UNIT – 10 FINANCIAL MARKETS

Meaning:

• Financial Market is a market for creation and exchange of financial assets like shares, bonds etc.
• It helps in mobilising savings and channelising them into the most productive uses.
• It helps to link the savers and the investors by mobilizing funds between them.
• The persons or institutions by which allocation of funds is done are called Financial
Intermediaries.
• They bring together borrowers and lenders and make funds available to those willing to pay for
their use.

Functions of Financial Market:-

1. Mobilisation of Savings and channeling them into the most productive uses:
• Financial market facilitates the transfer of savings from savers to investors.
• Thus helps to channelise surplus funds into the most productive use.
2. Facilitating Price discovery:
• Financial Market helps in interaction of savers and investors.
• This helps in the determination of prices of the financial assets such as shares,
debentures etc.
3. Provide Liquidity to Financial Assets :
• Financial market facilitates easy purchase and sale of financial assets.
• It provides liquidity to them so that they can be easily converted into cash whenever
required.
4. Reducing the cost of transactions:
• Financial market provides valuable information about securities.
• This helps in saving time, efforts and money and thus it reduces cost of transactions.

Types of Financial Markets

Money Market:-

• It is a market for short term funds / securities whose period of maturity is upto one year.
• The major participants in the money market are RBI, Commercial Banks, Non-Banking Finance
Companies, State Government, Large Corporate Houses and Mutual Funds.

The main instruments of money market are as follows:-

1. Treasury Bills :
• They are issued by the RBI on behalf of the Central Government to meet its short-term
requirement of funds.
• They are issued at a price which is lower than their face value and are repaid at par.
• They are available for a minimum amount of Rs 25000 and in multiples thereof.
 • They are also known as Zero Coupon Bonds.
• They are negotiable instruments i.e. they are freely transferable.
2. Commercial Paper :
• It is a short term unsecured promissory note issued by large credit worthy companies to
raise short term funds at lower rates of interest than market rates.
• They are negotiable instruments transferable by endorsement and delivery with a fixed
maturity period of 15 days to one year.
• Funds raised through commercial paper are used to meet the floatation costs. This is
bridge financing.
3. Call Money :
• It is short term finance repayable on demand, with a maturity period of one day to 15
days.
• It is used for interbank transactions.
• Call Money is a method by which banks borrow from each other to be able to maintain
the cash reserve ratio as per RBI.
• The interest rate paid on call money loans is known as the call rate which is fluctuating.
4. Certificate of Deposit :
• It is an unsecured instrument issued in bearer form by Commercial Banks & Financial
Institutions.
• They can be issued to individuals, Corporations and companies for raising money for a
short period ranging from 91 days to one year.
5. Commercial Bill :
• It is a bill of exchange used to finance the working capital requirements of business
firms.
• A seller of the goods draws the bill on the buyer when goods are sold on credit.
• When the bill is accepted by the buyer it becomes a marketable instrument and is called
a trade bill.
• These bills can be discounted with a bank if the seller needs funds before the bill
maturity.

Capital Market:

• It is a market for long term funds where debt and equity are traded. It consists of development
banks, commercial banks and stock exchanges.

The capital market can be divided into two parts:-

1. Primary Market.

2. Secondary Market.
Primary Market:

• lt deals with the new securities which are issued for the first time.
• It is also known as the New Issue Market.
• The investors in this market are banks, financial institutions, insurance companies, mutual funds
and individuals.
• It has no fixed geographical location and only buying of securities takes place in the primary
market.

Methods of floatation of New Issues in the Primary Market:-

1. Offer through Prospectus:

• It involves inviting subscription from the public through issue of prospectus.
• A prospectus makes a direct appeal to investors to raise capital through an
advertisement in newspapers and magazines.
2. Offer for sale:
• Under this method securities are offered for sale through intermediaries like issuing
houses or stock brokers.
• The company sells securities to intermediary / broker at an agreed price and the broker
resell them to investors at a higher price.
3. Private Placements:

• It refers to the process in which securities are allotted to institutional investor and some
selected individuals e.g. Financial Institutions, Insurance Companies etc.
• Capital is raised more quickly
• Companies who cannot afford a public issue choose this method
4. Rights Issue:
• It refers to the issue in which new shares are offered to the existing shareholders.
• They are offered in proportion to the number of shares they already possess.
5. e-IPOs:
• It is a method of issuing securities through an on-line system of stock exchange.
• A company proposing to issue capital to the public through the on-line system of the
stock exchange has to enter into an agreement with the stock exchange.
• This is called an e-initial public offer.
• SEBI's registered brokers have to be appointed for the purpose of accepting applications
and placing orders with the company.

