Professional Documents
Culture Documents
Financial Market
Financial Market
Financial Market
Money Market & Capital
Market
By
Jatin Verma
Topics to be Covered
1. Financial Market-Introduction
What It is?
A market is a place where two parties are involved in transaction of goods and services in
exchange of money. The two parties involved are:
● Buyer
● Seller
Markets work by placing the two counterparts, buyers and sellers, at one place so they can find
each other easily, thus facilitating the deal between them.
In other words, a financial market is a market in which people and entities can trade financial
securities, commodities and other fungible assets at prices that are determined by pure supply
and demand principles.
Securities include stocks and bonds, and commodities include precious metals or agricultural
products.
Producers advertise goods and services to consumers in a financial market in order to generate
demand. Also, the term "market" is closely associated with financial assets and securities prices
(for example, the stock market or the bond market).
A good example of a financial market is a stock exchange. A company can raise money by
selling shares to investors and its existing shares can be bought or sold.
How it works?
This may be a physical location (like the NYSE, BSE, LSE, JSE) or an electronic system (like
NASDAQ).
Here, people who have a specific good or service they want to sell (the supply) interact with
people who wish to buy it (the demand).Therefore,prices in a financial market are determined by
changes in supply and demand.
If market demand is steady, an increase in market supply results in a decline in market prices and
vice versa.
If market supply is steady, a rise in demand results in a rise in market prices and vice versa.
Financial markets may be viewed as channels through which flow loanable funds directed from
a supplier who has an excess of assets toward a demander who experiences a deficit of funds.
Note:
Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are
outside an exchange, while any two companies or people, for whatever reason, may agree to sell
stock from the one to the other without using an exchange.
● Since the markets are public, they provide an open and transparent way to set prices on
everything traded.
● They reflect all available knowledge about everything traded. This reduces the cost of
getting information, because it's already incorporated into the price.
● The sheer size of the financial markets provide liquidity.
● In other words, sellers can unload assets whenever they need to raise cash.
● The size also reduces the cost of doing business, since companies don't have to go far to find
a buyer, or someone willing to sell.
● Without financial markets, borrowers would have difficulty finding lenders themselves.
● Intermediaries such as banks, Investment Banks, and other financial institutions can help in
this process.
● More complex transactions than a simple bank deposit require markets where lenders and
their agents can meet borrowers and their agents, and where existing borrowing or lending
commitments can be sold on to other parties.
Intermediary functions:
The intermediary functions of financial markets include the following:
● Transfer of resources: Financial markets facilitate the transfer of real economic resources
from lenders to ultimate borrowers.
● Enhancing income: Financial markets allow lenders to earn interest or dividend on their
surplus invisible funds, thus contributing to the enhancement of the individual and the
national income.
● Productive usage: Financial markets allow for the productive use of the funds borrowed.
The enhancing the income and the gross national production.
● Capital formation: Financial markets provide a channel through which new savings flow to
aid capital formation of a country.
● Price determination: Financial markets allow for the determination of price of the traded
financial assets through the interaction of buyers and sellers.
● Sale mechanism: Financial markets provide a mechanism for selling of a financial asset by
an investor so as to offer the benefit of marketability and liquidity of such assets.
● Information: The activities of the participants in the financial market result in the generation
and the consequent dissemination of information to the various segments of the market. So as
to reduce the cost of transaction of financial assets.
Financial Functions
● Providing the borrower with funds so as to enable them to carry out their investment plans.
● Providing the lenders with earning assets so as to enable them to earn wealth by deploying
the assets in production debentures.
● Providing liquidity in the market so as to facilitate trading of funds.
● Providing liquidity to commercial bank
● Facilitating credit creation
● Promoting savings
● Promoting investment
● Facilitating balanced economic growth
● Improving trading floors
There are also different types of financial markets and their characterization depends on the
properties of the financial claims being traded and the needs of the different market participants.
● Capital market
1. The capital market aids raising of capital on a long-term basis, generally over 1 year.
2. It consists of a primary and a secondary market and can be divided into two main
subgroups – Bond market and Stock market.
