Chapter – 10

Financial Markets

• Financial Market is a market for creation and exchange of financial assets like shares,
bonds etc. It helps in mobilizing savings and channelizing 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, Household (Savers)Business Firms(Investors)Banks and
Financial Markets.

• Functions of Financial Market:

1. Mobilization of Savings and channeling them into the most productive uses:
Financial market facilitates the transfer of savings from, savers to investors and thus
helps to channelize surplus funds into the most productive use.
2. Helps in Price Determination: Financial Market helps in interact on of savers and
investors which in turn 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. Thus, it provides liquidity to them so that they can be easily
converted into cash whenever required.
4. Reduce Cost of Transactions: Financial market provides valuable information about
securities which helps in saving tune, 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
up to 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. Treasure 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 arc 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.
3. Call Money: It is short term finance repayable on demand, with a maturity period of one
day to 15 days, 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.
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 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: It 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 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 resells 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.
4. Rights Issue: It refers to the issue in which new shares are offered to the existing
shareholders 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 Market and Secondary Market
Basis Primary Market Secondary Market
Securities Only new securities are traded Existing securities are traded
Price of Prices of securities are Prices are determined by the forces
Securities determined by the by the demand and supply of the
management of the company. securities.
Purchase and Securities are sold to investors Investors exchange ownership of
Sale directly by the company or securities.
through intermediary.
Place of There is no fixed geographical Located at specified places.
Market location.
Medium Only buying of securities takes Both buying and selling of securities
place. can take place.

• 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 which
provide 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 channelized into the most productive investment proposals, which leads to capital
formation & economic growth.
5. Spreading of Equity Culture: Stock exchange helps in educating public about
investments in securities which leads to spreading of Equity culture.
6. Providing Scope for Speculation: Stock exchange provides scope within the provisions
of law for speculation in a restricted and controlled manner.
• 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. Placing the order: After selecting a broker, the investors specify the type and number of
securities they want to buy or sell.
3. Executing the order: The broker will buy or sell the securities as per the instructions of
the investor.
4. 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
de materialization of securities.
Difference between Capital and Money Market
Basis Capital Market Money Market
Participants Financial Institutions, Banks, RBI, Banks Institutions and
Corporate Entities, foreign finance companies.
investors and individuals.
Instruments Equity shares, bonds preferences Treasury Bills, Trade Bills
traded and debentures, call money etc. commercial paper
Investment Does not necessarily require a Entails huge sum of money as the
Outlay huge financial outlay. instruments are quite expensive.
Duration Deals in medium and long term Deals in short term funds having
securities having a maturity a maturity period upto one year.
period of one year.
Liquidity Securities are less liquid as Money markets instruments are
money market securities. highly liquid
Expected High return Low return
 Safety Capital Market Instruments are Money market instruments are
riskier both with respect to generally much safer with a
return and repayment. minimum risk of default.

• 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 and D-Mat
Account are very basis of this 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: NSDL. (National Securities Depository Ltd.) and CDSL
(Central Depository Services Ltd.). which are known as “Depository Participants”. (DPs)
• Services provided by Depository: Dematerialization (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 is
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 organization which issues the securities. This issuing
company sends a list of the shareholders to the depositories.
• Benefits of Depository Services:
Sale and Purchase of shares and stocks of any company on any stock Exchange.
Saves time.
Lower transaction costs
Ease in trading.
Transparency in transactions.
No counterfeiting of security certificate
Physical presence of investor is not required in stock exchange.
Risk of mutilation and loss of security certificate is eliminated.
• Demat Account: Demat account is the abbreviation of ‘Dematerialized Account’.
(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 transfers 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 January1992 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: