Financial Markets

Introduction
to
Financial Markets
 Topic: Introduction to Financial Markets

Firms

Banks Financial
Market

Household
 Topic: Introduction to Financial Markets

Introduction:
• In an economy, there are two major
sectors, viz, households and producers.
• Households usually save a part of their
income to earn returns on it through
investment.
• On the other hand, producers and
business firms are in need of finance at
all times for conducting business
activities.
• Financial markets and banks act as
intermediaries in the allocative
function of matching the demand and
supply of funds.
 Topic: Introduction to Financial Markets

Introduction:

• If the allocative function of directing

funds available for investment into the
most productive investment
opportunity is performed well, it leads
to:

1. Higher rate of return to households.

2. Allocation of scarce resources to
those firms, which have the highest
productivity.
 Topic: Introduction to Financial Markets

Terms Used in Definition of Financial

Market:
A financial market is a market for the creation
and exchange of financial assets:

Creation of financial assets Such as the initial

issue, i.e. the issue of shares and debentures by
a firm, for the first time.

Exchange of assets Purchase and sale of

existing financial assets like equity shares,
debentures, bonds, etc.

Financial assets Shares, debentures, treasury

bills, bonds, etc.
 Topic: Concept of Financial Markets

Firms

Banks Financial
Market

Household
Financial Markets
Functions
of
Financial Markets
 Topic: Functions of Financial Markets

Mobilisation of U
Reducing the cost
funds N of transactions
C

I
Providing
Facilitating price O
liquidity to
discovery N
financial assets
S
 Topic: Functions of Financial Markets

Mobilization of funds: Mobilization of

savings and channelizing them into the most
productive uses A financial market facilitates
the transfer of savings from savers to investors.
Thus, it helps in channelizing surplus funds into
the most productive uses.

Facilitating price discovery: Households

represent the supply of funds and the business
firms represent the demand. The interaction
between the demand and supply helps in the
price discovery of financial asset, which is
being traded in a particular market.
 Topic: Functions of Financial Markets

Providing liquidity to financial assets:

Financial market facilitates the easy
purchase and sale of financial assets. In
doing so, they provide liquidity, which
means that financial assets are easily
converted into cash whenever required.

Reducing the cost of transactions:

Financial markets provide a common
platform where buyers and sellers meet. It
helps in saving time, effort and money for
the buyers and sellers at the time of trading
in the market, by providing them with
valuable information.
 Classification of
Financial Markets
Money Market
 Topic: Money Market

Financial Market

Capital Market Money Market

Primary Market for

Market short-term

Secondary
Market
 Topic: Money Market

Introduction:
 Money market refers to the market for
short-term funds, which deals in monetary
assets whose period of maturity is up to one
year.

 It has no physical location and most of the

activities are conducted over the telephone
and internet.

 Money Market satisfies short-term financial

requirements of a business (like working
capital requirement)
 Topic: Money Market

Features of Money Market:

1. It’s a market for short-term funds which
deals in monetary assets whose period of
maturity is up to one year.
2. Instruments of the money market are quite
expensive.
3. Money market instruments are highly
liquid.
4. Money market instruments are less risky.
5. The expected return from money market
instruments is less due to their short
duration.
 Topic: Money Market

Major Participants of Money Market:

1. Reserve Bank of India (RBI),
2. Commercial Banks,
3. Life Insurance Corporation of India
(LIC),
4. General Insurance Corporation of
India (GIC),
5. Non-Banking Finance Companies,
6. State Governments,
7. Large Corporate Houses and
8. Mutual Funds.
 Classification of
Financial Markets
Money Market
Instruments
 Topic: Money Market Instruments

Treasury
Bill

Commercial
Commercial Bill
Paper

Money Market
Instruments

Certificate of
Call Money
Deposit
 Topic: Money Market Instruments

Treasury Bills (T-Bills):

