FINMAR (9:00-10:30am) (Thursday)

Introduction
Learning Outcomes
After the session the students is expected to:
Describe the elements of financial system, particularly the financial market
Describe the importance of financial market in maximizing firms profit and wealth
Differentiate the different types of financial market

What is a Financial System?

Six elements of the financial system
1. Ultimate lenders/borrowers
2. Financial intermediaries
3. Financial instruments (assets)
4. Creation of money
5. Financial markets
6. Price discovery
Classification of Financial Market
- Nature of claim
o Markets are categorized by the type of claim the investors have on the assets of
the entity in which they have made the investments. There are broadly two kinds
of claims, i.e. fixed claim and residual claim. Based on the nature of the claim,
there are two kinds of markets, viz.
 Debt market
 Debt market refers to the market where debt instruments such
as debentures, bonds, etc. are traded between investors. Such
instruments have fixed claims, i.e. their claim in the assets of the
entity is restricted to a certain amount. These instruments generally
carry a coupon rate, commonly known as interest, which remains
fixed over a period of time.
 Equity
 Higher income, more risks
 In this market, equity instruments are traded, as the name suggests
equity refers to the owner’s capital in the business and thus, have a
residual claim, implying, whatever is left in the business after
paying off the fixed liabilities belongs to the equity shareholders,
irrespective of the face value of shares held by them.
- Maturity of Claim
o While making an investment, the time period plays an important role as the
amount of investment depends on the time horizon of the investment, the time
period also affects the risk profile of an investment. An investment with a lower
time period carried lower risk as compared to an investment with a higher time
period.
 Money market
 Short term
 Stock market
 Money market is for short term funds, where the investors who
intend to invest for not longer than a year enter into a transaction.
This market deals with Monetary assets such as treasury
bills, commercial paper, and certificates of deposits. The maturity
period for all these instruments doesn’t exceeds a year. Since these
instruments have a low maturity period, they carry a lower risk
and a reasonable rate of return for the investors, generally in the
form of interest.
 No such market exist physically
 Capital market
 Long term
 Capital market refers to the market where instruments with
medium- and long-term maturity are traded. This is the market
where the maximum interchange of money happens, it helps
companies get access to money through equity capital, preference
share capital, etc. and it also provides investors access to invest in
the equity share capital of the company and be a party to the profits
earned by the company.
o Primary market
 Initial market
 Primary Market refers to the market, where the
company lists security for the first time or where the
already listed company issues fresh security. This
market involves the company and the shareholders
to transact with each other. The amount paid by
shareholders for the primary issue is received by the
company. There are two major types of products for
the primary market, viz. Initial Public Offer (IPO)
or Further Public Offer (FPO).

o Secondary market
 Once a company gets the security listed, the
security becomes available to be traded over the
exchange between the investors. The market that
 facilitates such trading is known as the secondary
market or the stock market.
- Timing of Delivery
o In addition to the above-discussed factors, such as time horizon, nature of the
claim, etc, there is another factor that has distinguished the markets into two parts,
i.e. timing of delivery of the security. This concept generally prevails in the
secondary market or stock market. Based on the timing of delivery, there are
two types of market:
 Cash market
 In this market, transactions are settled in real-time and it requires
the total amount of investment to be paid by the investors, either
through their own funds or through borrowed capital, generally
known as margin, which is allowed on the present holdings in the
account.
 Futures market
 In this market, the settlement or delivery of security or commodity
takes place at a future date. Transactions in such markets are
generally cash-settled instead of delivery settled. In order to trade
in the futures market, the total amount of assets is not required to
be paid, rather, a margin going up to a certain % of the asset
amount is sufficient to trade in the asset.
- Organizational Structure
o Markets are also categorized based on the structure of the market, i.e. the manner
in which transactions are conducted in the market. There are two types of market,
based on organizational structure:
 Exchange traded market
 Exchange-Traded Market is a centralized market, that works on
pre-established and standardized procedures. In this market, the
buyer and seller don’t know each other. Transactions are entered
into with the help of intermediaries, who are required to ensure the
settlement of the transactions between buyers and sellers. There are
standard products that are traded in such a market, there cannot
need specific or customized products.
 Over the counter market
 This market is decentralized, allowing customers to trade in
customized products based on the requirement.
 In these cases, buyers and sellers interact with each other.
Generally, Over-the-counter market transactions involve
transactions for hedging of foreign currency exposure, exposure to
commodities, etc. These transactions occur over-the-counter as
different companies have different maturity dates for debt, which
generally doesn’t coincide with the settlement dates of exchange-
traded contracts.
 Over a period of time, financial markets have gained importance in
fulfilling the capital requirements for companies and also
providing investment avenues to the investors in the country.
Financial markets provide transparent pricing, high liquidity, and
investor protection, from frauds and malpractices.