CHAPTER 10

FINANCIAL MARKETS
A financial market is a market for the creation and exchange of financial assets such as issue and sale of
equity shares, debentures and bonds.

Banks and financial markets are the competing intermediaries in the financial system and give
households a choice of where to plant their savings. The process by which allocation of funds is done is
called Financial Intermediation.

Functions of Financial Market:

1. Mobilization of saving and channeling them into the most Productive use: A financial market
facilitates the transfer of savings from savers to investors.
2. Facilitating Price Discovery: In the financial market households are the suppliers of funds and
business firms represents the demand. The interaction between them helps to establish a price
for the financial asset which is being traded.
3. Providing Liquidity to Financial Assets: financial markets facilitate easy trading if financial assets
and this provide liquidity to financial assets.
4. Reducing the Cost of Transaction: financial markets provide valuable information about
securities being traded in the market and this helps to save time, money and effort of both
buyers and sellers.

MONEY MARKET:

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

The major participants in this market are Reserve Bank of India (RBI), Commercial Banks, Non-Banking
Finance Companies, State Governments ,Large Corporate Houses and Mutual Funds.

Money market Instruments:

1. Treasuary Bill: It is basically an instrument of short-term borrowing by the Government Of India

maturing in less than one year. they Zero-coupon Bonds. They are issued in the form of
Promissory note. They have assured yield. They are issued at discount and repaid at par.
2. Commercial paper: it is a short term unsecured Promissory note, negotiable and transferable by
endorsement and delivery with a fixed maturity period. It is issued by large and creditworthy
companies to raise short-term funds at lower interest rates with a maturity period of 15 days to
one year.
3. Call money: it is a method by which banks borrow from each other to be able to maintain the
cash reserve ratio.it is a short term finance repayable on demand with a maturity period of one
day to fifteen days.the varied interest rate on this is known as Call rate.
4. Certificate of Deposit: these are unsecured , negotiable m short –term instruments in bearer
form , issued by commercial banks and development financial institutions.
 5. Commercial Bills: it is a bill of exchange used to finance the working capital requirement of
business firms.when goods are sold on credit, the seller draws the bill and the buyer accepts the
bill. On being accepted the bill becomes a marketable instrument and is called a Trade bill.

Capital Market: It refers to the facilities and institutional arrangements through which long-term funds ,
both debt and equity are raised and invested. The capital market consists of development banks,
commercial banks and stock exchanges. It is divided into Primary market and Secondary market.

Distinction between Capital market and Money market:

Basis Capital Market Money Market

Participants Financial institutions, banks ,corporate RBI, Banks, financial institutions,
entities, foreign investors, ordinary retail finance companies
investors
Instruments Equity shares, debentures, bonds, Short term debt instruments like
preference shares treasury bills, trade bills,
commercial paper etc.
Investment outlay Value of units of securities generally low. Transactions entail huge sums of
Example: Rs.10, Rs.100 money.
Duration Deals in medium and long term securities Term varies from one day to
maximum of one year.
Liquidity They are liquid instruments because they Discount Finance House of India
are marketable in the stock exchange. But provides a ready market for this
cannot be easily traded instruments and are highly liquid
Safety Riskier with respect to returns and Safer with a minimum risk of
principal repayment default.
Expected return Higher return than money market. Capital Low compared to capital market.
gain and high dividend if it kept for long
period of time.
PRIMARY MARKET: It also known as new issues market. It deals with new securities being issued for
the first time. The investors in this market are banks, financial institutions, insurance companies . mutual
funds and individuals.

Methods of Floatation in the Primary market:

1. Offer through Prospectus: It is the most popular method of raising funds . This involves inviting
subscriptions from the public through issue of Prospectus.it is a direct appeal to investors
through an advertisement in newspapers. The issue may be underwritten and required to be
listed in at least one stock exchange and provisions should be according to the guidelines of
SEBI
2. Offer for sale: in this a company sells securities at an agreed price to brokers who, in turn , resell
them to the investing public.
3. Private Placement: It is the allotment of securities by a company to institutional investors and
some selected individuals and it is chosen by the companies which cannot afford a public issue.
4. Rights Issue: The shareholders are offered the ‘right’ to buy new shares in proportion to the
number of shares they already possess.
 5. e-IPOs: 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 Initial
Public Offer (IPO).

Secondary Market: secondary market is also known as the stock market or stock exchange.

It is the market for the purchase and sale of existing securities . Securities are traded, cleared and
settled within the regulatory framework prescribed by SEBI.

Stock Exchange: Stock exchange is an institution help companies to raise finance, provide liquidity and
safety investment to the investors and enhance the creditworthiness of individual companies.

According to the Securities Contracts (Regulation) Act 1956, stock exchange means any body of
individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or
controlling the business of buying and selling or dealing in securities.

Functions of Stock Exchange:

1. Providing liquidity and marketability to existing securities: basic function of stock exchange is
the creation of continuous market where securities are bought and sold.
2. Pricing Securities: A stock exchange is a mechanism of constant valuation through which the
prices of securities are determined.
3. Safety of Transaction: Its dealing are regulated within the legal framework.
4. Contributes to Economic growth: Because through stock exchange the process of
disinvestment and reinvestment of savings get channelized into most productive investments.
5. Spreading of Equity Cult: stock exchange can play a vital role in ensuring wider share ownership
by regulating new issues better trading practices and taking effective steps in educating the
public about investments.
6. Providing scope for Speculation: certain degree of healthy speculation is necessary to ensure
liquidity and price continuity in the stock market.

Trading Procedure: Now trading in securities is now executed through an on-line , screen-based
electronic trading system.

Now trading has shifted from the stock market floor to the brokers office who are members of the stock
exchange. Every broker has to have access to a computer that is connected to the main stock exchange.
In this a member logs on to the site and any information about the share he wishes to buy or sell and
the price is fed into the computer. The transaction will be executed when a matching order is found
from a counter party. Both the parties being able to see the prices of all shares going up and down at all
times during business hours of the stock exchange. The computer in the brokers office is constantly
matching the orders at the best bid and offer price. That are not matched remain on the screen and
open for future matching.

Dematerialisation: It is a process where securities held by the investor in the physical form are
cancelled and the investor is given an electronic entry or number so that the investor can hold it as an
electronic balance in an account. This process of holding securities in an electronic form is called
dematerialization.
Depository: It is like a bank and keeps securities in electronic form on behalf of the investor.it is a
technology driven electronic storage system. In India there are Two depositories: National Securities
Depositories Limited (NSDL) and National Stock Exchange.

SEBI (Securities And Exchange Board Of India):

It was established by the Government of India on 12April 1988 as an interim administrative body to
promote orderly and healthy growth of securities market and for investor protection.

Objectives:

1. To regulate stock exchanges and the securities industry.

2. To protect the rights and interests of investors.
3. To prevent trading malpractices
4. To regulate and develop a code of conduct and fair practices by intermediaries like brokers,
merchant bankers etc.

Function of SEBI:

Regulatory functions: 1. Registration of brokers, sub-brokers and other players.

2. Registration of collective investment schemes and Mutual Funds.

3. Regulation of stock brokers, portfolio exchanges , underwriters etc.

4. Regulation of takeover bids by companies.

5. Calling for information by undertaking inspection, conducting enquiries and audits of stock exchanges
and intermediaries.

6. Levying fee or other charges.

7. Performing and exercising the powers delegated by the Government of India.

Development Functions:

1. Training of intermediaries
2. Conducting research and publishing information useful to all market participants
3. Undertaking measures to develop the capital markets.

Protective Function:

1. Prohibition of fraudulent and unfair trade practices

2. Controlling insider trading and imposing penalties for such practices.
3. Undertaking steps for investor protection
4. Promotion of fair practices and code of conduct in securities market.

Dept. Of Commerce