Commodity markets, which facilitate the trading of commodities.
 Money markets, which provide short term debt financing and investment.
 Derivatives markets, which provide instruments for the management of financial risk.
 Insurance markets, which facilitate the redistribution of various risks.
 Foreign exchange markets, which facilitate the trading of foreign exchange.

FUNCTIONS OF FINANCIAL MARKET

The key functions of financial market are:

1. Mobilisation of Savings and Channelising them into the most Productive Uses:
A financial market facilitates the transfer of savings from savers to investors. It gives
savers the choice of different investments and thus helps to channelise surplus funds
into the most productive use.
2. Facilitating Price Discovery: You all know that the forces of demand and supply help
to establish a price for a commodity or service in the market. In the financial market,
the households are suppliers of funds and business firms represent the demand. The
interaction between them helps to establish a price for the financial asset which is
being traded in that particular market.
3. Providing Liquidity to Financial Assets: Assets: Financial markets facilitate easy
purchase and sale of financial assets. In doing so they provide liquidity to financial
assets, so that they can be easily converted into cash whenever required. Holders of
assets can readily sell their financial assets through the mechanism of the financial
market.
4. Reducing the Cost of Transactions: Financial markets provide valuable information
about securities being traded in the market. It helps to save time, effort and money
that both buyers and sellers of a financial asset would have to otherwise spend to try
and find each other. The financial market is thus, a common platform where buyers
and sellers can meet for fulfilment of their individual needs.

CLASSIFICATION OF FINANCIAL MARKETS

 The financial markets in India can be classified as follows:
1. Capital Market
2. Money Market

CAPITAL MARKET
Capital Market is a place where long-term funds are mobilised by the corporate undertakings
and Government. It seeks to improve transactional efficiencies. Capital Market may be
divided into primary market and secondary market. Primary market deals with new securities
which were not previously tradable to the public. Secondary market is a place where existing
securities are bought and sold.
The securities which are traded include stocks, bonds, debentures, euro issues, etc. whose
maturity period is not limited up to one year or sometimes the securities are irredeemable (no
maturity).
The Capital Market has essentially three categories of participants, namely
 the issuers of securities,
 investors in securities and
 the intermediaries.
The Capital Market works under full control of Securities and Exchange Board to protect the
interest of the investors. The most common capital markets are the stock market and the bond
market.
Examples of Capital Markets in India are:
 Bombay Stock Exchange.
 Over the Counter Exchange of India.
 Depository System.
 Mutual Funds.
 Life Insurance Corporation of India.
Features of Capital Market

Important features of the capital market are:

 Deals in long-term and medium-term funds: Capital market provides funds for long
and medium term. It does not deal with channelizing saving for less than one year.
 Utilizes Intermediaries: Capital market makes use of different intermediaries such as
brokers, underwriters, depositories etc. These intermediaries act as working organs of
capital market and are very important elements of capital market.
 Capital formation: The capital market prides incentives to savers in the form of interest
or dividend to transfer their surplus fund into the deficit units who will invest it in different
businesses. The transfer of funds by the surplus units to the deficit units leads to capital
formation.
 Government rules and regulations: The capital market operates freely but under the
guidance of government policies. These markets function within the framework of
government rules and regulations, e.g., stock exchange works under the regulations of SEBI
which is a government body.
 Deals in marketable and non-marketable securities: Capital market trades in both,
marketable and non-marketable securities. Marketable securities are those securities that
can be transferred like shares, debentures etc. on the other hand, non-marketable securities
those securities that cannot be transferred like term deposits, loans etc.