Secondary Market:

• It is also known as the stock market or stock exchange where purchase and sale of existing
securities takes place.
• They are located at specified places and both the buying as well as selling of securities takes
place.
Difference between Primary and Secondary Market

Basis Primary Market Secondary Market

Securities traded Sale of securities by new or Trading of existing securities only
existing companies
Buying/selling Only buying of securities takes Both buying and selling takes
place place
Purpose Issued by the company Ownership of securities is
directly/intermediary exchanged between investors.
Company not involved
Capital formation Promotes capital formation Promotes capital formation
directly indirectly
Price determination Prices are determined by the Prices are determined by
company demand and supply
Location No fixed geographical location Located at specified places.

Stock Exchange / Share Market

• A Stock Exchange is an institution which provides a platform for buying and selling of existing
securities.
• It facilitates the exchange of a security i.e. share, debenture etc. into money and vice versa.

Following are some of the important functions of a Stock Exchange:-

1. Providing liquidity and Marketability to Existing Securities :

• Stock Exchange provides a ready and continuous market for the sale and purchase of
securities.
2. Pricing of Securities :
• Stock Exchange helps in constant valuation of securities.
• This provides instant information to both buyers and sellers and thus helps in pricing of
securities which is based on the forces of demand & supply.
3. Safety of transaction :
• The members of a stock exchange are well regulated, who are required to work within
the legal framework.
• This ensures safety of transactions.
4. Contributes to Economic Growth :
• Stock exchange provides a platform by which savings get channelised into the most
productive investment proposals.
• This leads to capital formation & economic growth.
5. Spreading of Equity cult:
• Stock exchange helps in educating public about investments in securities.
• This leads to spreading of Equity cult.
6. Providing scope for speculation:
 • Stock exchange provides scope within the provisions of law for speculation in a
restricted and controlled manner.
• This helps in regulating prices of securities.

Trading Procedure on a Stock Exchange:-

1. Selection of Broker :
• In order to trade on a Stock Exchange first a broker is selected who should be a member
of stock exchange as they can only trade on the stock exchange.
2. Opening of Demat account:
• In this account the securities are held electronically.
3. Placing the order :
• After selecting a broker, the investors specify the type and number of securities they
want to buy or sell.
4. Executing the order :
• The broker will buy or sell the securities as per the instructions of the investor.
5. Settlement :
• Transactions on a stock exchange may be carried out on either cash basis or carry over
basis (i.e. badla).
• The time period for which the transactions are carried forward is referred to as accounts
which vary from a fortnight to a month.
• All transactions made during one account are to be settled by payment for purchases
and by delivery of share certificates, which is a proof of ownership of securities by an
individual.

Earlier trading on a stock exchange took place through a public outcry or auction system which is now
replaced by an online screen based electronic trading system. Moreover, to eliminate, the problems of
theft, forgery, transfer, delays etc an electronic book entry from a holding and transferring securities has
been introduced, which is called process of dematerialisation of securities. The payment is T+2.

Difference between Capital and Money Market

Basis Capital Market Money Market

Participants Financial institutions, foreign RBI, Banks, Financial Institution
investors etc etc
Instruments Equity shares, debentures, T-bills, trade bills, C. P, certificate
bonds etc of deposit
Investment outlay Low-value of securities is less High-value of instruments is high
Duration Deals in medium and long term Deals in short term-one day to
securities one year
Liquidity Low-seller may not easily find a High-discount finance house of
buyer India is formed to provide ready
market
Safety Risky-long duration Very safe-short duration
Expected return High-securities remain for a long Short-securities are held only for
period with the investors one year

Depository Services and DEMAT Accounts:

Keeping in the mind the difficulties to transfer of shares in physical form, SEBI has developed a new
system in which trading in shares is made compulsory in electronic form Depository services system.

Depository services:-

'Depository' is an institution / organization which holds securities (e.g. shares, debentures, bonds,
mutual funds etc.) in electronic form, in which trading is done.

The services provided by a Depository are termed as 'Depository Services'.

At present there are two depositories in India:

1. NSDL (National Securities Depository Ltd.) and

2. CDSL (Central Depository Services Ltd.). which are known as "Depository Participants". (DPs)

Services provided by Depository

• Dematerialisation (usually known as demat) is converting physical certificates to electronic form.