 It is a short-term borrowing instrument issued by the
Government of India.
 RBI issues it on behalf of the Government of India. 14-364
 It is also known as zero-coupon bonds. Days
 It has a maturity of less than one year.
 It is issued at discount and repaid at par. e.g. A
treasury bill of face value of ₹1,00,000 will be sold at
₹ 96,000 and at the time of maturity, the investor will
get ₹ 1,00,000. Thus, ₹ 4,000 is the interest received
by him.
 It is in the form of a promissory note.
 It is highly liquid and has negligible risk.
 It is available in denominations of ₹ 25,000 and its
multiples.
 Topic: Money Market Instruments
Commercial Paper:
 Commercial paper is issued by large creditworthy
companies to raise short-term funds at lower rates of
interest than the market rate.
 It is an unsecured promissory note
15-364
 It is a negotiable instrument, transferable by Days
endorsement and delivery.
 It is sold at discount and redeemed at par.
 The original purpose of the commercial paper was to
meet the working capital needs of companies.
 It is used by companies for bridge financing, a method of
financing used by companies before issuing shares or
debentures, to cover the expenses associated with the
issue of such securities.
 Topic: Money Market Instruments
Call Money:
 Call money is a method used by commercial banks to
borrow funds from each other, in order to maintain the
Cash Reserve Ratio (CRR). 1-15 Days
 It is short-term finance repayable on demand.
 The interest paid on call money is called the call rate.
 Call rate is highly fluctuating, which varies from day to
day or even from hour to hour.
 There is an inverse relationship between call rates and
return on other short-term money market instruments.
 Increase in call rates makes the demand for call money
decrease, and increase in demand for other short-term
instruments, as they become cheaper in relation to call
money.
 Topic: Money Market Instruments

Certificate of Deposit:
 Certificates of deposits are issued by 91-364
commercial banks or developmental financial Days
institutions to individuals, institutions,
corporations and companies.
 It is an unsecured, negotiable instrument in
bearer form.
 It is issued in periods of tight liquidity, when
the deposits by individuals and households is
less, but the demand for credit is high.
 They help to mobilize large amounts of money
in a short time period.
 Topic: Money Market Instruments

Commercial Bill:
 It is a bill of exchange used by business firms to meet
their working capital needs.
 It is a short-term, self-liquidating, negotiable
instrument, used for financing credit sales of a firm.
 When goods are sold on credit, the seller(drawer) draws
a bill of exchange on the buyer (drawee), who accepts
it.
 When he accepts the bill, it becomes a marketable
instrument, which is called a trade bill.
 When the seller presents it to the bank for discounting
it, to get the funds before the maturity of the bill and
the bank accepts it,it is called a commercial bill.
 Classification of
Financial Markets
Capital Market
 Topic: Capital Market

Introduction:
 Capital Market refers to whole network that
provide medium and long-term funds.

 Capital market consists of a series of

channels through which savings of the
community are made available for industrial
and commercial enterprises and for the
public in general.

 It encourages people to invest their small

savings into the most productive use. It leads
to growth and development of the economy.
 Topic: Capital Market

Introduction:
 Capital Market consists of development
banks, commercial banks and stock
exchanges.

 Long-term funds are raised and invested in

the form of both debt and equity.

 The instruments used in capital market are:

Shares, Debentures, Bonds, Public deposits,
etc.
 Financial Market

Capital Market Money Market

Primary Market for

Market short-term

Secondary
Market
 Topic: Capital Market

Capital Market

Primary Market Secondary Market

 Classification of
Financial Markets

Definition
Of
Primary Market
Topic: Definition of Primary Market
 Topic: Definition of Primary Market

Introduction:
• The primary market refers to the
market wherein securities are created
and sold for the first time. A.K.A “New
Issues Market”.

• The essential function of a primary

market is to facilitate the transfer of
investible funds from savers to
entrepreneurs.

• The investors in this market are banks,

financial institutions, insurance
companies, mutual funds and
individuals.
 Topic: Definition of Primary Market

Introduction:

• The common securities through which

a company can raise capital in the
primary market are: Equity shares,
Preference shares, Debentures, etc.

