SPOM Set - Ch 1

CHAPTER 1
INTRODUCTION TO FINANCIAL
MARKETS
LEARNING OUTCOMES
After going through the chapter student shall be able to understand:

 Introduction to Financial Markets
 Role of Financial Market in Economic Development of a country
 Stakeholders in Financial Market (Domestic and Global)
 Indian Financial Market Scenario
©The Institute of Chartered Accountants of India

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1.2 FINANCIAL SERVICES AND CAPITAL MARKETS
CHAPTER OVERVIEW
Introduction
Introduction to Financial Market
Role of Financial Market in Economic

Development
Stakeholders in Financial Market

(Domestic and Global)
Indian Financial Market Scenerio

INTRODUCTION TO FINANCIAL MARKETS 1.3 1.3
1. INTRODUCTION TO FINANCIAL MARKETS
Stock
Markets
Foreign
Bond
Exchange
Markets
Markets
Insurance Financial Commodity
Markets
Markets Markets
Futures Money
Markets Markets
Derivatives
Markets
Financial markets are a marketplace that provides an avenue for the sale and purchase of financial
assets such as equity stocks, bonds, foreign exchange, commodities, derivatives, etc.
1.1 Major types of financial markets

1.1.1 Stock market
The stock market is the market for trading in equity stocks of companies. Typically, dividend yield in
stocks is on the lower side, as dividend is declared as a percentage of the face value of the stock
whereas the price in the secondary market runs up. That is, as a percentage of market price, the
return to the investor is on the lower side. Gains come from capital price appreciation in the
secondary market. This market is volatile, as the price in the secondary market reflects expectations
going forward on the economy and corporate earnings.
1.1.2 Bond market

The bond market offers an avenue for companies and the government to raise money to finance a
project or a deficit, with a defined repayment timeline. In a bond market, investors buy bonds from
a company, and the company returns the amount of the bonds on the stipulated date, along with the
coupon or interest payment as agreed.

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1.1.3 Commodities market

The commodities market is a market where traders and investors buy and sell natural resources or
commodities such as corn, oil, pulses, meat, gold, etc. Prices for goods that will be delivered at a
specific future date are determined in the present on the commodities future market.
1.1.4 Currency Markets

The currency market is a market for traders of currencies. It is a boon to the importers and exports
and others having foreign currency exposure. It provides the opportunity for participants to hedge
their currency exposures, provides depth to the market, making cross currency transactions and
hedging a reality.
1.1.5 Money Market

♦ It is a market for short term source of funds.
♦ Money market instruments have maturity of less than 1 year.
♦ The basic objective is to manage liquidity in the economy.
♦ The RBI along with other commercial banks are the key players in this market.
♦ It plays an important part in controlling inflation.
1.1.6 Derivatives market

This market deals in derivatives or contracts whose value is based on the market value of the asset
being traded, called the underlying. The commodities futures mentioned above are an example of a
derivative. Currency and equity derivatives are popular. Further, according to one study, India and
China top the world’s commodity market.

Source: https://www.accountingfoundation.org/jsp/Foundation/Page/FAFSectionPage&cid=1351027541272
1.2 Importance of Financial Markets

There are many social benefits that financial markets facilitate, including:
♦ They provide individuals, companies, governments, and quasi-government organizations

access to capital.
♦ People with surplus funds for investment get channels for investment and are assured of fair
treatment as there is a regulator i.e., transfer of funds from surplus units to deficit units. For
instance, people with extra money access the stock market despite being aware of the risk
inherent in it as they look for higher return and assured of transparency in the market because
of the presence of SEBI.

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♦ Financial markets create jobs as there are many people involved in direct and indirect
activities. For instance, the involvement of the brokers, underwriters, merchant bankers,
custodians, depositories etc. in the financial markets.
1.3 Size of the Global Financial Market

The biggest markets are those of derivatives, though conventionally we tend to think of Equity or
Bond markets as large. Globally, derivatives markets are much more developed.
Source: Google to https://topforeignstocks.com/2011/08/23/how-big-is-the-global-financial-industry/

The chart above shows that the notional amount of financial derivatives outstanding is much higher
than the traded volume of stocks and bonds.
2. ROLE OF FINANCIAL MARKET IN ECONOMIC

DEVELOPMENT OF A COUNTRY
For economic development, a country needs capital, and the capital markets discussed above e.g.,
equities, bonds, etc. channelize those resources. Through the financial market or capital market
system, funds flow from those who have surplus funds to those who have a shortage of funds, either
by direct, market-based financing or by indirect, bank-based finance. Without a properly functioning
stock market, price discovery of corporations would not happen and resource mobilization through
IPOs would be hampered. How a financial market helps to boost an economic of a country has been
highlighted in the following points:

• The financial market is a mode of channelizing savings to investments.