Functions OF CAPITAL MARKET

 Link between Savers and Investors: The Capital Market functions as a link between
savers and investors. It plays an important role in mobilising the savings and diverting
them in productive investment. In this way, Capital Market plays a vital role in
transferring the financial resources from surplus and wasteful areas to deficit and
productive areas, thus increasing the productivity and prosperity of the country.
 Promotes Economic Growth: The Capital Market not only reflects the general
condition of the economy, but also smoothens and accelerates the process of
economic growth. Various institutions of the Capital Market, like non-bank financial
intermediaries, allocate the resources rationally in accordance with the development
needs of the country. The proper allocation of resources results in the expansion of
trade and industry in both public and private sectors, thus promoting balanced
economic growth in the country.
 Stability in Security Prices: The Capital Market tends to stabilise the values of
stocks and securities and reduce the fluctuations in the prices to the minimum. The
process of stabilisation is facilitated by providing capital to the borrowers at a lower
interest rate and reducing the speculative and unproductive activities.
 Raising Long-Term Capital: The existence of a stock exchange enables companies
to raise permanent capital. The investors cannot commit their funds for a permanent
period but companies require funds permanently. The stock exchange resolves this
clash of interests by offering an opportunity to investors to buy or sell their securities,
while permanent capital with the company remains unaffected.
  Foreign Capital: Capital Markets makes possible to generate foreign capital. Indian
firms are able to generate capital funds from overseas markets by way of bonds and
other securities. Government has liberalised Foreign Direct Investment (FDI) in the
country. This not only brings in foreign capital but also foreign technology which is
important for economic development of the country.
 Easy liquidity: With the help of secondary market investors can sell off their
holdings and convert them into liquid cash. Commercial banks also allow investors to
withdraw their deposits, as and when they are in need of funds.

CLASSIFIFACTION OF CAPITAL MARKET

PRIMARY MARKET
The Primary Market provides the channel for sale of new securities and provides opportunity
to government as well as corporates to raise resources in order to meet their requirements of
investment and/or discharge their obligation. Hence it is also called new issue market.

There are two major types of issuers who issue securities. They are:
 Corporate entities: They issue mainly debt and equity instruments (shares, debentures,
etc.)
 Governments (central and state governments): They issue debt securities (dated
securities, treasury bills).
Issuers may issue the securities at face value, or at a discount/premium and these securities
may take a variety of forms such as equity, debt or some hybrid instruments that can be
issued in domestic market and international market. The securities can be directly bought
from the shareholders, which is not the case for the secondary market.

TYPES OF PRIMARY MARKET ISSUANCE

(a) Public issue: When an issue/offer of securities is made to new investors for becoming
part of shareholders’ family of the issuer it is called a public issue. It can be further classified
into 2 types:
 Initial public offer (IPO): When an unlisted company makes either a fresh issue of
securities or offers its existing securities for sale or both for the first time to the
public, it is called an IPO. This paves way for listing and trading of the issuer’s
securities in the Stock Exchanges.
 Further public offer (FPO): When an already listed company makes either a fresh
issue of securities to the public or an offer for sale to the public, it is called a FPO.
(b) Right issue (RI): When an issue of securities is made by an issuer to its shareholders
existing as on a particular date fixed by the issuer (i.e. record date), it is called a Rights Issue.
The rights are offered in a particular ratio to the number of securities held as on the record
date.
(c) Bonus issue: When an issuer makes an issue of securities to its existing shareholders as
on a record date, without any consideration from them, it is called a bonus issue. The shares
are issued out of the Company’s free reserve or share premium account in a particular ratio to
the number of securities held on a record date.
(d) Private placement: When an issuer makes an issue of securities to a select group of
persons not exceeding 49, and which is neither a rights issue nor a public issue, it is called a
private placement.

SECONDARY MARKET
Secondary Market refers to a market where securities are traded after being initially offered
to the public in the Primary Market or listed on the Stock Exchange. Hence it is also known
as the stock market or stock exchange. It comprises of equity markets and the debt markets.
It is a market for the purchase and sale of existing securities. It helps existing investors to
disinvest and fresh investors to enter the market. It also provides liquidity and marketability
to existing securities. It also contributes to economic growth by channelising funds towards
the most productive investments through the process of disinvestment and reinvestment.
Securities are traded, cleared and settled within the regulatory framework prescribed by
SEBI.

TYPES OF SECONDARY MARKET/CAPITAL MARKET ISSUANCE

 EQUITY INSTRUMENTS (instrument of ownership)

Equity shares are instruments issued by companies to raise capital and it

represents the title to the ownership of a company. You become an owner of a
company by subscribing to its equity capital (whereby you will be allotted shares)
or by buying its shares from its existing owner(s).

As a shareholder, you bear the entrepreneurial risk of the business venture and are
entitled to benefits of ownership like share in the distributed profit (dividend) etc.
The returns earned in equity depend upon the profits made by the company.
company’s future growth etc.
  DEBT INSTRUMENTS (loan instruments)

I. Corporate debt

a) Debentures: The term debenture is from Latin term “debere” which means ‘to owe
a debt’. It is an acknowledgement of debt, issued by companies to raise capital. As
an investor, you lend your money to the company, in return for a promise to pay
you an interest at a fixed rate (usually payable half yearly on specific dates) and to
repay the loan amount on a specified maturity date say after 5/7/10 years
(redemption).

