UNIT 2 FINANCIAL MARKET

Financial markets is a marketplace to trade financial instruments. These markets provide finance for
companies to help them in investing and thus grow. They also facilitate the smooth operation by
allocating resources and creating liquidity. Overall it satisfies the needs of lending and borrowing for
individual, government and corporations.
Financial markets serve as indicators of economic performance, reflecting changes in the demand and
supply of financial assets, as well as broader economic conditions. The following points summarize the
importance of financial markets:
 Capital Formation: Businesses and governments raise capital to fund their operations and
investments through financial markets. By issuing stocks, bonds, and treasury bills, businesses
gain the capital for investing in research and development.
 Risk Management: This market helps in risk management. Investors can manage risks by
diversifying their investments across different asset classes, such as stocks, bonds, and
commodities. Derivatives, such as futures and options contracts, provide investors with additional
tools for hedging against potential losses.
 Price Discovery: Financial markets provide a platform for buyers and sellers to come together to
determine the prices of financial assets. This price discovery process ensures that financial assets
are priced efficiently based on the supply and demand for them.
 Liquidity: Financial markets provide investors with the ability to buy and sell financial assets
quickly and easily. This liquidity makes it possible for investors to exit positions and access their
capital when needed, which is critical for managing cash flow and minimizing risk.
 Economic Growth: Financial markets promote economic growth by providing the capital and
liquidity that businesses need to invest in new products, services, and technologies. This
investment helps to drive innovation, create jobs, and boost productivity.
Basis Money Market Capital Market
Meaning A market for short-term funds that is A marketer including all institutions,
meant to use for a period of upto one organisations, and instruments providing
year is known as Money Market. medium and long-term funds is known as
a Capital Market.
Participants The participants of money market are The participants of capital market are
banks, financial institutions, foreign banks, financial institutions, foreign
investors, and public and private investors, ordinary retail investors from
companies. However, ordinary retail public, and public and private companies.
investors from public do not participate
in this market.
Duration The money market deals in securities of The capital market deals in securities of
short-term with a maximum tenure of medium and long term.
one year.
Instruments Some of the common instruments of Some of the common instruments of a
money market are Call Money, capital market are debentures, equity
Commercial Bills, T. Bills, Commercial shares, bonds, preference shares, and
Paper, Certificate of Deposits, etc. other innovative securities.
Liquidity Money market securities are highly The securities that comes under the
liquid. capital market are considered liquid. It is
because of the stock exchange. However,
these securities are less liquid as
compared to the instruments of money
market.
Safety The instruments of a money market are The instruments of a capital market are
less risky or safe as they are used for a riskier. The investors may face the risk in
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short period of time and also because of return as well as principal repayment, as
the soundness of the issuers. the companies issuing the securities may
fail.
Expected The duration of the money market is The expected return of a capital market is
Return short; therefore, the expected return higher. It is because along with regular
here is less. interest or dividend, the investors have
chances of capital gain.
A market for short-term funds that are meant to use for a period of up to one year is known as Money
Market. In the general case, the money market is the source of funds or finance for working capital. The
transactions held in the money market involve lending and borrowing of cash for a short term and also
consist of the sale and purchase of securities with one year term or securities which get paid back
(redeemed) within one year. Some of the common instruments of the money market are Call Money,
Commercial Bills, T. Bills, Commercial Paper, Certificates of Deposits, etc.
Characteristics of the Indian Money Market
Some of the key characteristics or features of the Indian Money Market are as follows:
1. Segmented Structure: The Indian money market can be categorised into organised and unorganised
sectors. The organised sector includes institutions like the Reserve Bank of India (RBI), commercial
banks, cooperative banks, and other financial institutions. However, the unorganised sector comprises
indigenous bankers and money lenders.
2. Regulatory Oversight by the RBI: The Reserve Bank of India plays a pivotal role in regulating and
supervising the Indian money market. It controls the money supply in the economy, manages liquidity,
and ensures the stability of the financial system.