• It helps in creating more capital for the industries.
• Which in turn creates more jobs because of the increase in production.
• More jobs increase the standard of living which leads to more demand for goods and services.
• Which further leads to more capex and the process goes on.
• Further this process helps generate more taxes for the Government.
• More tax collection facilitates more spending by the Government.
• Which in turn creates more jobs and more demand again.
• And the process goes on.
2.1 Functions of Financial Markets

The role of financial markets in the success and strength of an economy is immense. Some important
functions of financial markets are:
 Puts savings into more productive use
Money in the savings account should be put to productive use. Financial institutions like banks loan
it out to individuals and companies that need it for say home loan, study loan, business purposes,
big projects, etc. Further, savings as such do not have any meaning; it is investment that puts it to
productive use.
 Determines the price of securities
Once a security is listed, buyers and sellers trade in it, and the traded price reflects the prospects of
the company whose instruments are being traded. This is called price discovery. Prices of securities
are determined in financial markets, which is an important function.
 Makes financial assets liquid
Buyers and sellers can decide to trade their securities anytime, provided there is a counterpart.
Financial markets provide this avenue, and that creates liquidity in the security. This imparts liquidity
to investors and incentivizes them to invest.
 Lowers the cost of transactions
In financial markets, various types of information regarding securities can be acquired without the
need to spend. The Exchanges and market participant associations disseminate relevant

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information. The companies also can disseminate information, but they would put forth only what
they want to propagate, not what is useful for investors.
Source: Google to https://slideplayer.com/slide/5737595/
Financial markets facilitate the flow of savings and investment in the economy for generation of
capital and the production of goods and services.
2.2 The linkages in financial flows

As we see in the diagram above, households save and invest through financial institutions. Apart
from households, the corporate or business sectors also may have surplus from time to time, which
is invested through financial institutions. For economic development of a country, the business
sector and the government need resources, which are mobilized by the financial institutions and
markets? The government may need to borrow from the market, which is facilitated by financial
markets. Resources may be mobilized from abroad as well, depending on the relative growth
potential of the two economies.
The resources, i.e., funds, are deployed in the real economy by the government and private sector
business firms, for creation of capacities and for running the wheel i.e., necessary revenue
expenditure. The production of business firms is consumed by the household sector. Government

taxes are collected from the business sector. Economic development happens through increasing
the size of the pie shown above, which is denoted by the GDP growth rate, by generating efficiencies
in the production process and increasing the speed of the cycle. While generating efficiencies is the
job of the participants in the production process, the resource that moves the wheel is finance.
Financial markets provide this resource. It must be done at an optimum cost; it should be low enough
to incentivize producers to raise resources and high enough for households to save. The more
efficient financial markets are, the more efficient is this process of price discovery.
2.3 Contribution of market to economy

The state of development of the financial markets reflects the state of development of the economy,
and vice versa. It is a relationship of symbiosis, as the market and the economy feed from each
other.
According to Baily and Elliott, there are three major functions of the financial system:
Credit Provision - Credit supports economic activity. Governments can invest in infrastructure
projects by reducing the cycles of tax revenues and correcting spends, businesses can invest more
than the cash they have, and individuals can purchase homes and other utilities without having to
save the entire amount in advance. Banks and other financial service providers give this credit facility
to all stakeholders.
Liquidity provision - Banks and other financial providers protect businesses and individuals against
sudden cash needs. Banks provide the facility of demand deposits which the business or individual
can withdraw at any time. Similarly, they provide credit and overdraft facilities to businesses.
Moreover, banks and financial institutions offer to buy or sell securities as per need and often in
large volumes to fulfill sudden cash requirements of the stakeholders.
Risk management services - Finance provides risk management from the risks of financial markets
and commodity prices by pooling risks. Derivative transactions enable banks to provide this risk
management. These services are extremely valuable even though they receive a lot of flak due to
excesses during financial crisis.
According to Global Financial Development Report of World Bank of 2014, “Fundamentally, financial
sector development concerns overcoming “costs” incurred in the financial system. This process of
reducing costs of acquiring information, enforcing contracts, and executing transactions results in
the emergence of financial contracts, intermediaries, and markets. Different types and combinations
of information, transaction, and enforcement costs in conjunction with different regulatory, legal and

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tax systems have motivated distinct forms of contracts, intermediaries, and markets across countries
in different times.”
According to Levine, “The five key functions of a financial system in a country are: (i)
information about possible investments and capital allocation; (ii) monitoring investments and the
exercise of corporate governance after providing financing; (iii) facilitation of the trading,
diversification, and management of risk; (iv) mobilization and pooling of savings; and (v) promoting
the exchange of goods and services.”
3. STAKEHOLDERS IN FINANCIAL MARKET (DOMESTIC

AND GLOBAL)
Various stakeholders in the financial market can be categorized into following four segments:
(i) Primary stakeholders in financial market
 Shareholders
 Lenders
 Companies
 Mutual fund Organizations/holders/fund managers
(ii) Service providers in financial market
 Merchant Bankers
 Brokers
 Underwriters
 Depositories
 Custodians
(iii) Regulators in financial market
 Securities and Exchange Board of India (SEBI)
 Reserve Bank of India
 Insurance Regulatory and Development Authority of India (IRDAI)
 Pension Fund Regulatory and Development Authority (PFRDA)
(iv) Administrators to facilitate the financial market

 Association of Mutual funds of India (AMFI)

 Foreign Exchange Dealers Association of India (FEDAI)
 Fixed Income Money Market and Derivative Association of India (FIMMDA)
 Association of Investment Bankers of India (AIBI)
(i) Primary stakeholders in financial market

