Ch10- Financial Market

A financial market is a market for the creation and exchange of financial assets. Financial
market exists wherever a financial transaction occurs such as sale of shares, debentures, bonds
etc

→ Functions Of Financial Market

1) Mobilization of saving and channelizing 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, help to channelize surplus fund into
the most productive uses.

2) Facilitates price discovery:-

The forces of demand and supply help to establish a price for a commodity or service in the
market. In the financial market, the household and suppliers of funds and business firms
represent the demand.

The interaction between them helps to establish a price for the financial asset in the financial
market.

3) Provide Liquidity To Financial Assets:-

Financial market facilitate easy purchase and sale of financial asset, so that they can be
easily converted into cash whenever required.

Holders of these assets can quickly sell them to the financial market.
4) Reduce the cost of transactions:-

Financial market provide valuable information about securities being traded in the market . It
helps to save effort and time , money that both buyers and sellers of a financial asset would
have to otherwise spend to try and find each other.

-Thus, the financial market provides a common platform to the buyers and sellers of financial
assets.
 FINANCIAL MARKET

MONEY MARKET CAPITAL MARKET

(Short term funds) (long term funds)

Primary market Secondary market

(new issue of shares) (existing shares)

❖ Money Market :

The money market is a market for short term funds which deals in monetary assets whose
period of maturity is up to one year.

• It is a market where low risk, unsecured, and short term instruments that are highly
liquid are issued and actively traded everyday.

• It has no physical location , but is an activity conducted over the telephone and
through the internet.

The major participants in this market are R.B.I , Commercial Banks , Finance Companies ,
State Government , large corporate houses and mutual funds.

→ Money Market Instruments :-

1.). Treasury Bills: A treasury bill is basically an instrument of short term borrowings by
the government of India maturing in less than one year.

• They are issued by RBI on the behalf of central government and are also known as
zero coupon bonds.

• Treasury bills are issued in the form of promissory notes, and are highly liquid with
low risk.

• They are issued at a price which is lower than their face value and repaid at par.

• Treasury bills are available for the minimum amount of Rs25000/- in multiples there
off.
 2). Commercial Papers: Commercial paper is a short term promissory note, negotiable
and transferrable by endorsement of delivery with a fixed maturity period.

• It is issued by large and credit worthy companies to raise short term funds at lower
rate of interest.

• It usually has a maturity period of 15 days to one year.

• The original purpose of commercial paper was to provide short term funds for
seasonal and working capital needs.

• Commercial paper is sold at a discounted price and redeemed at par.

3). Call Money : Call money is a short term finance repayable on demand , with a
maturity period of one day to fifteen days, used for inter-bank transaction.

Commercial banks have to maintain a minimum cash balance known as Cash Reserve
Ratio. The RBI changes the CRR (cash reserve ratio) from time to time which in turn affects the
amount available to be given as loans by commercial banks.

Call money is a method by which banks borrow from each-other to be able to maintain
CRR. The interest rate paid on call money is known as call rate which is highly volatile that
changes from day to day and even hour to hour.

4). Certificate Of Deposit:- Certificate of deposits are unsecured, negotiable, short

term instruments in bearer form, issued by commercial banks and financial institutions.

• They can be issued to individuals, corporations and companies during period of tight
liquidity when the deposit growth of banks is slow but the demand for credit is high.

5).Commercial Bill:-

A commercial bill is a bill of exchange used to finance the working capital requirement of a
business firm. It is a short term, negotiable, self-liquidating instrument used to finance the credit
sales of a firm.

• When goods are sold on credit, the buyer becomes liable to make payment on a
specific date in future. The seller draws the bill and the buyer accepts it. On being
accepted, the bill becomes a marketable instrument and is called a trade bill.
• These bills can be discounted with the bank if the seller needs funds before maturity.
• When a trade bill is accepted by a commercial bank. It is known as commercial bill.
❖ Capital Market:-
The term capital market refers to facilities and institutional arrangements through which long
term funds, both debt and equity are raised and invested.

• The capital market consist of banks and stock exchanges.