● Secondary market:
a) It’s a market for secondary sale of securities.
b) In other words, securities which have already passed through the new issue market are traded
in this market.
c) Generally, such securities are quoted in the stock exchange and it provides a continuous and
regular market for buying and selling of securities.
d) Simply put, Secondary market is the market where the second hand securities are sold.
4. Determination of prices: In case of primary market, the prices are determined by the
management with due compliance with SEBI requirement for new issue of securities. But in
case of secondary market, the price of the securities is determined by forces of demand and
supply of the market and keeps on fluctuating.
➢ The organized form of money market in India is just close to three decades old. However, its
presence has been there, but restricted to the government only.
➢ It was the Chakravarthy Committee (1985) which, for the first time, underlined the need of
an organised money market in the country and the Vahul Committee (1987) laid the blue
print for its development.
➢ Today, money market in India is not an integrated unit and has two segments— Unorganized
Money Market and Organized Money Market.
• Money Lenders: They constitute the most localized form of money market in India and
operate in the most exploitative way. They have their two forms:
1. The professional money lenders who lend their own money as a profession to earn
income through interest.
2. The non-professional money lenders who might be businessmen and lend their money to
earn interest income as a subsidiary business.
Status:
• As per a survey carried out by the National Sample Survey Organisation (NSSO) in 2009–10,
the total employment in the country was of 46.5 crore comprising around 2.8 crore in the
organized and the remaining 43.7 crore workers in the unorganized sector.
• Out of these workers in the unorganized sector, there are 24.6 crore workers employed in
agricultural sector, about 4.4 crore in construction work and remaining in manufacturing and
service.
• Certificate of Deposit (CD): Organized in 1989, the CD is used by banks and issued to the
depositors for a specified period ranging less than one year—they are negotiable and
tradable in the money market. Since 1993 the RBI allowed the financial institutions to
operate in it— IFCI, IDBI, IRBI (IIBI since 1997) and the Exim Bank—they can issue CDs
for the maturity periods above one year and upto three years.
• Commercial Paper (CP): Organized in 1990 it is used by the corporate houses in India
(which should be a listed company with a working capital of not less than Rs. 5 crore). The
CP issuing companies need to obtain a specified credit rating from an agency approved by
the RBI (such as CRISIL, ICRA, etc.)
• Commercial Bill (CB): Organized in 1990, a CB is issued by the All India Financial
Institutions (AIFIs), Non Banking Finance Companies (NBFCs), Scheduled
Commercial Banks, Merchant Banks, Co-operative Banks and the Mutual Funds. It
replaced the old Bill Market available since 1952 in the country.
• Call Money Market (CMM): This is basically an inter-bank money market where funds are
borrowed and lent, generally, for one day that is why this is also known as over-night
borrowing market (also called money at call). Fund can be borrowed/raised for a maximum
period upto 14 days (called short notice).
• Rate of interest in this market ‘glides’ with the ‘repo rate’ of the time the principle remains
very simple—longer the period, higher the interest rate. The scheduled commercial banks,
cooperative banks operate in this market as both the borrowers and lenders while LIC,
GIC, Mutual Funds, IDBI and NABARD are allowed to operate as only lenders in this
market.
• Money Market Mutual Fund (MF): Popular as Mutual Funds (MFs) this money market
instrument was introduced/organized in 1992 to provide short-term investment opportunity
to individuals. Since March 2000, MFs have been brought under the preview of SEBI,
besides the RBI.
• Repos and Reverse Repos: ‘Repo’ is basically an acronym of the rate of repurchase. Repo
allows the banks and other financial institutions to borrow money from the RBI for short-
term (by selling government securities to the RBI). In reverse repo, the banks and financial
institutions purchase government securities from the RBI (basically here the RBI is
borrowing from the banks and the financial institutions).
• All government securities are dated and the interest for the repo or reverse repo transactions
are announced by the RBI from time to time.
Recommendations:
• Accepting the recommendations of the Urjit Patel Committee, the RBI in April 2014
(while announcing the first Bi-monthly Credit & Monetary Policy-2014–15) announced to
introduce term repo and term reverse repo. This is believed to bring in higher stability and
better signaling of interest rates across different loan markets in the economy.