(a) Shareholders: In simple language, shareholders are the owners of a company. So, a
shareholder is any person such as an individual, company or other institution who holds at
least one share out of the company’s total shares. As shareholders are owners of the
company, they benefit when the share prices increase. In the same way, the shareholders
lose out when the company’s shares plummet.
The shareholders participate in the financial market (secondary market) by buying and selling
shares. Their actions depend upon which way the market is behaving. If the market price is
low, they tend to buy more shares. On the other hand, if the market price of shares is high,
they will sell more shares to make a profit. Thus, they provide the much-needed liquidity in
the stock market.
(b) Lenders: A lender in relation to a financial market is either a company or any other form of
corporation that issues bonds or debentures to make its end meet. Funds are available to
another with the expectation that the funds will be repaid, in addition to any interest and/or
fees, either in increments or as a lump sum. They also provide the much-needed liquidity in
the financial market by facilitating the flow of funds from deficit spending to surplus spending
sectors.
(c) Corporates: Corporates raise money either through the share market route or through the
bond market route. Raising money by issuing shares to the public generally helps the
companies to amass huge amounts of capital. It keeps the financial market ticking by enabling
mobilization and allocation of saving from the people, be it, individual investors, companies,
and institutional investors whether foreign or domestic.
However, raising equity share capital has its repercussions. The cost of equity share capital
is costly. Moreover, companies must meet a lot of regulatory compliances at the time of initial
public offerings which takes a lot of time, energy, and money. But, if the company managed
to keep its share prices on the higher side, it will easily get more funds in the future whether
through equity or debt. If the company opting to raise funds through the debt route, it has
certain advantages and disadvantages. The benefits are lower cost of capital in comparison

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to equity. The debt route also tends to increase the earnings per share (EPS) of the company
which consequently leads to escalation of share prices of the company. However, the demerit
is that a debt must be repaid along with interest. So, too much debt may lead an organization
to financial/default risks and may land it in financial distress.
(d) Mutual fund Organizations: A mutual fund is a financial institution or intermediary that pools
the savings of investors for collective investment in a diversified portfolio of securities. A fund
is ‘mutual’ as all its returns, minus its expenses, are shared by the fund’s investors. A mutual
fund serves as a link between the investor and the securities market by mobilizing savings
from the investor and investing them in the securities market to generate returns.
(ii) Service providers in financial market

(a) Merchant Bankers: As per the Securities and Exchange Board of India (Merchant Banker)
Regulations, 1992, merchant banker means any person who is engaged in the business of
issue management, either by making arrangements regarding selling, buying, or subscribing
to securities, or acting as a manager, consultant, or advisor, or rendering corporate-advisory
services in relation to such issue management. It is mandatory to appoint a merchant banker
in case of a public issue. The functions of merchant banker include – submitting offer
documents to SEBI, due diligence i.e., certifying that all the disclosures made in the draft
prospectus or letter of offer are true and fair and will enable the investors to make an informed
decision etc.
Globally, merchant bankers play the same role as discussed above. Some of the top
Merchant Bankers in USA are Merrill lynch, Citigroup, Goldman Sachs, J.P. Morgan, and
Morgan Stanley. They provide services to top companies in the world. For example, Morgan
Stanley has been responsible for hundreds of technology financing and M&A transactions
aggregating over $500 billion in value. Further, Goldman Sachs has served all the big names
in tech, including Microsoft, Apple, Facebook, Twitter, Ebay and Alibaba.
(b) Brokers: Stockbrokers participate in the stock market on behalf of their clients. They buy and
sell shares on behalf of the clients on their instructions. To actively participate in the capital
market, they should be SEBI registered. So, they facilitate trading in the
stock market (secondary market) by undertaking buys and sell transactions on behalf of the
client.
In the USA, most "brokers" must be registered with the Securities Exchange Commission
(SEC) and join a "self-regulatory organization," or SRO. Globally, margin financing is popular,
in which, many large broking houses provide financing facilities to clients who borrow money

to invest in stocks. Therefore, Stock exchanges monitor the extent to which brokers are
lending in line with their net worth.
(c) Underwriters: Underwriters are those people who assume the risk of others. In the capital
market, in case of new issues, they assume risk by guaranteeing that in case the shares are
not subscribed fully by the public, the unsubscribed portion will be subscribed by the
underwriter itself. They do it by charging a small fee.
So, how do the underwriters make profit? They buy the shares of the company before they
are listed on a stock exchange. The underwriters make their profit on the difference in price
between what they paid before the IPO and when the shares are offered to the public.
(d) Depositories: Depository is an institution which maintains investors account in electronic
form. One of the main functions of the Depository is to transfer the ownership of shares from
one investor to another whenever the trading of shares takes place. It helps in reducing the
paperwork involved in trade, expedites the transfer, and reduces the risk associated with
physical shares such as damage, theft, and subsequent misuse of the certificates or fake
securities.
There are two types of depositories in India which are known as NSDL (National Securities
Depository Limited) and CSDL [Central Depository Services (India) Limited]. They interface
with the investors through their agents called Depository participants (DPs). DPs could be
the banks (private, public, and foreign), financial institutions or SEBI registered trading
members.
Globally, depositories provide the same set of services as has been rendered by CDSL and
NSDL.
(e) Custodians: Custodians provide custodial services for safe keeping of securities. Besides
safe keeping, they provide other services for a fee (generally 1% of the total volume of
transactions) such as physical transfer of share certificates, collecting dividends and interest
warrants and conforming to transfer regulations. Besides that, it also updates client status on
their investment status. Even though securities are in the custody of depositories, the
custodians act as a complementary to them by providing various services as mentioned
above. In India, The Stock Holding Corporation of India (SHCIL) and the SBI Share Holding
Corporation are the leading custodians.
After liberalization in 1991, foreign institutional investors (FIIs) were allowed to invest in
the Indian Capital Market. Most of the FII business in India is routed through foreign
custodians. According to US laws, no US fund is allowed to use a custodian that does not