• Funds raised may be for setting up of

new projects, expansion,
diversification, modernization of
existing projects, mergers and
takeovers, etc.
 Classification of
Financial Markets

Methods of Floatation in
Primary Market
 Topic: Methods of Floatation in Primary Market

Offer Through
Prospectus

Private
Offer for Sale
Placement

Methods of
Floatation

E-IPOs Rights Issue

 Topic: Methods of Floatation in Primary Market

Offer Through Prospectus:

• The company invites the public to apply for its

securities through the issue of a prospectus.
• It is the most popular method of raising funds by
public companies in the primary market.
• A prospectus makes a direct appeal to investors to
raise capital.
• The company also uses the services of underwriters
or brokers.
• The issue is required to be listed on at least one
stock exchange.
• The contents of the prospectus should be in
accordance with provisions of the Companies Act
and SEBI.
 Topic: Methods of Floatation in Primary Market

Offer for Sale:

• Under this method, securities are not issued

directly to the public.
• They are first issued to intermediaries like
issue houses and stock brokers at a fixed
price.
• These intermediaries, in turn, resell the
securities to the investing public at higher
price.
• This method saves the company from
formalities and complexities of issuing
securities directly to the public.
 Topic: Methods of Floatation in Primary Market

Private Placement:

• Under this method, company sells the

securities to some selected institutional
investors and individuals.
• This method helps to raise capital more
quickly as compared to public issue.
• This method is also economical as it saves
the various mandatory and non-mandatory
expenses of public issue.
• Companies, which cannot afford a public
issue, prefer the method of private
placement and issue securities privately to
investors like UTI, LIC, GIC, etc.
 Topic: Methods of Floatation in Primary Market

Rights Issue:

• Company offers the new shares to its

existing shareholders.
• This method gives right to the existing
shareholders to subscribe to new issue of
shares.
• If the existing shareholders do not
subscribe to the securities during the
prescribed time, then the offer is opened
for the general public.
• Rights Issue is a compulsory requirement
under the Companies Act. However, this
method can be used only by existing
companies.
 Topic: Methods of Floatation in Primary Market
E-IPOs:

• Company issues capital to public through

online system of stock exchange.
• This initial public offer (IPO) by company is
known as E-IPO as it makes use of electronic
technology.
• A registrar having electronic connectivity with
stock exchange is appointed.
• Securities have to be listed on any exchange
other than the exchange through which
company has earlier offered its securities.
• The lead manager coordinates all the activities
of various intermediaries connected with the
issue.
 Classification of
Financial Markets

Definition
Of
Secondary Market
Introduction:
• The secondary market is where investors buy and sell
securities they already own.

• Secondary markets are also called as stock market

or stock exchange.

• The national exchanges, such as the Bombay Stock

Exchange (BSE), National Stock Exchange (NSE),
New York Stock Exchange (NYSE) and
the NASDAQ are secondary markets.

• All securities in secondary market are traded, cleared

and settled within the regulatory framework
prescribed by SEBI
Secondary Market functions in Three-Tier Form:

Regional
Stock
Exchange
(22)

National
Stock
Exchange
(NSE)

Over The Counter

Exchange of India
(OTCEI)
Concept and Meaning
The Securities Contracts (Regulation) Act 1956,
defines stock exchange as

1. an institution which provides a platform for

buying and selling of existing securities.

2. Facilitates the exchange of a security (share,

debenture etc.) into money and vice versa.

3. Helps companies to raise finance, provide

liquidity and safety of investment to the
investors and enhance the credit worthiness of
individual companies.
Functions of Stock Exchange:
1. Determining the security prices:

• Since the stock exchange operates on the demand

and supply of securities, this concept is leveraged
for determining the prices on a continuous basis.

• The securities that are growth-oriented and

profitable have a higher value. Based on this
valuation of securities, investors and traders can
assess and determine the security that will give
them the most returns on investments.
Functions of Stock Exchange:
2. Maintaining Liquidity:

• One of the most important functions of stock

exchange is maintaining liquidity.

• As securities can be easily sold and bought on an

exchange, there is a higher probability of
converting them into cash.

• This function allows investors to stay confident

about trading in the stock exchange.
Functions of Stock Exchange:
3. Safety of Transaction:

• In the stock exchange, all securities are traded,

cleared and settled within the regulatory
framework prescribed by SEBI.

• To deal in securities even the brokers need to

take membership of stock exchange.

• The legal and regulatory framework of SEBI

ensures that investors get a safe and fair deal for
their securities in the capital market.
Functions of Stock Exchange:
4. Contributes to Economic Growth:

• The stock exchange provides investors the

opportunity to disinvest and reinvest in existing
securities by selling or purchasing securities.

• The disinvestment and reinvestment channelizes

the savings into most productive investment
ventures.

