Fundamentals

Of Financial
Markets
 Indian • Components
Financial
System • Functions

• Types of markets
TOPICS to Financial
Markets • Functions
be covered • Instruments

• Security Form of
Investment Investments
Avenues • Non Security Form
of Investment
 Indian Financial
System
Definition
– The financial system is a complex matrix of Institutions,
markets and financial instruments. It consists of specialized
and non-specialized financial institutions, of organized and
unorganized financial markets, of financial instruments and
services. All of these components facilitate transfer of funds.
– These parts are not always mutually exclusive; Inter-
relationships between these are a part of the system e.g.
In other words, the term financial system, implies a set
of complex and closely connected or inter-linked
Institutions, agent, practices, markets, transactions,
claims, and liabilities in the economy. The financial
system is concerned about money, credit and finance-
the three terms are intimately related yet are
somewhat different from each other.
Money -the current medium of exchange or means
of payment

Credit or loans is a sum of money to be returned, normally

with interest

Finance- monetary resources comprising debt and ownership

funds of the state, company or person
Features of Indian Financial System
 This system manages the flow of funds between the people (household
savings) of the country and the ones who may invest it wisely
(investors/businessmen) for the betterment of both the parties.
 It helps in mobilizing and allocating one’s savings.
 It facilitates the expansion of financial institutions and
markets
 Plays a key role in capital formation
 It helps forms a link between the investor and the one saving
 It is also concerned with the Provision of funds
 Functions of Indian Financial System

Liquidity Function Payment Function Saving Function

The financial system offers a
The most important An important function of a
function of a financial very convenient mode financial system is to
system is to provide of payment for goods and mobilize savings and channelize
money and monetary services. The cheque system them into productive activities. It is
assets for the production and credit card system through the financial system the
of goods and services. are the easiest methods of savings are transformed into
payment in the economy. The investments.
Monetary assets are cost and time of transactions
converted into cash or
money easily without loss are considerably reduced.
of value.
 Function Cont….

Risk Function Transfer Function

The financial markets provide protection
against life, health, and income risks. These
guarantees are accomplished through the
sale of life, health insurance, and property
insurance policies.
A financial system provides a mechanism
for the transfer of resources across
geographic boundaries.
Components of Indian Financial System
 Financial
Institutions Financial
Services

Financial
Intermediaries

Financial Financial
Markets Assets
Financial Instruments /Assets
This is an important component of financial system. The products which are traded in a financial
market are financial assets, securities or other type of financial instruments.
There is a wide range of securities in the markets since the needs of investors and credit seekers
are different.
•They indicate a claim on the settlement of principal down the road or payment of a regular
amount by means of interest or dividend.
•Equity Instruments: For example, Equity Shares and Preference Shares
•Debt Instruments: Debentures, Treasury bills, Bonds, Fixed deposits, cheques, bills etc.
•Derivative Instruments: Futures, forwards, options, swaps.
•Financial Intermediaries
•Financial intermediaries serve as middlemen for financial transactions, generally between
banks or funds.
•These intermediaries help create efficient markets and lower the cost of doing business.
•Intermediaries can provide leasing or factoring services, but do not accept deposits from
the public.
•Financial intermediaries offer the benefit of pooling risk, reducing cost, and providing
economies of scale, among others.
Financial Markets
A financial market is the place where financial assets are created or transferred. It can be
broadly categorized into money markets and capital markets. Money market handles short-
term financial assets (less than a year) whereas capital markets take care of those financial
assets that have maturity period of more than a year. The key functions are:
1. Assist in creation and allocation of credit and liquidity.
2.Serve as intermediaries for mobilization of savings.
3.Help achieve balanced economic growth.
4. Offer financial convenience.
primary markets and secondary markets. Primary markets handles new issue of securities in
contrast secondary markets take care of securities that are presently available in the stock
market.
Financial Services
The services offered by the different financial institutions for the management,
lending, borrowing and for the investment of funds is called as financial services.
There are various services provided by financial companies, few of them are:
• Housing finance Debit and credit card
• Consumer finance Asset management
• Depository services Online share trading
• Investment banking Credit rating services
• Different types of loans
 Role of Indian Financial System in Economic Development
1. Savings-investment relationship- To attain economic development, a country needs more investment and
production. This can happen only when there is a facility for savings. As, such savings are channelized to
productive resources in the form of investment.
2. Financial systems help in growth of capital market- Every business requires two types of capital namely,
fixed capital and working capital. Fixed capital is used for investment in fixed assets, like plant and machinery.
While working capital is used for the day-to-day running of business. It is also used for purchase of raw materials
and converting them into finished products.
• Fixed capital is raised through capital market by the issue of debentures and shares.
• Working capital is getting through money market, where short-term loans could be raised by the
businessmen through the issue of various credit instruments such as bills, promissory notes, etc.
3. Foreign exchange market- Enables the exporters and importers to receive and raise the
funds for settling transactions. It also enables banks to borrow from and lend to different
types of customers in various foreign currencies.
4. Government Securities market-Financial system enables the state and central
governments to raise both short-term and long-term funds through the issue of bills and
bonds which carry attractive rates of interest along with tax concessions.
5. Infrastructure and growth- Economic development of any country depends on the
infrastructure facility available in the country. In the absence of key industries like coal,
power and oil, development of other industries will be hampered. It is here that the
financial services play a crucial role by providing funds for the growth of infrastructure
industries.
6. Development of trade-The financial system helps in the promotion of both domestic and foreign trade. The

