CHAP 10 FINANCIAL MARKETS

Financial ● Financial market is a market which facilitates creation of assets and exchange of
Market securities to provide short, medium and long term business finance.
● It mobilises funds between savers and investors.
● It locates funds into the most productive investment opportunities.
● There are two types of Financial Markets:

1. Money Market
2. Capital Market

Functions of 1. Mobilisation of savings and channelling them into the most productive uses: A
Financial Market financial market performs the allocative function by linking the savers and
investors, thus mobilising savings and channelising them to make the most use of
these idle savings.
2. Facilitating price discovery: The interaction between the households (supplier of
funds) and business firms helps to establish a price for the traded financial asset in
the market.
3. Providing liquidity to financial assets: Financial assets can be easily converted into
cash as financial markets provide facility of purchase and sale of financial assets.
4. Reducing the cost of transactions: Financial markets provide information about
the traded securities and save time, effort and money of both the buyers and
sellers of a financial asset.

A. MONEY It is a market which deals in short term securities and whose maturity period is less than
MARKET: one year.
Money Market Instruments
INSTRUMENTS ISSUED BY DURATION PURPOSE

Treasury bills RBI on behalf of the 14 to 365 days To fulfill short term
central government. needs

Commercial Large and creditworthy 15 to 365 days Seasonal and working

paper company capital needs

Call money Inter -bank transactions 1 to 15 days To maintain CRR

Certificate of Commercial bank and 91 to 365 days Helps tight liquidity

deposits financial institution. period

Commercial bills Seller to buyer Upto 1 year Meet working capital

requirements.

B. Capital Market: It is a market which deals in medium and long term securities with a maturity period of
more than one year.
Capital market is of further two types:
1. Primary Market
2. Secondary Market

Primary ● Primary market deals with the securities which are issued for the first time in the
Market market and is also known as new issues market.

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DARSHAN BHATT (PHD SCHOLAR)
MCOM, LLM
 ● Banks, financial institutions, insurance companies, mutual funds and individuals
are the main participants in the primary market.

Methods of ● Offer through prospectus: The public companies issue prospectus to raise funds
Floatation from the public by issuing financial instruments like shares, debentures, etc.,
through an advertisement in the newspaper and magazines.
● Offer for sale: Public companies offer securities for sale to the brokers or issuing
houses at an agreed price and in turn, these intermediaries resell them to the
investors.
● Private placement: Private placement means issue and allotment of shares to the
selected individuals and companies privately and not to the general public through
public issue.
● Rights issue: Rights issue refers to issue of new shares to the existing shareholders
in accordance to the terms and conditions of the company.
● e-IPOs: A company can raise funds by issuing capital to the public through the
online system of stock exchange and this is called an initial public offer (IPO).

Secondary ● Secondary market is a market which deals with the sale and purchase of existing
Market securities. It is also called the stock market or stock exchange.
● SEBI prescribes the framework within which all the securities are traded, cleared
and settled.
● It provides opportunities of disinvestment and reinvestment to investors by
exchange of securities.

Stock According to Securities Contract (Regulation) Act 1956, defines stock exchange as a body
Exchange of individuals, whether incorporated or not, constituted for the purpose of assisting,
regulating or controlling the business of buying, selling or dealing in securities.

Functions of a ● Providing liquidity and marketability to existing securities: Stock exchange

Stock Exchange provides a continuous market for sale and purchase of existing securities.
● Pricing of securities: The forces of demand and supply determine the share prices
for securities in the stock exchange.
● Safety of transaction: Trading within the regulatory framework of SEBI ensures
safety of financial transactions.
● Contributes to economic growth: Process of disinvestment and reinvestment
channelizes savings into most productive investments contributing to capital
formation and economic growth.
● Spreading of equity cult: Providing constant information about securities traded
through stock exchange educates investors.
● Providing scope for speculation: Fluctuations in prices due to demand and supply
forces allows for restricted and controlled speculations.

Trading and 1. In traditional time: Outcry or auction system.

Settlement 2. In modern time: Electronic trading system for screen based trading. In this system
Procedure transactions are carried on the computer screen and both the parties are able to
see the prices of all shares going up and down all the time during business hours
of the stock exchange.