• This contributes towards capital formation and

economic growth.
Functions of Stock Exchange:
5. Spreading of Equity Cult:

• Stock exchange provides important information

to educate people about the listed companies and
the various securities available.

• This ensures better trading practices and

regulates new issues to widen the
share ownership.
Functions of Stock Exchange:
6. Providing Scope for Speculation:

• Prices of financial securities are determined by

the forces of demand and supply thus may
fluctuate from time to time.

• Stock exchange within the provisions of law

provides for a restricted and controlled
speculation to generate profits from fluctuations
in security prices.

• This restricted speculation ensures liquidity and

price continuity in the stock market.
Trading Procedure on a Stock Exchange:
 Before the companies start selling the
securities through the stock exchange, they
have to first get their securities listed on the
stock exchange.

 The name of the company is included in

listed securities only when the authorities of
the stock exchange are satisfied with the
financial soundness and various other aspects
of the company
1. Selection of Broker:

 One can buy and sell securities only through

the brokers registered under SEBI and who
are members of the stock exchange.

 Hence, the first step of the trading procedure

is the selection of a broker who will buy/sell
securities on the behalf of a speculator or
investor.

 After getting information regarding all the

said things, the broker opens a trading
account in the name of the investor.
2. Opening Demat Account with Depository

 An account that must be opened with the

Depository Participant for trading in the listed
securities in electronic form is known as Demat
(Dematerialised) Account or Beneficial Owner
(BO) Account.

 The Depository and the investor do not have direct

contact with each other and interact with each
other through Depository Participants only.

 The Depository Participant will have to maintain

the securities account balances of the investor and
intimate investor from time to time about the status
of their holdings.
National Securities Depository Ltd (NSDL)
Central Securities Depository Ltd (CDSL)
3. Placing the Order:

 The investor can place the order to the broker

either personally or through email, phone,
etc.

 The investor must make sure that the order

placed clearly specifies the range or price at
which the securities can be sold or bought.

 For example, an order placed by Kashish is,

“Buy 200 equity shares of Nestle for no more
than ₹200 per share.”
4. Executing Order:

 When the shares can be bought or sold at

the price mentioned by the investor, it will
be communicated to the broker terminal,
and then the order will be executed
electronically.

 Once the order has been executed, the

broker will issue a trade confirmation slip
to the investors.
 A Contract Note
( A legal document which may be use to settle
disputes or claims between the broker and the
investor )
5. Delivery of Share and making Payment:

 In the next step, the investor has to deliver the shares sold or has to pay cash for the shares
bought.

 The investor has to do so immediately after receiving the contract note or before the day when
the broker shall make delivery of shares to the exchange or make payment.

 This is known as Pay in Day.

6. Settlement Cycle:

 The payment of securities in cash or delivery of

securities is done on Pay in Day, which is before
T+2 Day.

 It is because the settlement cycle is T+2 days on

w.e.f April 2003 rolling settlement basis.
7. Delivery of Shares or Making Payment:

 On the T+2 Day, the Stock Exchange will then

deliver the share or make payment to the other
broker.

 This is known as Pay out Day.

 Once the shares have been delivered, the broker has

to make payment to the investor within 24 hours of
the pay out day, as he/she has already received
payment from the exchange.
8. Delivery of Shares in Demat Form:

 The last step of the trading procedure is

making delivery or shares in Demat form by
the broker directly to the Demat Account of
the investor.

 The investor is obligated to give details of

his Demat Account and instruct his
Depository Participant (DP) for taking
delivery of securities directly in his
beneficial owner account.
Demutualisation of Stock Exchanges:

• Earlier the stock exchanges were owned, controlled and managed

by the brokers who were registered as members with stock
exchanges.

• Stock exchanges being owned and managed by brokers trading

in financial instruments led to conflict of interest between the
brokers and their clients.

• To avoid the conflicts, stock exchanges were demutualised.

• This means the stock exchanges will be owned and controlled by

professionals who will not be the brokers involved in trading of
financial instruments or securities.
Benefits of Demutualisation:

(i) It ensures that stock exchange is not owned and

controlled by individuals or firms dealing in trading
of securities.

(ii) It reduces the possibility of conflict between the

stock exchanges, brokers and clients.