financial institutions finance traders and the financial market helps in discounting financial instruments such as

bills. Foreign trade is promoted due to per-shipment and post-shipment finance by commercial banks. They also

issue Letter of Credit in favor of the importer.

7. Employment growth is boosted by financial system- The presence of financial system will generate more

employment opportunities in the country. The money market which is a part of financial system provides

working capital to the businessmen and manufacturers due to which production increases, resulting in

generating more employment opportunities. Various financial services such as leasing, factoring, merchant

banking, etc., will also generate more employment. The growth of trade in the country also induces employment

opportunities.
8. Venture capital - There are various reasons for lack of growth of venture capital companies in India. The economic
development of a country will be rapid when more ventures are promoted which require modern technology and
venture capital. Venture capital cannot be provided by individual companies as it involves more risks. It is only through
financial system, more financial institutions will contribute a part of their investable funds for the promotion of new
ventures.
9. Financial system ensures balanced growth - Economic development requires a balanced growth which means growth
in all the sectors simultaneously. Primary sector, secondary sector and tertiary sector require adequate funds for their
growth. The financial system in the country will be geared up by the authorities in such a way that the available funds
will be distributed to all the sectors in such a manner, that there will be a balanced growth in industries, agriculture and
service sectors.
10. Financial system’s role in balanced regional development -Through the financial system, backward areas could be
developed by providing various concessions. This ensures a balanced development throughout the country and this will
mitigate political or any other kind of disturbances in the country. It will also check migration of rural population towards
towns and cities.
11. . Attracting foreign capital -Financial system promotes capital market. A dynamic capital market is capable
of attracting funds both from domestic and abroad. With more capital, investment will expand and this will
speed up the economic development of a country.
A financial market is a market where financial instruments are exchanged or
traded. Financial markets basically fulfill the role of exchanging securities
between Definition
buyers and sellers, a place where you can trade instruments.
– On a broader perspective, say globally, New York Stock Exchange, London
Stock Exchange, the Swiss Markets functions with buying and selling
bonds, stocks, convertible bonds etc. Within India, mainly two main stock
exchanges, Bombay Stock Exchange and National Stock Exchange make up
the stock markets. There are other regional stock exchanges mainly
Madras Stock Exchange, Bangalore Stock Exchanges ,etc.
 Functions of Financial Market

1. Mobilization of Savings and Channeling them into the most Productive Uses: A financial market
facilitates the transfer of savings from savers to investors. It gives savers the choice of different
investments and thus helps to channelize surplus funds into the most productive use .

2. Facilitating Price Discovery: You all know that the forces of demand and supply help to establish a price
for a commodity or service in the market. In the financial market, the households are suppliers of funds and
business firms represent the demand. The interaction between them helps to establish a price for the
financial asset which is being traded in that particular market.

3. Providing Liquidity to Financial Assets: Financial markets facilitate easy purchase and sale of financial
assets. In doing so they provide liquidity to financial assets, so that they can be easily converted into cash
whenever required. Holders of assets can readily sell their financial assets through the mechanism of the
financial market.