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have a capital adequacy of USD 200 million. No Indian custodian meets this requirement.
Therefore, only foreign banks operate as custodians for US based FIIs, pension funds, and
corporates. Hong Kong Bank, Deutsche Bank, Citi Bank, and Standard Chartered Bank are
some leading foreign banks which operate as custodians.
(iii) Regulators in financial market

(a) Securities and Exchange Board of India (SEBI): SEBI was born in 1992. The basic
objective was to protect the interest of investors in securities and promote the development
of the securities market. The important objectives of SEBI are:
i) Protect the interest of investors in securities.
ii) Promotes the development of securities market.
iii) Regulating the securities market.

Major Roles of SEBI
 Regulate the Business in Securities Exchanges.
 Register & Regulate intermediaries, collective investment schemes (including Mutual

Funds).
 Promote & regulate SRO’s. (Self-Regulatory Organizations)
 Prohibit unfair & fraudulent trade practices.
 Promote investor education & Training
 Prohibit Insider trading.
 Regulate substantial acquisition of shares & takeover of companies
 Inspection/Audit of intermediaries & SRO’s.
 Any other function as provided under the SCRA 1956, as delegated by the govt.
Outside India: Securities Exchange Commission (SEC) in USA performs more or less the
same functions as given to SEBI. But the stark difference is the amount of penalty. SEC can
impose an unlimited amount of fine which SEBI cannot. That is the reason SEC has more
teeth in comparison to SEBI and acts as an effective deterrent against malpractices in the
stock market.
(b) Reserve Bank of India: The Reserve Bank of India was established in 1935 with the
provision of Reserve Bank of India Act, 1934. Though privately owned initially, in 1949 it was

nationalized and since then fully owned by Government of India (GoI). The preamble of the
Reserve Bank of India describes its main functions as to regulate the issue of Bank Notes
and keeping of reserves with a view to securing monetary stability in India and generally to
operate the currency and credit system of the country to its advantage, RBI is Apex body for
regulation of Banking Sector, Controls money supply in India, Banker to Government and
banker to banks, Responsible for monetary and fiscal policy, Regulates the debt securities of
Government and forex markets.
Outside India: Federal Reserve (Fed) in the USA’s policies is primarily driven by growth and
employment figures, at the expense of inflation. On the other hand, we have the RBI, whose
policies are primarily driven by inflation, at the expense of growth. So which approach is better
depending upon the situation of the economy. In the USA and European Union, where the
rate of interest is very low encourages industry to borrow at cheaper cost and contributes
towards economic development and growth. However, in India, the aim of RBI is to keep the
rate of interest high to discourage the industry to borrow large amount of money and
consequently to contain inflation.
However, recently, due to the Covid–19 pandemic, RBI has lowered the interest rates to give
a firm push to the dwindling economic growth, but not by much. The reason is that too much
lowering of interest rates will give not contain the rising inflation rate. So, what is the way out
to keep interest rates low and bring them down further?
One solution is - given the prevailing environment, more proactive bond purchases will be
required over a longer period of time to provide support to the bond market and the overall
economy. Bank credit growth is expected to rise in the coming quarters even though NBFCs
are likely to stay in consolidation mode. Banks are unlikely to be able to support both private
credit demand and higher borrowings simultaneously. In this backdrop, the RBI needs to step
in proactively to buy bonds and keep longer duration yields from inching higher.
(c) Insurance Regulatory and Development Authority of India (IRDAI): IRDA Act was passed
in 1999. The main aim of the Insurance Regulatory and Development Authority of India is to
protect the interest of holders of Insurance policies to regulate, promote and ensure orderly
growth of Insurance industry & for matters connected therewith or incidental thereto. Under
this Act, Controller of Insurance under Insurance Act,1938 was replaced by newly established
authority called Insurance Regulatory and Development Authority (IRDA).
Outside India: In USA, insurance is almost regulated by the individual state governments. In
Canada, Office of the Superintendent of Financial Institutions Canada (OSFI)sets the
minimum regulatory requirements and expectations to support policyholder and creditor