(iii) It reduces the chance of brokers using the stock

exchanges for their personal gains.
Dematerialisation of Securities:
• In earlier times the Indian stock exchanges dealt in physical
form.

• To eliminate these problems 'Dematerialisation of

Securities' was introduced under the Depositories Act, 1996.

• Under dematerialization process the securities held by the

investor in physical form are cancelled and the investor is
given an electronic entry or number.

• An investor has to open a demat account with an

organisation called depository.

• 'Today SEBI has made it mandatory to trade all securities

through computer terminals.
Depository:

Depository is an organisation or institution which holds securities in an

electronic form.

Investors at any time can deposit or withdraw securities

The trading of securities is done electronically

In India there are two types of depositories :

(1)National Securities Depositories Limited (NSDL). It is India's

first and largest depository which was promoted as a joint venture of
the IDBI, UTI and NSE.

(2)The Central Depository Sources Limited (CDSL). It is the second

depository which was promoted by the Bombay Stock Exchange and
The Bank of India.
Depository Participants:

• Both depositories are operational across India through

intermediaries.

• These intermediaries are called depository participants (DP) who are

electronically connected with the depository and act as the contact
points with the investors.

• Depository participants maintain securities account balance and

inform the investors the status of their securities from time to time.

• Examples of Depository participants are financial institutions, banks,

clearing corporations, stock brokers, non-banking
financial corporations.
Securities and Exchange Board of India (SEBI)

The Finance Ministry of the Government of India established SEBI as

an interim administrative body to promote orderly and healthy growth
of securities and to protect interest of investors.

88
Securities and Exchange Board of India
(SEBI)

 SEBI was established on 12 April 1988. It was given a

statutory status through an Ordinance on 30 January
1992 which was later replaced by Act of Parliament
known as the 'Securities and Exchange Board of India
Act, 1992.

 SEBI functions under the overall administrative control

of the Ministry of Finance.

 SEBI has its head office at Mumbai and regional

offices in Kolkatta, Chennai and Delhi.

89
Reasons for the Establishment of SEBI

 Capital markets were emerging as the new sensation among the individuals of India.

 Many malpractices started taking place such as unofficial private placements, rigging of prices,
non-adherence of provisions of the Companies Act, violation of rules and regulations of stock
exchanges, delay in delivery of shares, price rigging, etc.

 The government felt a sudden need to set up an authority to regulate the working and reduce
these malpractices.

90
Role of SEBI:
 This regulatory authority acts as a watchdog for all
the capital market participants and its main purpose
is to provide such an environment for the financial
market enthusiasts that facilitate the efficient and
smooth working of the securities market.

 To make this happen, it ensures that the three main

participants of the financial market are taken care
of, i.e. issuers of securities, investors, and financial
intermediaries.

91
Role of SEBI:
1. Issuers of securities
These are entities in the corporate field that raise funds
from various sources in the market.

2. Investor
This regulatory authority is responsible for maintaining
an environment that is free from malpractices to restore
the confidence of the general public who invest their
hard-earned money in the markets.

3. Financial Intermediaries
These are the people who act as middlemen between
the issuers and investors. They make the financial
transactions smooth and safe. 92
Functions of SEBI:

93
1. Protective Functions

As the name suggests, these functions are

performed by SEBI to protect the interest of
investors and other financial participants.
It includes-

 Checking price rigging

 Prevent insider trading
 Promote fair practices
 Create awareness among investors
 Prohibit fraudulent and unfair trade
practices

94
2. Regulatory Functions
These functions are basically performed to keep a
check on the functioning of the business in the
financial markets.
These functions include-

 Designing guidelines and code of conduct for

the proper functioning of financial
intermediaries and corporate.
 Regulation of takeover of companies
 Conducting inquiries and audit of exchanges
 Registration of brokers, sub-brokers,
merchant bankers etc.
 Levying of fees
 Performing and exercising powers
 Register and regulate credit rating agency
95
3. Development Functions

This regulatory authority performs certain

development functions also that include but
they are not limited to-

 Imparting training to intermediaries

 Promotion of fair trading and reduction of
malpractices
 Carry out research work
 Encouraging self-regulating organizations
 Buy-sell mutual funds directly from
AMC(Asset Management Company)
through a broker

96