4.Reducing the Cost of Transactions: Financial markets provide valuable information about securities being
traded in the market. It helps to save time, effort and money that both buyers and sellers of a financial
asset would have to otherwise spend to try and find each other. The financial market is thus, a common
platform where buyers and sellers can meet for fulfillment of their individual needs.
Types of Financial Markets
 Debt Market
Nature of claim
Equity Market
Maturity of Money market Primary
claim Market
Types of Capital Market
Financial Timing of Secondary
Markets Delivery Cash Market Market
Future Market
Organizational Exchange Traded
Structure Market
Over the Counter
Market
Dr. Shaifali Mathur
By Nature of Claim
1. Debt Market: The market where fixed claims or debt instruments, such as debentures or bonds are bought
and sold between investors.
2. Equity Market: Equity market is a market wherein the investors deal in equity instruments. It is the market
for residual claims.

By Maturity of Claim
1. Money Market: The market where monetary assets such as commercial paper, certificate of deposits,
treasury bills, etc. which mature within a year, are traded is called money market. It is the market for short-
term funds. No such market exist physically; the transactions are performed over a virtual network, i.e. fax,
internet or phone.
2. Capital Market: The market where medium and long term financial assets are traded in the capital market. It
is divided into two types:
Primary Market: A financial market, wherein the company listed on an exchange, for the first time, issues
new security or already listed company brings the fresh issue.

Secondary Market: Alternately known as the Stock market, a secondary market is an organized marketplace,
wherein already issued securities are traded between investors, such as individuals, merchant bankers,
stockbrokers and mutual funds.

By Timing of Delivery
Cash Market: The market where the transaction between buyers and sellers are settled in
real-time.
Futures Market: Futures market is one where the delivery or settlement of commodities
takes place at a future specified date.

By Organizational Structure
Exchange-Traded Market: A financial market, which has a centralized organization with the
standardized procedure.
Over-the-Counter Market: An OTC is characterized by a decentralized organization, having
customized procedures.
 Types of
Financial
Markets

Money Capital
Market Market

Primary Secondary
Market Market
Money Market
Money Market is a market for financial assets that are close substitute for money. It is a market for overnight to short term funds and
instruments having a maturity period of one or less than one year.
The characteristics of Money market are :
 It is not a single market but collection of markets for several instruments.
 It is market purely for short-term funds or financial assets called near money.
 It deals with financial assets having a maturity period up to one year only.
 It deals with only those assets which can be converted into cash readily without loss and with minimum transaction cost.
 Generally transactions take place through phone i.e., oral communication. Relevant documents and written communications can be
exchanged subsequently. There is no formal place like stock exchange as in the case of a capital market.
 Transactions have to be conducted without the help of brokers.
 The components of a money market are the Central Bank, Commercial Banks, Non-banking financial companies, discount houses
and acceptance house. Commercial banks generally play a dominant in this market.
 Objectives of Money Market

The following are the important objectives of a money market:

 To provide a parking place to employ short-term surplus funds.
 To provide room for overcoming short-term deficits.
 To enable the Central Bank to influence and regulate liquidity in the economy
through its intervention in this market.
 To provide a reasonable access to users of Short-term funds to meet their
requirements quickly, adequately and at reasonable costs.
 Functions of Money Market

1. A money market by providing profitable investment opportunities for short-term surplus funds helps to
enhance the profit of financial institutions.
2. A money market enhances the amount of liquidity available to the entire country.
3. A well-developed money market helps to avoid wide seasonal fluctuations in the interest rates.
4. A well-developed money market, through quick transfer of funds from one place to another, helps to avoid
the regional gluts and stringencies of funds.
5. By providing various kinds of credit instruments suitable and attractive for different sections, a money
market augments the supply of funds.
6. A well-organized money market is essential for the successful operation of the central banking policies.
 Central Governm
Bank ent ( Participants
(Intermedia Borrowers
/ Issuers)
of Money
ry/Regulato
r Market
Financial
Banks Institutions
(Borrower ( Borrowers/
s/ Issuers) Issuers/Invest
ors

FIIs Dealers
( (Intermediari
es)
Investors)