➢ Difference between Capital market and Money market

Basis Capital Market Money

Market
1.Participants The participants in capital Participants are
market are financial R.B.I, banks,
institutions, banks, financial institution,
companies, foreign investors finance companies.
and ordinary retail investors. Individual investors
do not normally
participate in
money market.
2.Instruments The main instruments traded in The main
the capital market are shares, instrument traded in
debentures, bonds etc. money market are
T.Bills, commercial
paper, commercial
bill, call money.
3.Investment Investment in capital market In the money
doesn’t require high amount. market,
The value of units of securities transactions involve
is generally low. i.e. huge sum of
Rs10,Rs100 and so on. money, as these
instruments are
quite expensive.
4.Time The capital market deals in Money market
long and medium term instrument have a
securities such as equity maximum time
shares and debentures. period of one year.
5.liquidity Capital market securities are Money market
considered liquid because they instruments enjoy a
are marketable on the stock higher degree of
exchange . However, a share liquidity as there is a
formal arrangement
may not sometimes find a
for this. The Discount
buyer. Finance House of
India [DFHI] has been
established for the
specific objective of
providing ready
market for money
market instruments.
 6.SAFETY Capital market instruments are money market is
riskier both with respect to generally much safer
returns and principal repayment. with a minimum risk
Issuing companies may fail to of default. This is due
perform as per projections and to the shorter
promoters may defraud investors duration of investing
and also to financial
soundness of the
issuers, which
primarily are the
government, banks
and highly rated
companies
7.EXPECTED RETURN The investment in capital In money market
markets generally yield a higher the expoded
return for investors than the
money markets. The possibility of outurns are
earnings is higher if the securities generally low due to
are held for a longer duration short duration

❖ Primary Market:-
The primary market is also known as the new issue market . it deals with new securities being
issued for the first time.

• A company can raise capital through primary market in the form of equity
shares, preference shares, debentures, loans and deposits.
• The investor in this market are banks, financial institutions, insurance
companies, mutual funds and individuals.

→ Methods of floatation in the primary market:

1.Offer Through Prospectus: Offer through prospectus is the most popular method
of raising funds by public companies in primary market. This involves inviting
subscriptions from the public through issue of prospectus.

• A prospectus is a direct appeal to investors to raise capital, through an

advertisement in newspaper and magazines. The issue may be underwritten
and must be listed on at least one stock exchange.

2.Offer for sale: Under this method, securities are not issued to the public directly but
are offered for sale through intermediates like issuing houses or stock -brokers.

• In this case a company sell securities at an agreed price through brokers who
resell them to the investing public.
 3. Private Placement:- In private placement the allotment of securities takes place
by a company to institutional investors or some selected individuals. It helps to raise
capital quickly than a public issue.

• Primary market can be very expensive due to many compulsory and non-
compulsory expenses. Therefore, some companies which cannot afford a public
issue, choose the private placement.

4.Rights Issue:- This is a privilege given to existing shareholders to subscribe to

the new issue of shares, according to the terms and conditions of the company.

• The shareholders are offered the right to the new shares in proportion to the no.
of shares they already have.

5.e-IPO’s:- A company proposing to issue capital to the public through the online
system of the stock exchange has to enter into an agreement with the stock exchange.
This is called an initial public offer (IPO).

• SEBI registered brokers have to be appointed for the purpose of accepting

applications and placing orders with the company.

➢ Difference between Primary market and Secondary market

Basis Primary market Secondary market

1.Securities There is a sale of
traded/ securities by new
nature companies or further new
issue of securities by
existing companies.
2.Flow of The flow of funds is from
funds savers to investors, i.e. ,
the primary market
directly promotes capital
formation.
There is trading of existing
securities only. That is
why, it is called the market
for secondhand securities.
Promotes liquidity and
marketability of existing
securities i.e. the
secondary market
indirectly promotes capital
formation.

3.Buying & Only buying of securities Both buying and selling of

selling take place in the primary securities take place.
market
4.Prices Prices are determined and Prices are determined by
 decided by the demand and supply of the
management of the securities.
company.
5.Parties Securities are sold by the Ownership of existing
company to the investor securities is exchanged
involved
directly (or through an between investors,The
intermediary) company is not involved
at all
There is no fixed at
6.Geographical Located specified
geographical location places
Location
➢
❖ Secondary Market [ Stock Exchange]:-

The secondary market is also known as the stock market or stock exchange. It is a market for
the purchase and sale of existing securities.

• It helps in providing liquidity & marketability to the existing securities .

• It is a market which helps existing investors to disinvest & fresh investors to enter the
market.
• Securities are traded, cleared, and settled within the regulatory framework prescribed by
SEBI.
•
❖ Stock Exchange:-

A stock exchange is an institution which provides a platform for purchase and sell the existing
securities .

→ FUNCTIONS:

1. Providing liquidity & Marketability to the existing securities:-

The basic function of a stock-exchange is the creation of a continuous market where

securities are bought and sold.

• It gives investors a chance to disinvest and reinvest. This provides liquidity and easy
marketability to the existing securities.

2. Pricing of Securities:-
Share prices on a stock-exchange are determined by the forces of demand and supply.
A stock exchange is a mechanism of constant valuation through which the prices of
securities are determined.
 • Such a valuation provides instant information to both buyers & sellers in the stock
market

3. Safety of Transaction :-

The membership of a stock exchange is well regulated & its dealings are well defined
according to the existing legal framework.

• This ensures that the investing public gets a safe & fair deal on the market.