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protection, giving due regard to the need to allow institutions to compete effectively. As
healthy companies are in the best position to protect policyholders and creditors, OSFI is
aware of the impact of its requirements and expectations on competition domestically and
internationally.
Insurance regulators in other jurisdictions pursue similar goals but with different legislative
and policy tools and with different economic experiences and conditions. OSFI considers the
pace, scope and impact of reforms while renewing the regulatory framework ensures that we
can incorporate best practices, and limit – to the extent practical – unintended consequences
and an uneven playing field.
(Source: Office of the Superintendent of Financial institutions, Canada)
(d) Pension Fund Regulatory and Development Authority (PFRDA): The objective of PFRDA
is to be a model Regulator for promotion and development of an organized pension system
to serve the old age income needs of people on a sustainable basis. Pension systems
throughout the world have been under scrutiny over the last couple of decades. Numerous
reforms have been carried out to tackle the sustainability and adequacy of pension
arrangements in the face of the rising global demographic challenge.
Outside India: The main law which governs the establishment, maintenance, and termination
of pension plans in the United States is the Employee Retirement Income Security
Act (ERISA).
Prudential supervision of Australian pension funds started in 1993.The objective of the
regulation regarding superannuation aimed at reducing the riskiness of superannuation
investments, dealing with retirement incomes policy, equal treatment of members and various
other matters.
(iv) Administrative authorities to facilitate the financial market

(a) Association of Mutual funds of India (AMFI): The Association of Mutual Funds of
India (AMFI) is dedicated to developing the Indian Mutual Fund Industry on professional,
healthy and ethical lines and to enhance and maintain standards in all areas with a view to
protecting and promoting the interests of mutual funds and their unit holders.
AMFI, the association of SEBI registered mutual funds in India of all the registered Asset
Management Companies, was incorporated on August 22, 1995, as a non-profit organization.
As of now, all the 42 Asset Management Companies that are registered with SEBI are its
members.

Roles of AMFI
 It is an advisory body for mutual funds.
 It represents Mutual Fund (MF) industry before the Government.
 All Asset Management Companies (AMCs) are members of AMFI.
 It gives information about all the Mutual Fund schemes on its website.
 It is also responsible for framing code of conduct and ethics for AMCs.
The Mutual Fund Dealers Association of Canada (MFDA) is the national self-regulatory
organization (SRO) that oversees mutual fund dealers in Canada. The MFDA was established
in mid-1998 at the initiative of the Canadian Securities Administrators (CSA) in response to
the rapid growth of mutual funds in Canada in the late 1980s from $40 billion to $400 billion
and recognition by the CSA that the mutual fund industry and investors would benefit from
more effective regulation and oversight. As an SRO, the MFDA is responsible for regulating
the operations, standards of practice and business conduct of its members and their
representatives with a view to enhancing investor protection and strengthening public
confidence in the Canadian mutual fund industry.
(b) Foreign Exchange Dealers Association of India (FEDAI): Foreign Exchange Dealers
Association of India (FEDAI) was set up in 1958 as an Association of banks dealing in foreign
exchange in India (typically called Authorised Dealers - ADs) as a self-regulatory body and is
incorporated under Section 25 of The Companies Act, 1956. Its major activities include
framing of rules governing the conduct of inter-bank foreign exchange business among banks
vis-à-vis public and liaison with RBI for reforms and development of forex market.
Internationally, forex dealers provide online trading services to allow individuals to speculate
on rapidly changing foreign exchange rates. Forex Dealer Members (FDMs) are regulated in
the United States by the Commodity Futures Trading Commission (CFTC) and National
Futures Association (NFA), as well as by national and local regulatory bodies where they
conduct business.
(c) Fixed Income Money Market and Derivative Association of India (FIMMDA)
The Fixed Income Money Market and Derivatives Association of India (FIMMDA), an
association of Scheduled Commercial Banks, Public Financial Institutions, Primary Dealers,
and Insurance Companies was incorporated as a Company under section 25 of the
Companies Act, 1956 on June 3rd, 1998. FIMMDA is a voluntary market body for the bond,
money, and derivatives markets.

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FIMMDA has members representing all major institutional segments of the market. The
membership includes Nationalized Banks such as State Bank of India, its associate banks
and other nationalized banks; Private sector banks such as ICICI Bank, HDFC Bank, IDBI
Bank; Foreign Banks such as Bank of America, ABN Amro, Citibank, Financial institutions
such as IDFC, EXIM Bank, NABARD, Insurance Companies like Life Insurance Corporation
of India (LIC), ICICI Prudential Life Insurance Company, Birla Sun Life Insurance Company
and all Primary Dealers.
The International Swaps and Derivatives Association (ISDA) is a trade organization of
participants in the market for over-the-counter derivatives. It’s headquarter is in New York
City, and has created a standardized contract (the ISDA Master Agreement) to enter
into derivatives transactions.
(d) Association of Investment Bankers of India (AIBI)
In the early 1990s, the merchant banking industry in India witnessed a phenomenal growth
with over 1500 merchant bankers registered with SEBI. To ensure the wellbeing of the
industry and for promoting healthy business practices, it became necessary to set up a Self-
Regulatory Organization within the industry. This led to the birth of the Association of
Investment Bankers of India (AIBI). AIBI was promoted to exercise overall supervision over
its members in the matters of compliance with statutory rules and regulations pertaining to
merchant banking and other activities. AIBI was granted recognition by SEBI to set up
professional standards, for providing efficient services and to establish standard practices in
merchant banking and financial services. AIBI, in consultation with SEBI, is working towards
improving the compliance of statutory requirement in a systematic manner.
AIBI's primary objective is to ensure that its members render services to all its constituents
within an agreed framework of ethical principles and practices. It also works as a trade body
promoting the interests of the industry and of its members. (Source www.aibi.org.in)
Internationally, International Association of Investment Bankers (IAIB) since its
inception in 1994 has leveraged its collective expertise, best practice knowledge, industry
insights, and global reach to assist clients in executing mergers, acquisitions, divestitures,
and strategic partnerships.
Its membership is composed of established boutique investment banks from around the world
whose primary focus is advising middle market and emerging growth companies. As a highly
collaborative group, they hold monthly conference calls and gather twice each year to review
creative transaction structures and current market dynamics, as well as to share perspectives