• Cash Management Bill (CMB): The Government of India, in consultation with the RBI,
decided to issue a new short-term instrument, known as Cash Management Bills, since
August 2009 to meet the temporary cash flow mismatches of the government. The Cash
Management Bills are non-standard and discounted instruments issued for maturities less
than 91 days.
Note:
• Treasury Bills serve the same purpose, but as they were put under the WMAs (Ways &
Means Advances) provisions by the Government of India in 1997, they did not remain a
discretionary route for the government in meeting its short-term requirements of funds. CBM
does not come under the similar WMAs provisions.
Mutual Funds
• A mutual fund is a fund that is created when a large number of investors put in their money,
and is managed by professionally qualified persons with experience in investing in different
asset classes—shares, bonds, money market instruments like call money, and other assets
such as gold and property.
• For example, a diversified equity fund will invest in a large number of stocks, while a gilt
fund will invest in government securities, while a pharma fund will mainly invest in stocks
of companies from the pharmaceutical and related industries.
• There are three types of schemes offered by MFs:
Mutual Funds
• Open-ended Schemes: It is one which is usually available from an MF on an ongoing basis,
that is, an investor can buy or sell as and when they intend to at a Net Assets Value (NAV) -
based price.
• As investors buy and sell units of a particular open-ended scheme, the number of units issued
also changes every day and so changes the value of the scheme’s portfolio. So, the NAV also
changes on a daily basis.
• In India, fund houses can sell any number of units of a particular scheme, but at times fund
houses restrict selling additional units of a scheme for some time.
• Closed-ended Schemes:A close-ended fund usually issue units to investors only once, when
they launch an offer, called new fund offer (NFO) in India. Thereafter, these units are listed
on the stock exchanges where they are traded on a daily basis. As these units are listed, any
investor can buy and sell these units through the exchange.
• They are managed by fund houses for a limited number of years, and at the end of the term
either money is returned to the investors or the scheme is made open ended.
• Exchange-Traded Funds (ETFs): ETFs are a mix of open-ended and close-ended schemes.
ETFs, like close-ended schemes, are listed and traded on a stock exchange on a daily basis,
but the price is usually very close to its NAV, or the underlying assets, like gold ETFs.
● Derivatives market
1. It facilitates the trading in financial instruments such as futures contracts and options
used to help control financial risk.
2. The instruments derive their value mostly from the value of an underlying asset that can
come in many forms – stocks, bonds, commodities, currencies or mortgages.
3. The derivatives market is split into two parts which are of completely different legal nature
and means to be traded.
Derivatives (explained)
What is a 'Derivative'
• A derivative is a security with a price that is dependent
upon or derived from one or more underlying assets.
• The derivative itself is a contract between two or more
parties based upon the asset or assets. Its value is
determined by fluctuations in the underlying asset. The
most common underlying assets include stocks, bonds,
commodities, currencies, interest rates and market
indexes.
• Certain kinds of derivatives can be used for hedging, or
insuring against risk on an asset. Derivatives can also be
used for speculation in betting on the future price of an
asset or in circumventing exchange rate issues.
1. Exchange-traded derivatives:
• These are standardized contracts traded on an organized futures exchange.
• They include futures, call options and put options.
2. Over-the-counter derivatives
• Those contracts that are privately negotiated and traded directly between the two
counterparts, without using the services of an intermediary like an exchange.
• Securities such as forwards, swaps, forward rate agreements, credit derivatives, exotic
options and other exotic derivatives are almost always traded this way.
• These are tailor-made contracts that remain largely unregulated and provide the buyer and
the seller with more flexibility in meeting their needs.
● Insurance market
1. It helps in relocating various risks.
2. Insurance is used to transfer the risk of a loss from one entity to another in exchange for a
payment.
3. The insurance market is a place where two peers, an insurer and the insured, or the so-called
policyholder, meet in order to strike a deal primarily used by the client to hedge against the
risk of an uncertain loss.
3. Individuals and firms use financial services markets, to purchase services that enhance the
working of debt and equity markets.