3. Focus on Short-Term Financing: The Indian money market predominantly deals with short-term
financial instruments having maturities of up to one year. It enables participants to fulfil their short-term
funding requirements and efficiently manage liquidity.
4. Diverse Array of Instruments: The Indian money market offers a wide range of instruments,
including treasury bills, certificates of deposit, commercial papers, call money, etc. These instruments
serve as avenues for short-term borrowing, lending, and investment activities.
5. High Liquidity: The Indian money market is known for its high liquidity due to the presence of diverse
participants and instruments. Market participants can readily buy or sell their holdings without
significant price fluctuations.
6. Low-risk Instruments: Instruments in the Indian money market are generally considered low-risk
because of their short maturities and backing by credible issuers such as the government, banks, and
financial institutions. Consequently, they are attractive to risk-averse investors.
7. Significance in Monetary Policy Transmission: The money market plays a critical role in
transmitting monetary policy decisions. The RBI employs various tools, such as open market operations,
repo rate, and reverse repo rate, to regulate liquidity in the money market and influence overall interest
rates in the economy.
8. Dominance of Institutional Investors: Institutional investors, including banks, financial institutions,
and mutual funds, primarily dominate the Indian money market. Individual retail investors have limited
direct participation, although they can indirectly access the money market through mutual funds and
other investment vehicles.
9. Interconnectedness with Other Financial Markets: The Indian money market exhibits
interconnections with other segments of the financial market, such as the capital market and foreign
exchange market. Funds from the money market can flow into long-term investments or be utilised for
currency trading.
10. Ongoing Infrastructure Development: The Indian money market has experienced significant
growth and development in recent years. Efforts have been made to enhance market infrastructure,
improve transparency, and introduce new instruments to cater to the evolving needs of participants.
The money market is a market for short term transactions. Hence it is responsible for the liquidity in the
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market. Following are the reasons why the money market is essential:
 It maintains a balance between the supply of and demand for the monetary transactions done in
the market within a period of 6 months to one year..
 It enables funds for businesses to grow and hence is responsible for the growth and development
of the economy.
 It aids in the implementation of monetary policies.
 It helps develop trade and industry in the country. Through various money market instruments, it
finances working capital requirements. It helps develop the trade in and out of the country.
 The short term interest rates influence long term interest rates. The money market mobilises the
resources to the capital markets by way of interest rate control.
 It helps in the functioning of the banks. It sets the cash reserve ratio and statutory liquid ratio for
the banks. It also engages their surplus funds towards short term assets to maintain money supply
in the market.
 The current money market conditions are the result of previous monetary policies. Hence it acts
as a guide for devising new policies regarding short term money supply.
 Instruments like T-bills, help the government raise short term funds. Otherwise, to fund projects,
the government will have to print more currency or take loans leading to inflation in the economy.
Hence the it is also responsible for controlling inflation.
Call money At times even banks may need help with maintaining their funds. At such times they
lean on other commercial banks for a short-term loan. Such an instrument of the money
market is known as call money. One important factor is that this interbank transaction
has no maturity date, it is payable on demand.
Mostly banks depend on call money to main their cash liquidity ratio as per RBI
guidelines. The rate of interest on call money is known as call rates.
Treasury These are money market instruments issued by the Reserve bank of India (RBI) acting
bill on the behalf of the central government. These bills are issued when there is a shortage
of funds, or when the RBI wants to control the cash liquidity in the market.
The maturity of such bills, also known as Zero Coupon Bonds or is always one year or
less than one year. They are highly liquid instruments and are a very low-risk
instrument. Treasury bills are issued at a discount than the face value and are redeemed
at par. The difference is the interest received by the holder. which in this case will be
known as ‘discount’.
Example: A treasury bill of 108 days face value 50,000/- will be issued at 45.,000/-. If
the holder holds it for the whole 108 days, he will be repaid Rs 50,000/- and so the
difference, Rs. 5,000/- will be the discount.