on important industry issues. Through these efforts, they can offer their clients a truly
differentiated advisory service that leverages the significant transaction experience and
domain expertise of their member firms.
The International Association of Investment Bankers (IAIB) is an affiliation of investment
banking firms from Europe, North America, Australia, and Asia, working together to broaden
their reach and leverage their expertise within the global marketplace.
Since 1994, the IAIB member firms have utilized this network to offer their clients worldwide
access to providers of capital, advisory services and acquirers and sellers of businesses.
With this capability, member firms can provide substantial added value to their clients beyond
that typically offered by purely domestic advisors. (Source www.iaib.org)
4. INDIAN FINANCIAL MARKET SCENARIO

The Indian economy is a developing one and so is the Indian financial market ecosystem. The market
is well regulated by SEBI, along with other regulators. The pace of development, in terms of systems
and enablers, has been quite fast. Though we are yet to catch up with developed markets like the
USA on many parameters, it is because we are still a developing economy.
Let us look at the components of the Indian financial market:
Source: Google to http://practicemock.com/blog/lic-aao/insurance-financial-market-awareness-indian-financial-system/

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4.1 Money Market Instruments

The money market is the market for financial assets that are close substitutes for money. It is the
market for instruments ranging from one day deployment e.g., call money market to a few months,
but upto or less than one year.
4.1.1 Treasury Bills
Treasury Bills (T-Bills) are short term instruments issued by the Central Government with maturities
in less than one year. Their purpose remains the same as Dated Securities (i.e., regular Government
Securities), but they are intended more to be meeting the short-term funding needs of the Central
Government. Currently, the Central Government issues T Bills of 91-day, 182-day and 364-day
maturity. Since T Bills have a maturity of less than one year, they are a money market instrument.
4.1.2 Cash Management Bills
These are a short-term instrument issued by the Government of India and meant to specifically meet
temporary cash flow mismatches of the Government. These instruments have a maturity of less than
91 days. Further, they are issued at a discount to par value (in zero-coupon securities). CMBs have
similar characteristics as Treasury Bills.
4.1.3 Call Money, Notice Money, and Term Money
These are the terms used for short-term borrowing and lending operations between Banks and
sometimes with and between Primary Dealers. The difference between the three is in their tenure of
lending. Call money is for overnight deployment i.e., one day, notice money is two to fourteen days
and term money is for a tenure fifteen days and longer.
4.1.4 Certificate of Deposits (CDs)
CDs are issued by banks for short-term funding needs. Usually, banks issue CDs when credit pick-
up is higher than bank deposit growth. CDs save on operational costs of the Bank as these take
place in bulk. Issued for 3, 6 and 12 months maturity. Also, issued at a discount and redeemed at
par.

4.1.5 Commercial Papers (CPs)
CPs are issued by corporates (mostly NBFCs), primary dealers and all-India financial institutions
(other than Banks), as a source of short-term finance. In a way CDs and CPs are similar, difference
being CDs are issued by Banks and CPs are issued by corporates. Issued at a discount to face
value and contains higher risk and yield than T-Bills.
4.1.6 Repurchase Agreements

These are short-term loans in which two parties agree to sell and repurchase the same security.
When considering a transaction from the seller's point of view, it is called a repo, and when
considering it from the buyer's point of view, it is called a reverse repo.
Only transactions in Central Government dated securities, Treasury bills, state development loans,
and GOI special securities like oil bonds that have been approved by the RBI may be conducted
through Repo or Reverse Repo between parties that have received RBI approval.
4.2 Capital Market

The capital market provides support to corporates for raising resources. The Securities and
Exchange Board of India (SEBI), along with the Reserve Bank of India are the regulatory authorities
for Indian securities market, to protect investors and improve the microstructure of capital markets
in India.
There are two components of capital market, primary and secondary. In primary markets,
companies, governments, or public sector institutions can raise funds through bond issues. In the
primary market, the investor directly buys shares / bonds of a company. In secondary markets, the
shares / bonds are bought and sold by the customers. On the platforms provided by Exchanges like
NSE or BSE, investors buy and sell instruments like stocks and bonds through brokers / sub-brokers.
4.2.1 Indian Capital Market scenario (Equity Market)
The market capitalization to Gross Domestic Product (GDP) ratio shows to what extent the market
is assigning a value to the listed corporates against the GDP of the economy. The perspective is the
current value against the historical average. The stock market capitalization-to-GDP ratio is also
known as the Buffett Indicator, after legendary investor Warren Buffett, who popularized its use. This
measures the total value of all listed shares divided by GDP.

1.22
113.332
103.803
94.824
88.788
78.893
76.448 77.368
72.886
69.608 69.020
61.190 62.707
Source: www.ceicdata.com
The chart above shows that investments in, and discounting of future earnings growth of Indian
companies has been moving up during the FY 2011 to 2022 represented by the increase in the ratio of
market capitalization to GDP.
However, earnings growth of companies has not kept pace with the increase in valuations given by
the market, as indicated in the chart above. If EPS does not grow as much and price goes up, the
market valuation, as represented by P/E ratio, moves to the higher side.
Source: PhillipCapital India Research

The P/E ratio, calculated on the basis of forward or expected EPS, has moved to the higher side.