● Insurance market
● Equity Markets:
• A stock market, equity market or share market is the aggregation of buyers and sellers (a
loose network of economic transactions, not a physical facility or discrete entity) of stocks
(also called shares), which represent ownership claims on businesses; these may include
securities listed on a public stock exchange, as well as stock that is only traded privately,
such as shares of private companies which are sold to investors through equity crowd
funding platforms.
• An example of a secondary equity market for shares is the Bombay stock exchange(BSE),
National Stock Exchange (NSE) etc.
● What's the Difference Between the Equity Market and the Stock Market?
• Stocks and equity are same, as both represent the ownership in an entity (company) and
are traded on the stock exchanges. Equity by definition means ownership of assets after the
debt is paid off. Stock generally refers to traded equity.
• Stock is the type of equity that represents equity investment. When you buy a stock, you
expect returns in the form of dividend. Equity can also mean stocks shares.
● Debt market:
1. The market where funds are borrowed and lent is known as debt market.
2. Arrangements are made in such a way that the borrowers agree to pay the lender the original
amount of the loan plus some specified amount of interest.
● Depository markets:
• A depository market consists of depository institutions that accept deposit from individuals
and firms and uses these funds to participate in the debt market, by giving loans or
purchasing other debt instruments such as treasury bills.
● Non-depository market:
1. Non-depository market carry out various functions in financial markets ranging from
financial intermediary to selling, insurance etc.
2. The various constituency in non-depositary markets are mutual funds, insurance
companies, pension funds, brokerage firms etc.
Others
● Foreign Exchange Market
1. The foreign exchange market is a global decentralized or over-the-counter market for the
trading of currencies. This market determines foreign exchange rates for every currency.
2. It includes all aspects of buying, selling and exchanging currencies at current or determined
prices.
3. It’s the largest, most liquid market in the world with an average traded value of more than $5
trillion per day.
● Commodity market
The commodity market manages the trading in primary products which takes place in about 50
major commodity markets where entirely financial transactions increasingly outstrip physical
purchases which are to be delivered. Commodities are commonly classified in two subgroups.
1. Hard commodities are raw materials typically mined, such as gold, oil, rubber, iron ore etc.
2. Soft commodities are typically grown agricultural primary products such as wheat, cotton,
coffee, sugar etc.
Bonds
What are bonds?
• Bonds are instruments issued by a borrower to raise capital from investors or the public at
large. Bonds are like loans which mature on a fixed date. In return, the borrower pays
interest. Depending on the terms and conditions of the bond, the interest can be paid either at
specified intervals or on maturity (deep discount bond).
These are the different types of bonds available for investment in India:
Central Government bonds:
• These bonds are issued by the Central Government to raise funds. These bonds are issued by
the RBI on behalf of the Government.
• The primary purpose of these bonds is to finance fiscal deficit and meet the shortfall of
revenue in the Government budget.
• These bonds are the safest bonds to invest in, since they are backed by the Government and
will be repaid on maturity.
Corporate bonds:
• These are highly risky bonds since the maturity depends on the track record of the company.
Before investing in such bonds, you must do a complete study into the company and its
performance.
• Public Sector bonds:
These bonds are issued by highly rated public sector companies for meeting their growth and
expansion needs. These bonds are relatively less risky since PSUs are under the Government.
Generally, these bonds are issued by companies where the Central Government is the
majority shareholder.
1. Primary market:
This is the market where the borrower approaches investors to raise capital. The issue price
of the bonds and the coupon rate is fixed at the time of raising capital.
2. Secondary market:
Most of the bonds are traded in the stock market. They can be sold depending on when the
investor wishes to exit from the bond.
Government Securities
• A government security (G-Sec) is a tradeable instrument issued by the central government
or state governments. It acknowledges the government’s debt obligations.
• Such securities are short term called treasury bills with original maturities of less than one
year, or long term called government bonds or dated securities with original maturity of one
year or more.
• In India, the central government issues both: treasury bills and bonds or dated securities.
• While state governments issue only bonds or dated securities, which are called the state
development loans. Since they are issued by the government, they carry no risk of default,
and hence, are called risk-free gilt-edged instruments.
• The profit of the investors is the difference between the discounted issue price and the face
value. A weekly auction is carried out by the RBI for the purpose of issuing the treasury bills.