Normally specific asset(s) of the company are held (secured) in favour of

debenture holders. This can be liquidated, if the company is unable to pay the
interest or principal amount. Unlike loans, you can buy or sell these instruments in
the market.

Types of Debentures:
 Non-convertible debentures (NCD) – Total amount is redeemed by the
issuer
 Partially convertible debentures (PCD) – Part of it is redeemed and the
remaining is converted to equity shares as per the specified terms
 Fully convertible debentures (FCD) – Whole value is converted into equity
at a specified price

b) Bonds: Bonds are broadly similar to debentures. Debt instruments with maturity
more than 5 years are called bonds. They are issued by companies, financial
institutions, municipalities or government companies and are normally not secured
by any assets of the company (unsecured).

Types of Bonds:

 Regular Income Bonds: Regular Income Bonds provide a stable source of income
at regular, pre- determined intervals.

 Tax-Saving Bonds: Tax-Saving Bonds offer tax exemption up to a specified

amount of investment, depending on the scheme and the Government notification.
Example- Infrastructure Bonds under Section 88 of the Income Tax Act, 1961;
RBI Tax Relief Bonds etc.

 Corporate Bonds: These are the bonds issued by the private corporate companies.
Indian corporates issue secured or non-secured bonds.

II. Government debt:

 • Government securities (G-Secs): They are instruments issued by Government of
India to raise money. G Secs pays interest at fixed rate on specific dates on half-
yearly basis. It is available in wide range of maturity, from short dated (one year)
to long dated (up to thirty years). Since it is sovereign borrowing, it is free from
risk of default (credit risk). You can subscribe to these bonds through RBI or buy
it in stock exchange.

 HYBRID INSTRUMENTS (combination of ownership and loan instruments)

• Preferred Stock / Preference shares: Preferred Stock / Preference shares entitle

you to receive dividend at a fixed rate. Importantly, this dividend had to be paid to
you before dividend can be paid to equity shareholders. In the event of liquidation
of the company, your claim to the company’s surplus will be higher than that of
the equity holders, but however, below the claims of the company’s creditors,
bondholders / debenture holders.

• Cumulative Preference Shares: A type of preference shares on which dividend

accumulates if remains unpaid. All arrears of preference dividend have to be paid
out before paying dividend on equity shares.

• Cumulative Convertible Preference Shares: A type of preference shares where

the dividend payable on the same accumulates, if not paid. After a specified date,
these shares will be converted into equity capital of the company.

• Participating Preference Shares: Participating Preference Shares gives you the

right to participate in profits of the company after the specified fixed dividend is
paid. Participation right is linked with the quantum of dividend paid on the equity
shares over and above a particular specified level.

PRIMARY MARKET V/S SECONDARY MARKETS

BASIS PRIMARY MARKET SECONDARY MARKET

Meaning It is a market for new shares. It is a market where

formerly issued securities
are traded.
Another Name New Issue Market (NIM) After Market

Purchase Type Direct Indirect

Buying and Selling Parties Between Company and Only between Investors
Investors
  Intermediaries involved Underwriters Brokers

Price Fixed Fluctuates, depending on the

demand and supply forces

Money Market
Money Market is a market for short-term nature up to one year and financial assets that are
close substitutes for money are dealt in the money market. It deals in monetary assets whose
period of maturity is less than one year. The instruments of money market include treasury
bills, commercial paper, call money, Certificate of deposit, commercial bills, participation
certificates and money market mutual funds.
It provides access to providers and users of short-term funds to fulfil their investments and
borrowings requirements respectively at an efficient market clearing price. The money
market is one of the primary mechanisms through which the Central Bank influences
liquidity and the general level of interest rates in an economy.
Mostly government, banks and financial institutions dominate this market. The money market
is basically a telephone market and all the transactions are done through oral communication
and are subsequently confirmed by written communication and exchange of relative
instruments like T-bills, commercial papers etc.