Advantages ● Ensure transparency

● Increases efficiency of operation and information.
● Large number of participants, which improves liquidity.
● Single trading platform.
Drafted by
DARSHAN BHATT (PHD SCHOLAR)
MCOM, LLM
 Steps in trading 1. Selection of broker:
and settlement ● As a first step, an investor needs to select a broker who is registered with the stock
procedure exchange and sign a trading agreement with him/her. He also needs to provide
information about his PAN number, Birth date, address, qualifications, occupation,
residential status, bank account information
2. Opening Demat Account:
● It involves opening a demat account with a depository participant and a bank
account for cash transactions.
3. Placing the order:
● As next step, the investor has to place an order with the appointed broker to trade
in securities giving him clear instructions regarding number and price at which
securities must be traded.
4. Executing the order:
● On receipt of order, the broker goes online and executes the order matching the
price and securities needed by the client. On completion of the transaction he/she
issues a contract note to the investor giving all the details of the transaction.
5. Settlement:
● After receipt of contract note and a day before the final settlement, the investor
delivers the securities sold or makes payment for securities purchased, which is
called pay in day. On T+2 day the broker delivers payment or securities to the
exchange.

Dematerialisa Dematerialisation It refers to the process of cancelling the physical form of securities and converting them
tion and into electronic form. It was introduced under the Depositories Act 1966.
Depositories:

Working of Demat 1. Identify depository participants either bank, broker or financial institution.
System 2. An account opening form and formalities related to other documentation like PAN
card details, photograph, etc. is completed.
3. The physical certificate related to existing securities is given to the depository
along with a dematerialisation form.
4. If investors plan to apply for shares in the IPO, then details of depository
participant and demat account has to be provided in the application form. The
allotted shares automatically get credited to the demat account.
5. If shares are sold through to a broker then the depository participant is to be
instructed to debit the account with the number of shares the broker then gives
instruction to his depository to deliver the shares to the stock exchange the broker
receives payment from the buyer and paste them to the seller of securities.
6. The entire transaction is completed within a period of 2 days the delivery of shares
and receipt of payment from the buyer is on T + 2 basis settlement period.

Depository: ● It is an organization which provides an electronic storage system to store

electronic forms of securities.
● There are two depositories:
1. NSDL: National Securities Depositories Limited.
2. CDSL: The Central Depository Services Limited.

Depository Participants:
● Depository participants are intermediaries electronically connected with the
depository. They act as a connect point between the depository and the investor.

Drafted by
DARSHAN BHATT (PHD SCHOLAR)
MCOM, LLM
National Incorporated in 1992, National Stock Exchange was recognised as a stock exchange in April
Stock 1993. It operates in the wholesale debt market segment and capital market segment.
Exchange of
India (NSE)

Objectives of NSE 1. To provide a nationwide trading facility for securities.

2. To set up a communication network to provide equal access to investors.
3. To set up an electronic trading system to provide a fair, efficient and transparent
securities market.
4. To ensure that the settlement cycles are short.
5. To enable book entry settlements.
6. To meet international benchmarks and standards.

Market segments Exchange provides trading in following segment:

of NSE
1. Wholesale debt market segment
2. Capital market segment

Over the It is the counter market where buyers and sellers seek each other to purchase/sell
Counter securities of small and medium companies as per terms and conditions. OTCEI was
Exchange of incorporated in 1992 under the Companies Act, 1956.
India (OTCEI)

Advantages of OTC 1. Trading platform to small companies.

Market 2. Cost effective method for businesses.
3. Trade in both primary and secondary markets.
4. Gives freedom of choice to investors.
5. Transparent system of trading.
6. Free flow of information.

BSE (Bombay It was Asia's first stock exchange and was established in 1875. It provides a platform for
Stock raising capital which has contributed to the growth of the corporate sector. Permanent
Exchange recognition to BSE was granted as per the Securities Contract (Regulation) Act, 1956
Limited)

Objectives of BSE 1. Efficient and transparent market for trade.

2. Trading platform for equities.
3. Ensure active trade.
4. Services to capital market participants
5. Conform to international standards.

Securities and ● SEBI was established by the Government of India on 12th April, 1988 and given
Exchange statutory powers in 1992 being passed by the Indian Parliament.
Board of India ● SEBI has its headquarters at the business district of Bandra-Kurla complex in
(SEBI) Mumbai and it has regional offices in New Delhi (northern), Kolkata (eastern),
Chennai (southern), and Ahmedabad (western).
● SEBI works as an interim administrative body which aims to promote growth of the
securities market as well as protect the interest of the investors.