Commercial Commercial paper is a promissory note. It is a short term. uninsured debt instrument.
paper These are generally issued by large companies and corporations in need of quick short-
term loans. The funds could be required for working capital needs, or some seasonal
changes, to meet expenses of issue of shares etc.
Commercial papers have a maturity date of between 15 days to 1 year. They are also
issued at a discount and redeemed at par. They are highly liquid and easily transferable
instruments of the money market.
Certificate These are money market instruments issued only by commercial banks and financial
of deposit institutions (under the guidelines of the RBI). They are like a promissory note, but can
also be issued in a demat form. Their maturity is between 7 days to a year when issued
by banks. When issued by other financial institutes the maturity is between one to three
years.
Certificates of Deposit are issued at discount. The return on them is the difference
between the said issue price and their higher face value. They are issued only in
multiples of one lacs. They are easily transferable and highly liquid.
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Commercial A commercial bill is essentially a bill of exchange. In a credit sale, the seller will draw a
bills bill of exchange. The buyer of the goods will accept such bill, and the bill becomes a
trade bill which is a marketable financial instrument.
The seller can then go to his bank and get the bill discounted. Here the bank will
promise to pay the amount if the buyer is unable to do so. And this way a trade bill
becomes a commercial bill. The general term for such bills is 30, 60, or 90 days. It is a
negotiable instrument and is also self-liquidating.
Inter Deposits made by one firm to another are known as inter-corporate deposits. All public
corporate companies, whether they have share capital or not, have the option of using this finance.
deposits: It consists of
1. When a company acquires security of another company
2. When a company gives loans to another company.
3. When a company gives a guarantee to any person or institution who provides a
loan to another company. In general, we can say when companies arrange funds
from another company it is known as Inter-corporate deposits.
Basis Commercial Paper Certificate Of Deposits
Issued by Corporations and financial institutions Banks
Risk Unsecured and carries higher risk Insured by DICGC
Return Potentially higher return Typically lower return
Liquidity Usually held until maturity, cannot be Can be traded in secondary market, but may require
traded in secondary market payment of penalty fee for early withdrawal
Investment Typically higher minimum investment Typically lower minimum investment requirement
Amount requirement
Maturity Date Short-term (From 1 to 270 days) Short-term (But minimum 7 days)
Characteristics of a Capital Market
1. Fund Mobilization : Channels savings from investors to businesses for productive use. Drives
economic growth by facilitating investments in infrastructure, innovation, and job creation.
2. Risk Transfer & Portfolio Diversification: Enables investors to spread risk across various
assets, mitigating individual losses. Businesses can raise capital without relying solely on personal
funds or bank loans.
3. Price Discovery: Market forces determine the value of financial instruments through supply and
demand. Provides investors with information about potential returns and risks.
4. Liquidity: Efficiently trades securities, allowing investors to buy and sell quickly. Enables
businesses to raise capital quickly and access additional funds when needed.
5. Regulation & Transparency Regulatory frameworks ensure fair market practices and investor
protection. Transparent information flow fosters trust and confidence in the market.
6. Efficiency Minimizes transaction costs and maximizes resource allocation. Promotes competition
and innovation among financial institutions.
7. Market Integration Connects domestic and international markets, facilitating global capital flows.
Provides access to a wider range of investment opportunities for investors.
8. Evolution & Adaptability Continuously evolves with new financial instruments and technologies.
Adapts to changing economic and regulatory environments.
Functions of Capital Market
1. Links Borrowers and Investors: Capital markets serve as an intermediary between people with
excess funds and those in need of funds.
2. Capital Formation: The capital market plays an important role in capital formation. By timely
providing sufficient funds, it meets the financial needs of different sectors of the economy.
3. Regulate Security Prices: It contributes to securities' stability and systematic pricing. The system
monitors whole processes and ensures that no unproductive or speculative activities occur. A standard or
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minimum interest rate is charged to the borrower. As a result, the economy's security prices stabilize.