Corporates
(Issuers)
 Instruments of Money Market

Treasury
Call Money
Bills

Commercial Certificate
papers of deposits

Commercial
Bills
 Treasury Bills

 TBs are short term instruments issued by the Reserve Bank of India on behalf of the government to tide
over short term liquidity shortfalls.
 This instrument is used by the government to raise short term funds to bridge seasonal or temporary
gaps between its receipts and expenditure.
 They are also known as Zero Coupon Bonds issued by the Reserve Bank of India on behalf of the Central
Government to meet its short-term requirement of funds. Treasury bills are issued in the form of a
promissory note.
 They are issued at a price which is lower than their face value and repaid at par. The difference between
the price at which the treasury bills are issued and their redemption value is the interest receivable on
them and is called discount.
 They are negotiable securities.
 They are highly liquid as they are of short tenure and there is possibility of inter bank repos in
them.
 There is absence of default risk.
 They are not issued in scrip form The purchase and sales are effected through Subsidiary Ledger
account (SGL).
 They have an assured yield, low transaction cost and are eligible for inclusion the securities for SLR
purposes.
 Treasury Bills are available for a minimum amount of Rs 25,000 and its multiples thereof.
 At present , there are 91 days ,182 days, and 364 days T bills .
 Call Money

Call money is short term finance repayable on demand, with a maturity period of one day to fifteen days,
used for inter-bank transactions. Commercial bank borrow money without collateral from other bank banks
to maintain a minimum cash balance known as the cash reserve requirement. This interbank borrowing
has led to the development of call money market.
Participants of Call money market
 1971- UTI and LIC were allowed to operate as lender in call money market.
 1978- brokers were allowed to participate in call money market and they would affect transactions
between lenders and borrowers.
 1996-97- RBI permitted primary dealers to participate in this market as both borrowers and lender.
 The call money market is now a pure inter bank money market with effect from August 6,2005.
Dr. Shaifali Mathur
 Commercial Bills

 A commercial bill is a bill of exchange used to finance the working capital

requirements of business firms. It is a short-term, negotiable, self-liquidating
instrument which is used to finance the credit sales of firms.
 The bank discounts the bills keeping certain margin and credit the proceeds.
 Banks, when in the need of money, can also get such bills rediscounted by financial
institutions such as LIC, UTI, GIC, ICICI and IRBI .
Capital Market

 The capital market is a marketplace, which focuses on long-term loans.

 It provides the industry with fixed and working capital and finances long term and medium-term

borrowings of the state, local and central governments. Therefore, the capital market deals in

ordinary stocks like debentures of corporations and shares, securities, and bonds of governments.

 Moreover, the funds, which flow into the capital market come from people who have savings to

invest, the commercial banks, the merchant banks, and non-bank financial intermediaries, like,

finance houses, building societies, insurance companies, venture capital, leasing finance, mutual

funds, unit trusts, investment trusts, etc

Functions of Capital Market

1.Mobilization of Savings : Capital market is an important source for mobilizing idle savings from the
economy. It mobilizes funds from people for further investments in the productive channels of an economy.
In that sense it activate the ideal monetary resources and puts them in proper investments.
2. Capital Formation : Capital market helps in capital formation. Capital formation is net addition to the
existing stock of capital in the economy. Through mobilization of ideal resources it generates savings; the
mobilized savings are made available to various segments such as agriculture, industry, etc. This helps in
increasing capital formation.
3. Provision of Investment Avenue : Capital market raises resources for longer periods of time. Thus it
provides an investment avenue for people who wish to invest resources for a long period of time. It provides
suitable interest rate returns also to investors. Instruments such as bonds, equities, units of mutual funds,
insurance policies, etc. definitely provides diverse investment avenue for the public.
4. Speed up Economic Growth and Development : Capital market enhances production and productivity in
the national economy.
 As it makes funds available for long period of time, the financial requirements of business houses are
met by the capital market.
 It helps in research and development. This helps in, increasing production and productivity in economy
by generation of employment and development of infrastructure.
5. Proper Regulation of Funds : Capital markets not only helps in fund mobilization, but it also helps in
proper allocation of these resources. It can have regulation over the resources so that it can direct funds in
a qualitative manner.
6. Service Provision : As an important financial set up capital market provides various types of services. It
includes long term and medium term loans to industry, underwriting services, consultancy services, export
finance, etc. These services help the manufacturing sector in a large spectrum.
7. Continuous Availability of Funds: Capital market is place where the investment avenue is
continuously available for long term investment. This is a liquid market as it makes fund available on
continuous basis. Both buyers and seller can easily buy and sell securities as they are continuously
available. Basically capital market transactions are related to the stock exchanges. Thus marketability in
the capital market becomes easy.
8. Stability in Security Prices: The capital market tends to stabilise the values of stocks and securities
and reduce the fluctuations in the prices to the minimum. The process of stabilisation is facilitated by
providing capital to the borrowers at a lower interest rate and reducing the speculative and
unproductive activities.
Types of Capital Markets
# It sometimes referred to as the new issue market. Thus, it solely deals with the issue of new
securities such as securities that investors get for the first time.
# The main objective of the primary market is the capital formation for governments, institutions,
companies, etc.
# It helps investors invest their extra funds and savings in enterprises looking to expand their
companies or companies starting new projects
# Type is commonly known as the stock exchange or the stock market. in the secondary market, the
trading appears for existing securities.
# On the secondary market, the securities, i.e., debentures, bonds, bills, shares, etc. are sold and
bought by the investors.
# The securities traded in a highly legalized and regularised market within regulations and strict rules.
This, therefore, ensures that the investors can invest without the fear scammers.
 Capital Market Instruments

