BBAIIYEAR III SEMESTER Financial Management I

Unit 2. Indian Financial Markets

1. Introduction,

2. Functions of Financial Markets,

3. Primary and secondary market.

2.1 Introduction
Financial markets - an overview
Think of a local marketplace. There are perhaps many stalls selling different
kinds of goods and products and they are constantly buzzing with activity. If we
asked you what your local marketplace is, you’ll probably say that it’s a space
where both buyers and sellers come together to buy and sell goods.

So, what are financial markets?

Much like a local marketplace, the financial markets are also virtual or physical
spaces that are dedicated to the purchase and sale of one kind of product -
financial assets. These financial assets can be anything, ranging from stocks and
bonds to commodities and currencies.

Financial markets are also sometimes referred to as the ‘capital markets’ or

simply ‘the markets.’ Whatever the name may be, the core nature of the
financial markets always remains the same - they’re designated spaces where
financial assets are traded.

Meaning of Financial Markets

The term ‘financial markets’ refers to those marketplaces where financial assets
are bought and sold. Financial assets include instruments like stocks and bonds.
Broadly speaking, the financial markets include various smaller marketplaces
like the stock market, the bond market, the forex market, the commodities
market and the derivatives market.

Some financial markets are regulated, while some may not be. And as with any
marketplace, the prices of the financial assets traded in financial markets also
keep fluctuating based on a number of factors.

Interested traders and investors can take advantage of these price movements
to earn returns on their investments.
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Evolution of Financial Markets

If you observe semi-urban areas or weekend markets, you’ll find an array of
sellers, all calling out to the customers and shouting out the prices of their goods.
This was mostly how people bought and sold things back in the day. Now,
however, we have air-conditioned supermarkets and sophisticated malls to buy
goods from. And that’s not to mention the scores of online marketplaces that
have cropped up in recent years.

Much like how regular marketplace has evolved, the financial markets too have
transformed radically over the years. A few decades earlier, financial markets
were essentially physical spaces where buyers and sellers would meet in person
to execute a financial transaction. This system of trading was commonly known
as the ‘open outcry system.’

But with the advancement of technology, these markets are now fully electronic.
So, buyers and sellers can conduct transactions from anywhere in the world,
through the power of the internet. However, there are still a few financial
markets where financial assets are traded through the traditional ‘open outcry
system.’

Ever since technology took over the financial markets, their popularity has
skyrocketed. As a matter of fact, millions of trades now take place every second
in the financial markets, generating a business of trillions of dollars in just a
single day.

2.2 Functions of Financial Markets

The functions of financial markets are not limited to just being trading spaces
for buyers and sellers. The financial markets perform a variety of roles to keep
the economy of a country functioning well. Let’s take a look at some of the
other functions of financial markets in order to understand them better.

1.They enable the mobilisation of money

Think about it. When you save a portion of your income, the money just sits
idle till you decide to use it for something. But financial markets allow you to
mobilise your savings by providing you with a way to invest. Financial markets
thereby help connect individuals and businesses that require capital with those
who are in possession of the said capital.

They also help you redirect the stagnated money back into the economy and put
it to good use, instead of merely leaving it idle. After all, the economy of a
nation can only be successful if there’s adequate circulation of money.
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2.They help determine the price of assets

The price of an asset fluctuates based on its demand and supply. Remember
grade school economics? When the demand is greater than the supply, the price
of goods rises. And when the supply is greater than the demand, the price falls.
That’s how demand and supply help determine the price of goods. And this
principle applies to financial markets as well.

Clearly, demand and supply are two of the most important forces out there,
driving global economic systems constantly and consistently. An economy
cannot exist in balance without either demand or supply. And since financial
markets are powered entirely by these two forces, they help determine the price
of the financial assets being traded. Without these markets, the prices of
financial assets would be unregulated and nearly impossible to determine fairly.

3.They ensure liquidity of the assets

Liquidity is essentially a metric that determines the ability of an asset to be

quickly purchased, sold, or converted to cash. Let’s simplify it even further with
a comparative example.

Gold is considered to be a highly liquid form of investment since it can be

quickly sold and converted to cash. That’s because of the high levels of demand
for the yellow metal. A real estate property, on the other hand, is generally
considered to be much less liquid because it cannot be sold off as quickly.

Financial markets act as fair platforms for sale and purchase of assets. By
allowing you to purchase and sell the said assets smoothly, they also ensure that
these financial assets are liquid. In other words, you don’t have to go too far to
find a buyer or a seller in these markets.

4.They help save time and money

Building up on the idea of liquidity and considering the fact that you can find a
buyer or a seller almost instantly, financial markets save a lot of time for
everyone involved. That’s not all. They also save you a lot of effort, which you
may have otherwise spent on finding probable buyers or sellers.

Furthermore, thanks to the financial markets going completely electronic, the

costs and fees associated with each transaction have reduced significantly. This,
in turn, helps you save a lot of money.
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5. Easy Access to Capital:

Industries require the investors to raise funds, and the investors require the
industries to invest their money and earn profitable returns.

Financial markets provide a venue for potential buyers and sellers to meet,
interact, agree, and deal.
This feature of the financial market not only helps in saving resources like time
and money but also makes trading much easier.

6. Risk sharing:
The financial market performs the function of risk sharing as the person who is
making the investments is different from the person who is selling their
assets/fund.
Here, the risk is transferred from the person who is selling the investments to
those who are buying the assets.
Further, it can be liquidated from the buyer to the next buyer of the financial
security. Hence, risk sharing is swiftly completed between parties.