4. Provides Opportunities to Investors: The capital markets have enough financial instruments to
meet any investor's needs, regardless of the risk level. Capital markets also provide investors with the
opportunity to increase their capital yields. The interest rate on most savings accounts is extremely low
compared to the rate on equities. Therefore, investors can earn a higher rate of return on the capital
market, though some risks are involved as well.
5. Minimises Transaction Cost And Time: Long-term securities are traded on the capital market.
The whole trading process is simplified and reduced in cost and time. A system and program automate
every aspect of the trading process, thus speeding up the entire process.
6. Capital Liquidity: The financial markets allow people to invest their money. In exchange, they
receive ownership of a stock or bond. Bond certificates cannot be used to purchase a car, food, or other
assets, so they may need to be liquidated. Investors can sell their assets for liquid funds to a third party
on the capital markets.
The capital market is a vital component of the financial system. It complements the intermediated credit
channel and enhances competition by granting alternative financing mechanisms for firms, projects and
attractive investment options that can help adjust to the risk and return levels for investors.
These markets are important for several reasons:
1. Facilitate Capital Formation: Capital markets provide a platform for companies and
governments to raise capital by issuing securities.
2. Resource Allocation: Capital markets help to allocate capital to its most productive uses by
providing investors with a wide range of investment opportunities.
3. Price discovery: These markets play a crucial role in price discovery, determining the fair value
of securities.
4. Debt Management – Capital markets allow the issuance of debt, which is a more efficient and less
restrictive form of borrowing for corporations. These markets equalize borrowers and investors
regarding debt, acting as buffers during economic stress or market turmoil.
5. Liquidity: Capital markets provide liquidity to investors by allowing them to buy and sell
securities quickly and easily, thus freeing up capital for other investments.
6. Risk management: Capital markets offer a range of risk management tools, such as derivatives,
which allow investors to manage their exposure to various types of risks.
7. Building Wealth – These markets help people build wealth and invest in their future. Investors
can invest in many types of securities, including stocks, ETFs, mutual funds, corporate bonds, etc.
Individuals can use invested principal and any corresponding appreciation to invest in their
pension, buy their own home, or save for higher education.
8. Innovation – A capital market fuels companies or entrepreneurs to turn an idea or industrial
innovation into a real business or expansion for an existing company. This, in turn, creates jobs
and stimulates economic growth.
Basis Primary Market Secondary Market
Meaning A market in which securities are sold A market in which the sale and
for the first time is known as a Primary purchase of newly issued securities and
Market. second-hand securities are made is
known as a Secondary Market.
Types of In the primary market, the sale of new In the secondary market, the sale and
Securities securities takes place. purchase of existing or second-hand
securities take place.
Issued by In the primary market, the securities In the secondary market, the securities
are directly issued by companies. are transferred between the investors
only.
Capital A primary market directly contributes A secondary market indirectly
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Formation to the capital of a company as it contributes to the capital of a company
involves the transfer of funds from as it involves an exchange of funds
surplus units to deficit units. between surplus units only.
Entry The companies enter a primary market The securities of listed companies only
for raising capital for their operations. are bought and sold in this market.
Geographical There is no fixed geographical location There is a fixed geographical location of
Location of a primary market. Every bank, a secondary market and it also has fixed
institution, foreign investor, etc., working hours.
contribute to this market.
Price The price of securities in a primary The price of securities in a secondary
market is fixed by the management of market is fixed by the demand and
the company issuing them. supply of the stock exchange market.
Stock Exchange
The Securities Contract and Regulation Act defines a stock exchange as, “An organisation or body of
individuals, whether incorporated or not established for the purpose of assisting, regulating, and
controlling of business in buying, selling, and dealing in securities.”