• Rematerialisation, known as remat, is reverse of demat, i.e getting physical certificates from the
electronic securities.
• Transfer of securities, change of beneficial ownership.
• Settlement of trades done on exchange connected to the Depository.

Now a day’s on-line paper-less trading in shares of the company is compulsory in India. Depository
services are the name of that mechanism. In this system transfer of ownership in shares take place by
means of book entry without the physical delivery of shares. When an investor wants to deal in shares
of any company he has to open a Demat account.

There are four players who participate in this system.

1. The Depository: A depository is an institution which holds the shares of an investor in electronic
form. There are two depository institutions in India these are NSDL and CDSL.

2. The Depository Participant: He opens the account of Investor and maintains securities records.

3. The Investor: He is a person who wants to deal in shares whose name is recorded

4. The Issuing Company: That organisation which issues the securities. This issuing company sends a
list of the shareholders to the depositories.
Benefits of Depository Services

1. Sale and Purchase of shares and stocks of any company on any stock Exchange.
2. Saves time.
3. Lower transaction costs.
4. Ease in trading.
5. Transparency in transactions.
6. No counterfeiting of security certificate
7. Physical presence of investor is not required in stock exchange.
8. Risk of mutilation and loss of security certificate is eliminated.

Demat Account

Demat account is the abbreviation of 'Dematerialized Account'. Demat (Dematerialized account refers to
an account which an Indian citizen must open with the depository) participant (banks, stockbrokers) to
trade in listed securities in electronic form wherein one can hold shares of various companies in the
Dematerialized {electronic} form. Access to De-mat account requires an internet password and a
transaction password. Transfer and purchase of securities can then be initiated. Purchase and sale of
securities on the De-mat account are automatically made once transaction is confirmed and completed.

Benefits of Demat Account

1. Reduces paper work.

2. Elimination of problems on transfer of shares such as loss, theft and delay.

3. Exemption of stamp duty when transfer of shares.

4. The concept of odd lot stand abolished.

5. Increase liquidity through speedy settlement.

6. Attract foreign investors and promoting foreign investment.

7. A single demat account can hold investments in both equity and debt instruments.

8. Traders can work from anywhere.

9. Automatic credit into demat account for shares arising out of bonus / split /consolidation / merger.

10. Immediate transfer of securities.

11. Change in address recorded with a DP gets registered with all companies in which investor holds
securities eliminating the need to correspond with each of them.
Opening of Demat Account

A Demat account is opened on the same lines as that of a bank account. Prescribed account opening
forms available with the DP, need to be filled in. Standard agreement is to be signed by the client and
the DP, which details the rights and obligation of both parties. Along with the form, the client is required
to attach photograph, attested copies of residence proof and proof of identity need to be submitted.

Securities and Exchange Board of India (SEBI)

SEBI was established by Government of India on 12 April 1988 as an interim administrative body to
promote orderly and healthy growth of securities market and for investor protection. It was given a
statutory status on 30 January 1992 through an ordinance, which was later replaced by an Act of
Parliament known as the SEBI Act, 1992. It seeks to protect the interest of investors in new and second
hand securities.

Objectives of SEBI

1. To regulate stock exchange and the securities market to promote their orderly functioning.

2. To protect the rights and interests of investors and to guide & educate them.

3 To prevent trade mal practices such as internal trading.

4. To regulate and develop a code of conduct and fair practices by intermediaries like brokers, merchant
bankers etc.

Functions of SEBI

The SEBI performs three important functions:-

1. Regulatory functions - These functions are performed by SEBI to regulate the business in stock
exchange.

2. Development functions - These functions are performed by SEBI to promote and develop activities in
stock.

3. Protective functions - These functions are performed by SEBI to protect the interest of investors and
provide safety on investments.

Functions of SEBI

Protective functions:

1. Prohibition of fraudulent and unfair trade practices e.g price rigging, misleading statements in
prospectus etc
2. Controlling and imposing penalties for insider trading
3. Protecting the interest of the investors
4. To promote fair practices and code of conduct in stock market
Regulatory functions:
1. Registration of brokers, sub-brokers etc
2. Registration of collective investment schemes and mutual funds
3. Regulation of stock brokers, underwriters etc
4. Regulation of take-over bids by companies
5. Levying charges and fee for carrying out activities for this purpose.
6. Undertaking of inspections, audits of stock exchanges and intermediaries.
Development functions:
1. Training of intermediaries
2. Conducting research and publishing information useful for market participants
3. Undertaking measures to develop the capital market
4. Investor education