National University of Modern Languages Islamabad

Name: Abrar Ishaq

Roll No: 9201023
Class: BBA5A Morning
Subject: Money & Banking

Assignment: No.02
(Financial Markets)
Submitted to: Mrs. Ayesha Khalid
Submission Date: 24th September 2022

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 Financial Markets
There are two types of financial markets: -
1) Money Market
2) Capital Market
Money Market
The money market is a component of the economy that provides short-
term funds. Money market deals in short-term loans, generally for a
period of one year or less.
Examples:
 Central Bank and Government
 Primary Dealers/ Markets.
 Banks
 Non-bank financial institution
 Money Market Funds & Corporate
 Money Market Brokers
Characteristics of Money Market
 All of the securities traded in the money market are highly liquid
having a maturity period ranging between one day and one year
only.
 Money is a collection of markets but not a single place.
 It is termed a wholesale market of short-term instruments.
 Money market instruments are characterized by their high-safety
nature.
Instruments of Money Market
Commercial Paper: Short-term debt instruments issued by
commercial banks for financing the accounts payables, inventories,
and short-term debt instruments.

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 Treasury bills: When the government needs funds for a short period,
treasury bills are issued by the central government, and the interest on
these is measured by the market forces.
Government bonds: These bonds are related to the capital market
but sometimes different companies can lend these bonds to one
another to meet their short-term financial requirements. Sometimes
these bonds are also traded in the money market.
Bills of Exchange: The traders draw bills of exchange on each other
when they make credit transactions. In the case of need before the
maturity of the bills which can be got discounted from commercial
banks.
Promissory Notes: These instruments carry a promise to pay a
certain amount within a period of up to 90 days. They can also be
discounted before maturity.
Bankers’ Acceptance: Banks play the role of guarantors between
two international companies in business transactions. The bank
charges its fee. When a bank issues a letter of credit and it is accepted
by both parties then it becomes an instrument of the money market.
When the bank receives a draft from the seller it becomes bank
acceptance.
Certificate of Deposits: These are widely used by commercial banks
to get short-term loans.
Tax Exempt Securities: Such securities are tax-free and issued by
the federal government.

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 Functions of Money Market
A well-developed money market is essential for a modern economy. The
importance of a developed money market and its various functions are
discussed below:
1. Financing Trade:
Money Market plays a crucial role in financing both internal as
well as international trade. Commercial finance is made
available to traders through bills of exchange, which are
discounted by the bill market. The acceptance houses and
discount markets help in financing foreign trade.
2. Financing Industry:
The money market contributes to the growth of industries in two
ways:
(a) Money market helps industries in securing short-term loans to
meet their working capital requirements through the system of finance
bills, commercial papers, etc.
(b) Industries generally need long-term loans, which are provided in
the capital market. However, the capital market depends upon the
nature of and the conditions in the money market. The short-term
interest rates of the money market influence the long-term interest
rates of the capital market. Thus, the money market indirectly helps
industries through its link with and influence on the long-term capital
market.
3. Profitable Investment:
The money market enables commercial banks to use their excess
reserves in profitable investments. The main objective of commercial
banks is to earn income from their reserves as well as maintain
liquidity to meet the uncertain cash demand of the depositors. In the

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 money market, the excess reserves of the commercial banks are
invested in near-money assets (e.g. short-term bills of exchange)
which are highly liquid and can be easily converted into cash. Thus,
commercial banks earn profits without losing liquidity.
4. Self-Sufficiency of Commercial Bank:
Developed a money market that helps commercial banks to become
self-sufficient. In a situation of emergency, when commercial banks
have a scarcity of funds, they need not approach the central bank and
borrow at a higher interest rate. On the other hand, they can meet their
requirements by recalling their old short-run loans from the money
market.
5. Help to Central Bank:
Though the central bank can function and influence the banking
system in the absence of a money market, the existence of a
developed money market smoothens the functioning and increases the
efficiency of the central bank. The money market helps the central
bank in two ways:
(a) The short-run interest rates of the money market serve as an
indicator of the monetary and banking conditions in the country and,
in this way, guide the central bank to adopt an appropriate banking
policy.
(b) The sensitive and integrated money market helps the central bank
to secure quick and widespread influence on the sub-markets, and
thus achieve effective implementation of its policy.
6-Economy in Use of Cash:
As the money market deals in near-money assets and is not money
proper, it helps in economizing the use of cash. It thus provides a
convenient and safe way of transferring funds from one place to
another, thereby immensely helping commerce and industry.

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 How Money Market Works
The money market effectively works as a short-term lending and
borrowing system for its various participants. Those who invest in the
money market benefit by either gaining access to funds or by earning
interest on their investments. Treasury bills are a great example of the
money market at work. When you buy a T-bill, you’re essentially
agreeing to lend the federal government your money for a certain
amount of time. T-bills mature in one year or less from their issue date.
The government gets the use your money for some time. Once the T-bill
matures, you get your money back with interest.

Capital Market
A capital market is a financial market in which long-term debt or
equity-backed securities are bought and sold. Here long-term debt and
equity instruments are traded, Examples are:
 Pakistan Stock Exchange (PSX)
 National Clearing Company (NCC)
 Central Depository Company (CDC)
Characteristics of Capital Market
 It includes the stock market and bond market.
 They help people with ideas become entrepreneurs and help
small businesses grow into big companies.
 Allocate risk and support economic growth by financing the
economy.
How Capital Market Works
The capital market works by allowing companies and other entities to
raise capital. Publicly-traded stocks, bonds, and other securities are

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traded on stock exchanges. Generally speaking, the capital market is
well-organized. Companies that issue stocks are interested in long-term
capital for long-term, which can be used to fund growth and expansion
projects or simply to meet operating needs. In terms of the difference
between capital and money market investments, it usually boils down to
three things: liquidity, duration, and risk. While the money market short
termed on short-term, the longer-term market is a longer-term play.
Capital markets can deliver higher returns, though investors may assume
greater risk. Understanding the capital market is important because of
how it correlates to economic movements as a whole. The capital market
helps to create stability by allowing companies to raise capital, which
can be used to fund expansion and create jobs.