4.2.2 Historical Returns from Equity

Returns from the equity market have been volatile. The following chart shows returns from Sensex
since inception on a rolling basis. Annual rolling means returns of every one year calculated every
year, three-year rolling return means returns over past three years, calculated every year, and so
on.
Year Sensex Rolling 1 Rolling 3 Rolling 5 Rolling 10 Rolling Rolling 20

End (1) YR Growth YR YR YR 15 YR YR
Growth Growth Growth Growth Growth
(2) (3) (4) (5) (6) (7) (8)
Mar-79 100
Mar-80 129 29%
Mar-81 173 35%
Mar-82 218 26% 30%
Mar-83 212 -3% 18%
Mar-84 245 16% 12% 20%
Mar-85 354 44% 18% 22%
Mar-86 574 62% 39% 27%
Mar-87 510 -11% 28% 19%
Mar-88 398 -22% 4% 13%
Mar-89 714 79% 8% 24% 22%
Mar-90 781 9% 15% 17% 20%
Mar-91 1168 50% 43% 15% 21%
Mar-92 4285 267% 82% 53% 35%
Mar-93 2281 -47% 43% 42% 27%
Mar-94 3779 66% 48% 40% 31% 27%
Mar-95 3261 -14% -9% 33% 25% 24%
Mar-96 3367 3% 14% 24% 19% 22%
Mar-97 3361 0% -4% -5% 21% 20%
Mar-98 3893 16% 6% 11% 26% 21%

1.24
Mar-99 3740 -4% 4% 0% 18% 20% 20%

Mar-00 5001 34% 14% 9% 20% 19% 20%
Mar-01 3604 -28% -3% 1% 12% 13% 16%
Mar-02 3469 -4% -2% 1% -2% 14% 15%
Mar-03 3049 -12% 15% -5% 3% 15% 14%
Mar-04 5591 83% 16% 8% 4% 15% 17%
Mar-05 6493 16% 23% 5% 7% 15% 16%
Mar-06 11280 74% 55% 26% 13% 16% 16%
Mar-07 13072 16% 33% 30% 15% 8% 18%
Mar-08 15644 20% 34% 39% 15% 14% 20%
Mar-09 9709 -38% -5% 12% 10% 6% 14%
Mar-10 17528 81% 10% 22% 13% 12% 17%
Mar-11 19445 11% 8% 12% 18% 12% 15%
Mar-12 17404 -10% 21% 6% 18% 12% 7%
Mar-13 18836 8% 2% 4% 20% 11% 11%
Mar-14 22386 19% 5% 18% 15% 13% 9%
Mar-15 27957 25% 17% 10% 16% 12% 11%
Mar-16 25342 -9% 10% 5% 8% 14% 11%
Mar-17 29621 17% 10% 11% 9% 15% 11%
Mar-18 32969 11% 6% 12% 8% 17% 11%
Mar-19 38673 17% 15% 12% 15% 14% 12%
Mar-20 29468 -24% 0% 1% 5% 11% 9%
Probability of Gain 27/41 32/39 34/37 31/32 27/27 22/22
Source: HDFC Mutual Fund

How to read it?
Return of 29% from March 1979 to March 1980 means over a holding period of one year. Then it
goes on like this every year. Return of 30% from March 1979 to March 1982 means over a holding

period of 3 years, annualized. Similarly, the same pattern will be followed for other 3-year holding
periods.
Conclusion:
On a one-year holding period basis, returns were positive in 27 out of 41 years, hence the probability
of positive return is 27/41. Over 10-year holding periods, it is positive in 31 out of 32 years, hence
over a long holding period probability of positive return is 31/32. Over 15 and 20 year holding periods,
it is always positive.
4.2.3 Bond Market

The Government and corporates issue bonds / debentures for raising resources. The market
capitalization concept is not used in the bond market as the market price is not much different from
the face value of instruments. To gauge the size of the market, we will look at the outstanding
quantum of securities. The primary goal of the bond market is to provide a mechanism for long term
funding of public and private expenditures. The most important advantage of investing in bonds is
that it helps diversify and grow your money. Debt or Bond can be defined as a loan for which an
investor is the lender. The issuer of the bond pays the investor interest (at a predetermined rate and
schedule) in return for the funding. The maturity date refers to the date on which the issuer has to
repay the principal to the investor. When an investor invests money via equity, he becomes an owner
in the corporation. In case of debt, the investor becomes a creditor to the issuing entity. To build a
diversified and stable portfolio, investing in debt securities is a must since it assures fixed income.
Amount outstanding % of total Amount outstanding as on
as on 31 Dec. 2015 Dec. 2015 (` Cr)
(` Cr)
G Secs 45,19,205 51 1,00,33,518.106
(as on Dec. 4, 2023)
SDLs 14,51,236 16 95,77,920
(as on Oct. 2023)
T Bills 4,25,648 5 1,00,65,404.70
(24 Nov. 2023)
Total Sovereign 63,96,089 72 No added the numbers above as
the dates are different
Corporate Bonds 19,11,226 22 44,16,320 (Sept. 2023)
CPs 3,08,109 4 3,64,999.65 (April 30, 2022)
CDs 2,06,559 2 201427.56 (April 22, 2022)