Functions of Money Market

 Maintains Liquidity in the Market: One of the most crucial functions of the money
market is to maintain liquidity in the economy. Some of the money market
instruments are an important part of the monetary policy framework. RBI uses these
short-term securities to get liquidity in the market within the required range.
 Provides Funds at a Short Notice: Money Market offers an excellent opportunity to
individuals, small and big corporations, banks of borrowing money at very short
notice. These institutions can borrow money by selling money market instruments and
finance their short-term needs.
 Utilisation of Surplus Funds: Money Market makes it easier for investors to dispose
off their surplus funds, retaining their liquid nature, and earn significant profits on the
same. It facilitates investors’ savings into investment channels. These investors
include banks, non-financial corporations as well as state and local government.
 Aids in Financial Mobility: Money Market helps in financial mobility by allowing
easy transfer of funds from one sector to another. This ensures transparency in the
system. High financial mobility is important for the overall growth of the economy,
by promoting industrial and commercial development. 
  Helps in monetary policy: A developed money market helps RBI in efficiently
implementing monetary policies. Transactions in the money market affect short term
interest rate, and short-term interest rates gives an overview of the current monetary
and banking state of the country. This further helps RBI in formulating the future
monetary policy, deciding long term interest rates, and a suitable banking policy.

FEATURES OF MONEY MARKET

 High Liquidity: The maturity period of one year offered by these funds makes them
highly liquid. Additionally, these funds tend to generate fixed income for the investors
in such a short period; owing to which they are taken for close substitutes of money.
 Secure Investment: These financial instruments are considered one of the most secure
investment avenues available in the market. Since issuers of money market
instruments have a high credit rating and the returns are fixed beforehand, the risk of
losing the invested capital is minuscule.
 Fixed returns: Since money market instruments are offered at a discount to the face
value, the amount that the investor gets on maturity is decided in advance. This
effectively helps individuals in choosing the instrument that would suit their financial
needs and investment horizon.
 Wholesale Market: Money markets are designed to provide and accept bulk orders.
Thus, retail investors who have enough capital can directly participate in money
markets, while individual investors must invest in debt mutual funds that invest in
money markets in order to benefit from this market.
 Regulated by RBI: The Indian money market is controlled and regulated by the
Reserve Bank of India. RBI is the only institution that can influence the organised
sector, while the smaller unorganised sector is largely beyond its control.

MONEY MARKET INSTRUMENTS

1. Call Money: Call/Notice money is an amount borrowed or lent on demand for a

very short period. If the period is more than one day and up to 14 days it is called
'Notice money' otherwise the amount is known as Call money'. Intervening
holidays and/or Sundays are excluded for this purpose. No collateral security is
required to cover these transactions. It is a method by which banks borrow from
each other to maintain the cash reserve ratio. The interest rate paid on call money
loans is known as the call rate that is highly volatile.
2. Treasury Bills (T-bills): In the short term, the lowest risk category
instruments are the treasury bills. They are also known as Zero Coupon Bonds.
RBI issues these at a prefixed day and a fixed amount. Treasury bills are
available for a minimum amount of Rs 25,000 and in multiples thereof. There
are four types of treasury bills.

 14-day T-bill: The maturity period is 14 days. Its auction is on every

Friday of every week. The notified amount for this auction is Rs. 100
crores.
 91-day T-bill: The maturity period is 91 days. Its auction is on every
Friday of every week. The notified amount for this auction is Rs. 100
crores.
 182-day T-bill: The maturity period is 182 days. Its auction is on every
alternate Wednesday (which is not a reporting week). The notified amount
for this auction is Rs. 100 crores.
 364-Day T-bill: The maturity period is 365 days. Its auction is on every
alternate Wednesday (which is a reporting week). The notified amount for
this auction is Rs. 500 crores.

3. Certificate OF Deposit (CD): After treasury bills, the next lowest risk category
investment option is the certificate of deposit A CD is a negotiable promissory note,
secure and short term (up to a year) in nature. A CD is issued at a discount to the face
value, the discount rate being negotiated between the issuer and the investor. The
foreign and private banks, especially, which do not have large branch networks and
hence lower deposit base use this instrument to raise funds. The rates on these
deposits are determined by various factors. Low call rates would mean higher
liquidity in the market.