Reasons for the To control unfair trade practices and malpractices in trading securities such as rigging of
Establishment of prices, violation of rules, unofficial private placements, etc.
SEBI

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DARSHAN BHATT (PHD SCHOLAR)
MCOM, LLM
 To protect the interest of the investors.

Purpose and Role Issuers: To the issuers, it provides a market for raising finance in an easy, fair, cost effective
of SEBI and efficient manner.

Investors: To the investors, to protect the interest of the investors by disclosing accurate
information on a continuous basis.

Intermediaries: To the intermediaries, to offer a competitive and professional market with

efficient infrastructure.

Objectives of SEBI ● To regulate the stock exchange and the securities industry in order to promote
orderly functioning of capital markets.
● To protect the rights as well as the interests of the investors.
● To prevent and keep a check on any unfair trading malpractices
● To maintain and create a balance between self and statutory regulations.
● To attend investor’s complaints, liaise with the issuers, intermediaries and other
stock exchanges in the region through its regional offices

Functions of SEBI 1. Regulatory Functions

● Registration of brokers, sub-brokers and other intermediaries.
● Registration of collective investment schemes.
● Regulation of Stock Bankers, underwriters, portfolio exchanges, and merchant
bankers.
● Regulation of takeover bids by companies.
● Undertakes inspection, conducts enquiries and audits of stock exchange and
intermediaries.
● Changing fee or other charges for carrying out the purposes and operations of the
Act.
● Performing and exercising powers under Securities Contracts (Regulation) Act
1956, delegated by the Government of India.
2. Development Functions
● Educating and training investors and intermediaries of the securities market.
● Conduct research and publish information related to trading of securities.
● Taking measures for the development of the capital market through the adoption
of a flexible approach.
3. Protective Functions
● Prohibiting fraudulent and unfair trade practices.
● Controlling insider trading and imposing penalties for malpractices.
● Educate and protect the investors.
● Promoting fair trade practices and a strict code of conduct in the securities
market.

The Organisation SEBI has five operational departments headed by the Executive Director. It is advised or
Structure Of SEBI assisted in policy formation by two advisory committees –
1. The primary market advisory committee
2. The secondary market advisory committee

Objectives of ● To advise SEBI on matters related to regulations.

Advisory ● To advise SEBI on development and regulation of the primary market.
Committees ● It advises SEBI on disclosure requirements for the companies as per the provisions

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DARSHAN BHATT (PHD SCHOLAR)
MCOM, LLM
 mentioned in the Act.
● To advise SEBI in the legal framework for making dealing in the primary market
simple and transparent.
DISTINCTION BETWEEN CAPITAL MARKET AND MONEY MARKET
BASIS MONEY MARKET CAPITAL MARKET

PARTICIPANTS RBI, banks, financial institutions and finance Financial institutions, banks , corporate entities,
companies foreign investors.

INSTRUMENTS Treasury bills, trade bills reports, commercial Equity shares, bonds, debentures, preference
papers and certificate of deposit shares

INVESTMENT Requires a huge investment outlet e.g. treasury Requires a small investment outlet as a unit value of
OUTLET bills require a minimum amount of 25000 and its securities is very low i.e.10 or 100.
multiples thereof.

DURATION Deals in short term securities with maturity period Deals in medium and long term securities with a
of less than one year or even a single day maturity period of more than one year

LIQUIDITY Instruments are highly liquid as there is a ready Instruments are liquid as they can easily be traded
market for sale or purchase or discounting. in stock exchange but comparatively less liquid.

SAFETY Instruments are safe due to shorter duration Instruments are risky due to longer duration

EXPECTED Comparatively less due to short duration Capital market securities yield higher returns due to
RETURN longer duration

DISTINCTION BETWEEN PRIMARY MARKET AND SECONDARY MARKET

BASIS PRIMARY MARKET SECONDARY MARKET

NATURE OF Securities issued for the first time Sale and purchase of securities which already exist
SECURITIES

PROCESS OF Issue directly to investors or through an Ownership changes between brokers

TRANSACTIONS intermediary

CAPITAL Promotes direct capital formation Promotes indirect capital formation

FORMATION

TRADING OF Only buying of securities Buying and selling of securities

SECURITIES

PRICE Decided by management of the issuing company Determined by market forces of demand and supply
DETERMINATION

LOCATION No geographical boundaries Located at a specific place.

Drafted by
DARSHAN BHATT (PHD SCHOLAR)
MCOM, LLM