1.26
Total Corporate 24,26,294 28 No added the numbers above as

the dates are different
Total 88,22,383 100
Source: RBI, SEBI

As we observe from the chart above, the outstanding quantum of Government Securities, both
Centre and States, have been going up steadily. This is in line with the GDP growth of the country
and increase in size of Government budgets. The Central Government is the major issuer of
securities in the bond market.
Corporate bonds and Commercial Papers have also been increasing steadily, in line with the growth
of the corporate sector. This is another means of raising resources for them, apart from Bank loans.
Money market instruments like Treasury Bills and Certificates of Deposit have not increased much
as these are means of short-term funding. CPs have increased in quantum as the major issuers are
NBFCs; NBFCs require money as that is their input and output.
4.2.4 Subscribers to Government Securities
Source: RBI

TEST YOUR KNOWLEDGE
Multiple Choice Questions (MCQs)

1. The derivatives market deals in contracts whose value is based on the market value of the
asset being traded, called the ………….
(a) Forwards
(b) Futures
(c) Options
(d) Underlying
2. Which among the following is not a function of Financial Markets?
(a) puts savings into more productive use

(b) determines the price of securities
(c) makes financial assets risky and liquid
(d) lowers the cost of transactions
3. Which among the following is the primary stakeholder in the financial market?
(a) Merchant Bankers
(b) Brokers
(c) Underwriters
(d) Companies
4. The ………… make their profit on the difference in price between what they paid before the
IPO and when the shares are offered to the public.
(a) Underwriters
(b) Merchant Bankers

(c) Brokers
(d) Custodians

1.28
5. ………… is a voluntary market body for the bond, money, and derivatives markets.
(a) AMFI
(b) FIMMDA
(c) AIBI
(d) FEDAI
Theoretical Questions
1. What do you understand by financial markets? Discuss the importance of financial markets.
2. Explain briefly the various service providers in financial markets.
3. Discuss the important objectives of SEBI and make a brief comparison to its compatriot in
USA.
4. Explain briefly the various administrative authorities to facilitate the financial market.
ANSWERS/SOLUTIONS
Answers to the MCQ based Questions
1. (d) 2. (c) 3. (d) 4. (a) 5. (b)
Answers to the Theoretical Questions

1. Please refer to paragraph 1.2
2. Please refer to paragraph 3
3. Please refer to paragraph 3.(iii)
4. Please refer to paragraph 3.(iv)

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CHAPTER 1

After going through the chapter student shall be able to understand:

©The Institute of Chartered Accountants of India

Role of Financial Market in Economic

Stakeholders in Financial Market

Indian Financial Market Scenerio

©The Institute of Chartered Accountants of India

1. INTRODUCTION TO FINANCIAL MARKETS

Insurance Financial Commodity

1.1 Major types of financial markets

1.1.2 Bond market

©The Institute of Chartered Accountants of India

1.1.3 Commodities market

1.1.4 Currency Markets

1.1.5 Money Market

1.1.6 Derivatives market

©The Institute of Chartered Accountants of India

1.2 Importance of Financial Markets

♦ They provide individuals, companies, governments, and quasi-government organizations

©The Institute of Chartered Accountants of India

1.3 Size of the Global Financial Market

Source: Google to https://topforeignstocks.com/2011/08/23/how-big-is-the-global-financial-industry/

2. ROLE OF FINANCIAL MARKET IN ECONOMIC

©The Institute of Chartered Accountants of India

• The financial market is a mode of channelizing savings to investments.

2.1 Functions of Financial Markets

©The Institute of Chartered Accountants of India

Source: Google to https://slideplayer.com/slide/5737595/

2.2 The linkages in financial flows

©The Institute of Chartered Accountants of India

2.3 Contribution of market to economy

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3. STAKEHOLDERS IN FINANCIAL MARKET (DOMESTIC

©The Institute of Chartered Accountants of India

 Association of Mutual funds of India (AMFI)

(i) Primary stakeholders in financial market

©The Institute of Chartered Accountants of India

(ii) Service providers in financial market

©The Institute of Chartered Accountants of India

©The Institute of Chartered Accountants of India

(iii) Regulators in financial market

iii) Regulating the securities market.

 Register & Regulate intermediaries, collective investment schemes (including Mutual

©The Institute of Chartered Accountants of India

©The Institute of Chartered Accountants of India

(iv) Administrative authorities to facilitate the financial market

©The Institute of Chartered Accountants of India

©The Institute of Chartered Accountants of India

©The Institute of Chartered Accountants of India

4. INDIAN FINANCIAL MARKET SCENARIO

Source: Google to http://practicemock.com/blog/lic-aao/insurance-financial-market-awareness-indian-financial-system/

©The Institute of Chartered Accountants of India

4.1 Money Market Instruments

4.1.1 Treasury Bills

4.1.2 Cash Management Bills

4.1.3 Call Money, Notice Money, and Term Money

4.1.4 Certificate of Deposits (CDs)

©The Institute of Chartered Accountants of India

4.1.5 Commercial Papers (CPs)

4.1.6 Repurchase Agreements