4. Banker’s Acceptance: This is a financial instrument produced by an individual or a

corporation in the name of the bank, wherein the issuer must pay a specified amount to the
instrument holder on a predetermined date, between 30 and 180 days, starting from the date
of issue of the instrument. It is a secure financial instrument as the payment is guaranteed by
a commercial bank, issued at a discounted price, and the actual price is paid to the holder at
maturity. The difference between the two is the profit made by the investor.
5. Commercial Paper (CP): CPs are negotiable short-term unsecured promissory notes
with fixed maturities, issued by well rated companies generally sold on discount basis.
Companies can issue CPs either directly to the investors or through banks. These are
basically instruments evidencing the liability of the issuer to pay the holder in due course a
fixed amount (face value of the instrument) on the specified due date. These are issued for a
fixed period (15 days – 1 year) of time at a discount to the face value and mature at par. It is
sold at a discount and redeemed at par. The original purpose of commercial paper was to
provide short-terms funds for seasonal and working capital needs.

CAPITAL MARKET Vs. MONEY MARKET

BASIS CAPITAL MARKET MONEY MARKET

Meaning A section of financial A segment of the financial

market where long-term market where lending and
securities is issued and borrowing of short-term
traded. securities are done.
Nature of Market Formal Informal
Financial Instruments Shares, Debentures, Bonds, Treasury Bills, Commercial
Retained Earnings, Asset Papers, Certificate of
Securitization, Euro Issues Deposit, Trade Credit etc.
etc.
Institutions Commercial banks, Stock Central bank, Commercial
exchange, non-banking bank, non-financial
institutions like insurance institutions, bill brokers,
companies etc. acceptance houses, and so
on.
Risk Factor Comparatively High Low

Liquidity Low High

Purpose of Market To fulfil long-term credit To fulfil short-term credit

needs of the business. needs of the business.
Maturity Period More than one year Up to one year
 Main Function Mobilization of Savings in Increases liquidity of funds
the economy. in the economy.

Return on Investment Comparatively High Low

Role of Central Bank Indirect impact Direct impact

Market Regulation Loosely regulated Closely regulated

Conclusion

The detailed and comparative study of financial markets and its classification pointed out the
following points.

 The main aim of the financial market is to channelize the money between parties in
which Money Market and Capital Market help by taking surplus money from the
lenders and giving them to the borrower who needs it.

 Both markets work for the betterment of the global economy. They fulfil the long
term and short-term capital requirements of the individual, firms, corporate and
government and by providing good returns they encourage investments in a country.

 For investors with a long-time horizon (maturity period), such as a saving for
retirement, the capital market is the better pick.

 If you need that money within a year or two, it’s best to just put it in the money
market because of that volatility. The money market has low risk.

 Despite the risk, those who invest in the capital market can be rewarded better than
the money market if they wait it out as return on investment is comparatively higher
in capital market than money market.
REFERENCES

1. BOOKS

 R.S. Aggrawal, Emerging Money Market (first published 2001, Penguin 1985), 78
 M.S. Gopalan, Indian Money Market Structure, operation and Development (first
published 2005, Oxford University Press 2005), 56
 Coyne, Christopher J., The Oxford Handbook of Austrian Economics ((Oxford
University Press, 2015), 324
 Carmen Reinhart & Kenneth Rogoff, This Time Is Different: Eight Centuries of
Financial Folly ( Princeton University Press), 205

2. RESEARCH ARTICLES

 Ildikó Wieland, Levente Kovács and Taras Savchenko, ‘Conceptual study of the
difference between the money market and the capital market’ (2020) Financial
Markets, Institutions and Risks, Volume 4, Issue 1, 51
 Preda, Alex, ‘Framing Finance: The Boundaries of Markets and Modern Capitalism.’
(2009) Financial Economics Journal, Volume 3, Issue 2, 79
 Mishkin, F.S. , ‘The Economics of Money, Banking, and Financial Markets’ (2002)
The Economics of Financial Markets, Volume 3, 93
 Bodie, Z., Merton, R. C., ‘(Money- and capital markets’ (1998) Financial Markets and
Institutions, Volume 1, 100

3. WEBSITES

 Zucchy, K., ‘Financial Markets: Capital Vs. Money Markets’(Investopedia,10 July

2021) < http://www.investopedia.com/articles/investing/052313/financial-markets-
capital-vs-money-markets.asp> accessed 10 July 2021
 Madhuri Thakur, ‘Financial Market’ (wallstreetmojo, 10 July 2021)
<https://www.wallstreetmojo.com/money-market-vs-capital-market/ > accessed 10
July 2021
 Lindsey Danis, ‘Capital Market Vs. Money Market: What’s the Difference and Where
to Invest’ (nextadvisor, 11 July 2021)
<https://time.com/nextadvisor/investing/money-market-vs-capital-market/ > accessed
10 July 2021