4. Contributes to Economic Growth:-

A stock exchange is a market in which existing securities are traded . Through this process of
disinvestment & re-investment, savings get channelized into the most productive uses.

• This leads to capital formation & economic growth.

5. Spreading of Equity Cult:-

The stock exchange can play an important role in ensuring wider share ownership by
investors, better trading practices & educating the people about investments.

6. Providing scope for speculation :-

The stock-exchange provides sufficient scope within the provision of law for speculative
activity in a restricted and controlled manner.

• A certain degree of healthy speculation is necessary to ensure liquidity and price

continuity in the market.

SEBI:
Securities Exchange Board of India [SEBI] was established by the government of India on 12
April,1998 to promote orderly and healthy growth of securities market & for investor protection.

→ Reason for establishment of SEBI :-

The capital market has witnessed a tremendous growth during 1980’s. the no. of investors
participating in the capital market increased considerably . this led to a variety of mal practices
on the part of companies , broker, merchant banker and other involved in the securities market.
The example of these mal practices include unofficial private placement , rigging of prices,
unofficial premium on new issues, violation of rules & regulations of stock exchanges, delay in
delivery of shares etc.
These mal practices eroded investors confidence in stock market.

In the view of the above, the government of India decided to setup a separate regulatory body
known as Securities Exchange Board of India [SEBI].

→Objectives :-
The overall objective of SEBI is to protect the interest of investors & promote the development
of securities market.

• To Regulate stock exchanges & the securities market. To promote their orderly
functioning.
• To Protect the rights & interest of the investors & to guide & educate them.
• To Prevent trading malpractices & achieve a balance b/w self regulation & statutory
regulation.
• To Regulate & develop a code of conduct & fair practices by intermediaries like
brokers, merchant bankers etc.

Functions:
Regulatory Functions:
➔ Registration of brokers & sub-brokers & other players in the market.
➔ Registration of collective investment schemes & mutual funds.
➔ Regulation of stock-brokers, port-folio exchanges, underwriters & merchant bankers and
the business in stock exchanges.
➔ Regulation of take-over bids by companies.
➔ Calling for information by undertaking inspection, conducting enquiries & audits of stock
exchanges & intermediaries .
➔ levying fees or other charges for carrying out the purpose of the act.

Development Functions:
➔ Training of intermediaries of the securities market.
➔ Conducting research & publishing information useful to all market participants.
➔ Undertaking measures to develop capital markets by adapting a flexible approach.

Protective Functions:

➔ Prohibition of fraudulent & unfair trade practices, making misleading statements ,

manipulation, price.
➔ Controlling insider trading & imposing penalties for such practices.
➔ Undertaking steps for investor protection.
➔ Promotion of fair practices & code of conduct in securities market.
➢ Trading procedure on a stock exchange

The procedure for purchase and sale of securities in a stock exchange involves the following
steps:-

1. Selection Of A Broker
The first step is to select a broker who will buy / sell securities on behalf of the speculator
/ investor. This is necessary because trading of securities can only be done through SEBI
registered brokers who are the members of a stock exchange. Brokers may be individuals,
partnership firms or corporate bodies.

2. Opening Demat Account With Depositary

The next step is to open a demat account. Demat (Dematerialized) account refers to an account
which an Indian citizen must open with the depositary participant (banks, stockbrokers) to trade
in listed securities in electronic form.

• The securities are held in the electronic form by a depositary. ‘Depositary’ is an

institution / organization which holds securities (e.g. shares, debentures, bods, mutual
funds etc.) in electronic form, in which trading is done. At present there are two
depositaries in India: NSDL (National Securities Depositary Ltd.) and CDSL (Central
Depositary Services Ltd.)
• Depositary interacts with the investor through depositary participants. PDS are agents –
Stock brokers. Your depositary participant will maintain your securities account
balances and intimate to you the status of your holding from time to time.

3. Placing The Order

The next step is to place the order with the broker. The order can be communicated to the
broker either personally or through telephone, cell phone, e-mail

• The instructions should specify the securities to be bought and sold and the price range
within which the order is to be executed. Only the securities of listed companies can be
traded on the stock exchange.

4. Executing The Order

According to the instructions of the investor, the broker buys or sells securities.

• The broker then issues a contract note. A copy of the contract note contains the name
and the price of the securities, names of the parties, brokerage charges. It is signed by
the broker.

5. Settlement
This is the last stage in the trading of securities done by the brokers on behalf of their clients.
The mode of settlement depends upon the nature of contract.

• Equity spot markets follow a T + 2 rolling settlement. This means that any trade taking
place on Monday gets settled by Wednesday. All trading on stock exchanges takes
place between 9:55 am to 3:30 pm, Indian Standard Time, Monday to Friday. Delivery of
shares must be made in decartelized form, and each exchange has its own clearing
house, which assumes all settlement risk.