Functions of Stock Exchange/Secondary Market
The functions of stock exchange are as follows:
1. Economic Barometer
A stock exchange is a reliable barometer that helps in the measurement of economic conditions of a
country. If there is a major change in a country and economy, it is reflected through the price of shares. In
other words, a rise or fall in the price of shares indicates the boom or recession cycle of the economy. As
the stock exchange reflects the economic conditions of a country, it is also known as a Pulse of
Economy or Economic Mirror.
2. Pricing of Securities
The stock market helps in valuing securities based on the demand and supply factors. The demand for the
securities of profitable and growth-oriented companies is more; therefore, they are valued higher. This
valuation of securities is essential for the government, investors, and creditors. With this, the government
can impose taxes on the value of securities, investors can know the value of their investment in securities,
and the creditors can value the creditworthiness of the company.
3. Safety of Transactions
Only the listed securities are traded in the stock market. Besides, the stock exchange authorities consist
of the company’s names in the trade list only after they have verified the soundness of the company. The
companies listed in the stock exchange have to operate within the strict rules and regulations laid down
by the authority, as it helps in ensuring the safety of dealing through stock exchange.
4. Contributes to Economic Growth
Securities of various companies are bought and sold on a stock exchange. This process of disinvestment
and reinvestment in securities helps a trader invest in the most productive investment proposal. This
result leads to capital formation and economic growth of a country.
5. Spreading of Equity Cult
Stock exchange regulates new issues, provides better trading practices, and educates the public about the
investment to encourage people to invest in the ownership securities.
6. Providing Scope for Speculation
The stock exchange permits health speculation of securities so that it can ensure liquidity and demand of
supply of securities.
7. Liquidity
The main function of stock market is provision of ready market for the sale and purchase of securities.
The presence of stock exchange market assures the investors that they can convert their investment into
cash whenever they want. Because of the stock exchange, investors can without hesitating, invest in long-
term investment projects. Besides, with the help of stock exchange, investors can convert their long-term
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investments into short-term and medium-term investments.
8. Better Allocation of Capital
The shares of a profit-making company are quoted at a higher price and are traded actively so that the
companies can easily raise fresh capital from the stock market. As the general public hesitates while
investing in securities of a loss-making company, the stock exchange helps by facilitating the allocation of
investor’s funds to profitable channels.
9. Promotes the habits of Savings and Investment
To promote the habit of savings and investment among people, the stock market offers attractive
opportunities for investment in different securities to them. With these opportunities, people save more
and invest in the securities of the corporate sector rather than investing in unproductive assets like
silver, gold, etc.
The Securities and Exchange Board of India (SEBI) is the regulatory body that oversees the functioning of
the securities market in India. It was established in 1988 as a non-statutory body and was given statutory
powers in 1992 under the SEBI Act. In this blog, we will discuss the various roles and functions of SEBI.
1. Regulatory role
SEBI plays a crucial role in regulating the securities market in India. Its main objective is to protect the
interests of investors and to ensure fair and transparent dealings in securities. SEBI regulates various
players in the securities market, including stockbrokers, merchant bankers, and other intermediaries. It
also ensures that listed companies comply with the regulations and guidelines laid down by it.
2. Supervisory role
SEBI is responsible for supervising the functioning of the securities market in India. It monitors the
operations of various players in the market to ensure that they comply with the regulations and
guidelines laid down by it. SEBI also conducts inspections and investigations to ensure that there are no
malpractices or violations of regulations.
3. Developmental role
SEBI plays a developmental role in the securities market by promoting and developing it. It has taken
various initiatives to develop the securities market in India, such as introducing new products and
instruments, encouraging foreign investment, and promoting investor education and awareness. SEBI has
also taken steps to improve the infrastructure and technology used in the securities market.
4. Investor protection role
One of the primary functions of SEBI is to protect the interests of investors. It does so by ensuring that
listed companies provide accurate and timely information to investors, preventing insider trading and
fraudulent practices, and by taking action against those who violate regulations. SEBI also educates
investors about the risks and rewards of investing in securities and provides them with a grievance
redressal mechanism.