Shares Bonds

Government
Securities

Debentures Derivatives
1. Shares: Share is the share in the share capital of the company. Share is one of the units into which
the capital of company is divided. A person having the shares of the company is called as shareholder of
that company, He is regarded as the part of owner of the company.
There are 2 types of shares:
Equity shares-An equity instrument offers ownership rights in a firm, like a share certificate. Equity
instruments are generally issued to company shareholders and are used to fund the business.
Preference shares-Preferred stock also represents owning a share of the company. Preferred stock
pays a predetermined dividend, whereas the dividends paid to common shareholders tend to vary
according to the company's fortunes.

2. Debentures : Debentures are long term borrowed funds of the company. They have fixed
maturity period as well as fixed interest rate. These are the certificates issued under common seal of
the company
3. Bonds: Bonds are debt instruments that are issued by companies/governments to raise funds for
financing their capital requirements. By purchasing a bond, an investor lends money for a fixed period of
time at a predetermined interest (coupon) rate. Bonds have a fixed face value, which is the amount to be
returned to the investor upon maturity of the bond.

4. Derivatives: These are instruments that derive from other securities, which are referred to as
underlying assets. The price, riskiness and function of the derivative depend on the underlying assets since
whatever affects the underlying asset must affect the derivative.
Some examples of derivatives are:
 Futures & Forwards
 Options
 Swaps
 Commodities
5. Government Securities:
Securities issued by the central government or state governments are referred to as government securities
(G-Secs). They have the safety and security of investments made in them with regularity of return. These are
guaranteed by the government. The central government raises funds through the issue of dated securities
(securities with maturity period ranging from two years to 30 years, long-term) and treasury bills (securities
with maturity periods of 91 or 364 days, short-term). State governments go about raising money through
State Development Loans (SDLs). Local bodies of various states like municipalities also tap the bond market
from time to time.
They are issued in denominations of Rs. 100 or Rs. 1000. The interest is payable half yearly. They are issued
through the public debt office of RBI (PDO). The Public Debt Office (PDO) of RBI manages the government
issues. G-secs may be issued in Physical form or in dematerialised form. They are issued by RBI in
consultation with Government, through auctions conducted electronically.
Functions of Primary Market
A. Origination
Origination means to examine, evaluate, and process new project proposals in the
primary market. Before an issue is present in the market, it begins. With the help of
commercial bankers, it is done.
The merchant bankers might be banks, private investment firms, financial institutions,
etc.
The preliminary investigation in the primary market includes a thorough study of
economic, financial, lawful, industrial aspects to make sure the soundness of the
project. Supporting institutions also perform the functions of capital markets. They
provide advisory service.
Well, advisory service involves;
 Magnitude of Issue
 Types of issue
 Pricing
 Techniques of selling securities
B. Underwriting
To ensure the success of a new issue in the primary market, there is a need for
underwriting firms. The functions of capital market also force the company to
employ underwriters. They can be economic institutions, banks, or specialized
underwriting firms. Underwriting is an agreement, where by the underwriter
promises to subscribe to a specified number of shares or debentures or a specified
amount of stock in the event of public not subscribing to the issue.
 Underwriters guaranteed minimum subscription. There will be no liability left for underwriters if
the issue is completely subscribed.
 In any case, when by chance any part of the issue remains unsold then the underwriters have to
buy all the unsubscribed shares as they don’t have any option.
C. Distribution
In the functions of financial market or primary market, the success of any grand new
issue is the pivot on the issue being subscribed by the people. Brokers and dealers are
given job distribution.
The brokers or agents do direct contact with supreme investors.
Capital market plays a significant role in mobilizing resources and diverting them in
productive channels. It facilitates and encourages the procedure of economic growth in
the country. Functions of capital market include linking between savers and investors.