Types of Capital Market

 Primary Market
 Secondary Market
Primary Market:
The primary market is a new issue market that mainly deals with the
issues of new securities. It is a place where the trading of financial
instruments is done for the first time also known as an initial Public
Offer (IPO).

Instruments of Primary market

Stocks of the Company: A security that represents the ownership of a
fraction of the issuing corporation.

Corporate Bonds: A corporate bond is a bond issued by a corporation

to raise financing for a variety of reasons such as ongoing operations or
to expand the business. The term is usually applied to long-term debt
instruments, with a maturity of at least one year.

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 Government bonds: A government bond is a debt security issued by a
government to support government spending and obligations.

Currencies: A currency is a standardization of money in any form, in

use or circulation as a medium of exchange, for example, banknotes and
notes.

Spot commodities: A commodity is traded on its cash market as

opposed to a derivatives market.

Functions of Primary Market

 Origination: Origination refers to the examination, evaluation, and

process of new project proposals in the primary market. It begins before
an issue is presented in the market with the help of commercial bankers.
 Underwriting: Underwriting firms ensure the success of new issues that
guarantee minimum subscription. When the issue remains unsold then it
is bought by the underwriters.
 Distribution: For the success of the issue generally the brokers and
dealers who are in direct contact with investors are given the job of
distribution.

Secondary Market

The secondary market is another type of capital market where trading

takes place for existing securities.
It is known as the stock market where securities are bought and sold by
investors

Instruments of the Secondary Market

Ordinary shares: Represents a form of fractional ownership in which a
shareholder, as a fractional owner, undertakes the maximum
entrepreneurial risk associated with a business venture.

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Right issues/Right shares: The issue of new securities to existing
shareholders at a ratio to those already held.

Bonus Shares: Shares issued by the companies to their shareholders

free of cost by the capitalization of accumulated reserves from the
profits earned in earlier years.

Preferred stock: These are entitled to a dividend calculated at a fixed

rate to be paid regularly before ordinary shares. They also enjoy priority
over the equity shareholders in payment of the surplus. But in the event
of liquidation, their claim ranks below the claims of the company’s
creditors, bondholders’/debenture holders.

Cumulative Preferences Shares: A type of preference shares on which

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

Security Receipts: Security receipt means a receipt or other security,

issued by a reconstruction company to any qualified institutional buyer
under a scheme, evidencing the purchase or acquisition by the holder
thereof, of an undivided right, title, or interest in the financial asset
involved in securitization.

Government securities: These are sovereign (credit risk-free) coupon-

bearing instruments that are issued by the state bank on behalf of the
government. These securities have a fixed coupon that is paid on
specific dates on a half-yearly basis. These securities are available in a
wide range of maturity dates, from short-dated (less than one year) to
long-dated (up to twenty years).

Convertible Bonds: A bond gives the investor the option to convert the
bond into equity at a fixed conversion price.

Zero Coupon Bond: It is issued at a discounted rate and repaid at face

value. No periodic interest is paid. The difference between the issue
price and the redemption price represents the return to the holder. The

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 buyer of these bonds receives only one payment at the maturity of the
bond.

Debentures: Bonds issued by a company bearing a fixed rate of interest

are usually payable half-yearly on specific dates and the principal
amount is repayable on a particular date on the redemption of the
debentures. Debentures are normally secured/charged against the asset
of the company in favor of the debenture holder.

Participating Preference Shares: The right of certain preference

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

Functions of Secondary Market

 It regularly informs about the value of the security.

 It offers liquidity to the investors for their assets.
 It involves continuous and active trading.
 It provides a marketplace
 where the securities are traded.
Functions of Capital Market

 The capital market acts as the link between investors and savers.
 It helps in facilitating the movement of capital to more productive
areas to boost national income.
 It boosts economic growth.
 It helps in the mobilization of savings for financing long-term
investments.
 It facilitates the trading of securities.
 It reduces transaction and information costs.

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  It helps in quick valuations of financial instruments.
 Through derivative trading, it offers hedging against market risks.
 It helps in facilitating transaction settlement.
 It improves the effectiveness of capital allocation.
 It provides continuous availability of funds to the companies and
government.

CONCLUSION

Both are part of the financial markets. The main aim of the financial
markets is to channel funds and generate returns. The financial markets
stabilize the money supply by lending borrowing mechanisms, i.e.,
surplus funds are provided to borrowers by lenders. Both are required
for the betterment of the economy as they fulfill the business and
industry’s long-term and short-term capital needs. The markets
encourage individuals to invest money to gain good returns.

Investors can tap into each of the markets depending on their needs.
Capital markets are generally less liquid but provide good returns at
higher risk, whereas money markets are highly liquid but provide lower
returns. Money markets are also considered safe assets.

However, market anomalies and inefficiency due to some aberrations

above may not hold. Due to such irregularities, investors look for
arbitrage opportunities to get higher returns. Money markets are
considered safe, but they sometimes give negative returns. Thus,
investors should study the pros and cons of each financial instrument
and the condition of the financial market before putting their money in
the short term or long term.

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