5. Enforcement role
SEBI has the power to enforce its regulations and guidelines by taking action against those who violate
them. It can impose fines, initiate legal proceedings, and even suspend or cancel the registration of
intermediaries who violate its regulations. SEBI also has the power to investigate and take action against
insider trading and other fraudulent practices.
SEBI’s role in the securities market in India is multifaceted, and it has made significant contributions to
the growth and development of the market. Here are some additional points on SEBI’s functions and
responsibilities:
6. Market development role
SEBI plays a crucial role in developing and promoting the securities market in India. It has taken various
initiatives to increase market liquidity, such as introducing new products like equity derivatives, allowing
short-selling, and enabling algorithmic trading. SEBI has also relaxed some of the regulations to
encourage the listing of start-ups and small and medium-sized enterprises (SMEs). These measures have
helped to deepen the market and make it more attractive to investors.
7. Promoting transparency and disclosure
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SEBI’s regulations mandate that companies must provide accurate and timely information to investors.
Listed companies must comply with the listing agreement and disclosure requirements, including
disclosing material information such as financial statements, board meetings, and other important
information to the stock exchange and investors. This requirement ensures that investors can make
informed decisions and increases transparency in the securities market.
8. Promoting Corporate Governance
SEBI has also been instrumental in promoting corporate governance practices in India. It has laid down
rules for the appointment of independent directors, audit committees, and other governance structures,
making it mandatory for listed companies to adhere to these regulations. These regulations help to
ensure that listed companies operate transparently, ethically and responsibly, and ultimately benefit the
investors.
9. Regulating Mutual Funds
SEBI also regulates the mutual fund industry in India, which has witnessed tremendous growth in recent
years. It regulates the formation, registration, and functioning of mutual funds in India, ensuring that they
comply with the regulations and guidelines laid down by it. SEBI also monitors the performance of
mutual funds and takes action against those who violate the regulations.
10. Regulating Credit Rating Agencies
SEBI also regulates credit rating agencies, which play a critical role in the securities market. It lays down
the guidelines for the registration, functioning, and conduct of credit rating agencies. SEBI also monitors
their performance and takes action against those who violate the regulations.
11. Regulating Insider Trading
SEBI also plays an important role in regulating insider trading in India. Insider trading is the practice of
buying or selling securities based on confidential information that is not available to the public. This
practice can be harmful to the integrity of the securities market, and can cause significant losses to
investors. SEBI has laid down stringent regulations to prevent insider trading, and it monitors the market
to detect any instances of insider trading. It takes strict action against those who violate the regulations,
including imposing fines, suspending trading activities, and even initiating criminal proceedings.
12. Promoting Investor Education and Awareness
SEBI recognizes the importance of investor education and awareness, and it has taken various initiatives
to promote this. It has launched several campaigns to educate investors about the risks and rewards of
investing in securities, and to create awareness about the regulations and guidelines laid down by it. SEBI
has also set up an investor grievance redressal mechanism, which allows investors to file complaints and
seek redressal for their grievances. This mechanism has helped to increase investor confidence and has
made the securities market more accessible to investors.
13. Regulating Stock Exchanges
SEBI also regulates the functioning of stock exchanges in India. It lays down the guidelines for the
registration, functioning, and conduct of stock exchanges. SEBI monitors the performance of stock
exchanges and takes action against those who violate the regulations. This ensures that the stock
exchanges operate efficiently and transparently, and that investors can have confidence in the integrity of
the market.
14. Regulating Foreign Investments
SEBI also plays a crucial role in regulating foreign investments in India. It lays down the guidelines for
foreign investment in the securities market, including the registration, functioning, and conduct of
foreign investors. SEBI monitors the performance of foreign investors and takes action against those who
violate the regulations. This helps to ensure that foreign investments in India are transparent and
compliant with the regulations.