7. Reduction in transaction costs and provision of the information:

It takes a lot of effort and time to operate in a typical market where people trade.
The financial market provides complete information regarding the price of
securities, availability of relevant derivatives, and cost of various financial
securities.
Investors and companies do not have to spend much on resources for getting
any kind of information as it is readily available in financial markets.
Usually, any trader requires various types of information for doing the
transaction of buying and selling the securities, which is obtained with the
disposal of time and money.
Here, the financial market helps provide every type of information to the traders
without the requirement of spending any money by them, hence reducing the
cost of the transactions.
**Some additional function of Financial Markets**
a.They help put idle money to good use
Without the financial markets, investors’ funds would remain idle. The markets help mobilize
funds and allow investors to earn returns in the process.
b.They ensure fair pricing of financial assets
Unregulated buying and selling of financial assets could drive prices irrationally high or send
them plummeting. Thankfully, market forces ensure that the securities are priced more fairly.
c.They give businesses easier access to capital
Companies and businesses that list their securities in the markets find it an easier and more
efficient way to raise the capital they need for their business operations or expansion.
d. They make financial assets more liquid
The financial markets also ensure that securities and financial assets are generally liquid.
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Otherwise, investors would find it harder to convert their assets to cash.

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2.3 Primary and secondary market.

Primary Market & Secondary Market: Meaning, Features, Key Differences, &
Types

For their short term fund requirements, businesses raise funds through the
money market. However, when they are in need of long term capital, businesses
turn to the capital market.
The capital market comprises the primary and secondary markets. In the
following finance study notes, we shall study more about the primary and
secondary markets, their meaning, key differences, and other types of financial
markets.

To start with, both the primary and secondary market are distinct terms.
Securities are created in the primary market. Whereas, these securities are
traded by the investors in the secondary market.

In the primary market, businesses are engaged in selling new bonds and stocks
to the public for the first time. This is also called the initial public offer or IPO.
The secondary market is nothing but the stock market, where securities are
traded.
A few examples of the secondary market are the National Stock Exchange of
India (NSE), Bombay Stock Exchange (BSE), New York Stock Exchange
(NYSE) NYSE Composite (^NYA), Nasdaq, etc.
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A.What is the Primary Market?

A primary market is one in which the securities are sold for the first time in
order to collect long-term capital for the businesses. It is basically responsible
for acquiring new issues. Therefore, it is also called the new issue market.

Funds collected for? Funds are used for?

1. Newly established businesses 1. Setting up a new business unit
2. Existing businesses 2. Expanding the business
3. Modernizing the plant, machinery,
etc.

Features of primary market:

1. It is a market for creation of long-term capital
2. Fresh issue of securities takes place in the primary market, wherein the
buyers are retail and institutional investors

What are the sources for raising capital in the primary market?
Sources of Raising Capital in the Primary Market
Public Issue Company issues the prospectus and invites the public to purchase
its shares and debentures
Offer for Sale New securities are offered to an intermediary firm or stockbroker at
a fixed price only to be resold to the general public.
Private Company sells securities to the institutional brokers or investors
Placement instead of selling them to the general public. The securities are then
sold to selected clients at a higher price.
(The Company issuing securities under private placement shall not
release any public advertisements or utilise any media, marketing
or distribution channels or agents to inform the public at large
about such an offer.)
Rights Issue It is used by a company who has already issued their shares.
However, in this case, the shareholder holds the right to either
accept the offer for himself or assign a part of his right in favour of
another person.
(No such restriction under the right issue since the issue involves
only existing shareholders.)
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B.What is the Secondary Market?

A secondary market is the one in which the securities of the companies are
traded among the investors. That means, the investors can buy and sell
securities freely without any intervention of the issuing company. In such
transactions that take place among the investors, the issuing company does not
participate in the income generation. Besides, the share valuation is based on the
share’s performance in the market.

Features of the Secondary Market

Apart from ensuring true and fair dealing for the protection of the investors’
interest, the features of the secondary market include the following:

1.Creating Liquidity: The most important feature of the secondary market is to

create liquidity, that means, immediate conversation of the securities into cash.
Besides, as the secondary market security can be sold and bought a number of
times, it aids in liquidity creation.

2.Follows the primary market: Unlike the primary market, any new security
cannot be sold for the first time in the secondary market. All the new securities
are first issued in the primary market and then are sold and bought in the
secondary one.

3.Stock Exchange: The secondary market has a particular place wherein the
securities are traded, it is called the Stock Exchange.

4.Encourages new investment: As the rates of the securities often fluctuate in

the share market, many investors come to trade and earn profits, giving rise to
new investment. This results in increased investment in the industrial sector.

Types of Secondary Market

The secondary market is mainly categorized into the Stock Exchanges and
Over-the-Counter markets. Given below is the brief summary of the same:
1.Stock Exchange
The stock exchanges are nothing but a centralized platform that enables trading
of the securities without any contact between the buyers and the sellers. The
Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) are the
foremost examples of the stock exchanges in India.
All the transactions taking place in the stock exchanges are subjected to
constricted regulations in the securities trading. A stock exchange acts as a
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guarantor and thus there is no risk of the counterparty risks.

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2.Over-the-Counter (OTC) Markets

These are decentralized markets, mainly consisting of participants that are
engaged in trading among themselves. As there is no regulatory authority
involved, and the parties deal directly with each other, there are counterparty
risks in the OTC markets. The FOREX (foreign exchange market) is an
example of the over-the-counter market.

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