Financial Market

Class 12
 Financial market
Refers to a market for the creation and exchange of financial assets (such as
shares and debentures).
Through this market, surplus money of investors is transferred to the entities
which requires it for investment and operational purposes, by exchange of
securities, known as financial assets.
Investors are surplus units and business enterprises are deficit units, where
the financial market acts as a link between surplus and deficit unit
 Functions of Financial Markets

• Mobilisation of savings and channelising them into the most productive uses: Financial markets act
as a link between savers and investors. Financial markets transfer savings of savers to most
appropriate investment opportunities.
• Facilitate price discovery: Price of anything depends upon the demand and supply factors. Demand
and supply of financial assets and securities in financial markets help in deciding the prices of
various financial securities.
• Provide liquidity to financial assets: In financial markets financial securities ca n be bought and
sold easily so financial market provides a platform to convert securities in cash.
• Reduce the cost of transaction: Financial market provides complete information regarding. price,
availability and cost of various financial securities. So investors and companies do not have to
spend much on getting this information as it is readily available in financial markets
 Classification of financial market
1. MONEY MARKET

Money market is a market for short term funds meant for use for a period of up to one year.
Generally, money market is the source of finance for working capital. Transactions of money
market include lending and borrowing of cash for a short period of time and also sale and
purchase
of securities having one year term or which gets redeemed (paid back) within one year period.

Money market is not a fixed geographical area but it constitutes all organisations and institutions
which deal with short-term debts. The common institutes are Reserve Bank of India, State Bank of
India, other Commercial Banks, LIC, UTI, etc.
 Features of Money Market
1. High Liquidity

They generate fixed-income for the investor and short term maturity make them highly liquid. Owing to this
characteristic money market instruments are considered as close substitutes of money.
2. Secure Investment

Since issuers of money market instruments have a high credit rating and the returns are fixed beforehand, the
very low or minimal risk of losing the invested capital.
3. Fixed returns

Since money market instruments are offered at a discount to the face value, the amount that the investor gets
on maturity is decided in advance. This effectively helps individuals in choosing the instrument which would
suit their needs and investment horizon.
 Features of Money Market
4. No fixed geographical location.
5. Major institutions involved in money market are RBI, Commercial Banks, LIC, GIC, etc.
6. Common instruments of money market are Call money, Treasury bill, Commercial Paper,
Certificate of Deposits, Commercial bills, etc.
 Types of Money Market Instruments

1. Treasury Bills (T-Bills)

These are issued by the RBI on behalf of the CG for raising money. They have short
term maturities with highest up to one year. Currently, T- Bills are issued with 3 different
maturity periods, which are, 91 days T-Bills, 182 days T- Bills, 1 year T – Bills.

T-Bills are issued at a discount to the face value. At maturity, the investor gets the face
value amount. This difference between the initial value and face value is the return
earned by the investor. They are the safest short term fixed income investments as they
are backed by the Government of India.
Types of Money Market Instruments
2. Commercial Papers (CP)

Large companies and businesses issue promissory notes to raise capital to meet short term
business needs, known as Commercial Papers (CPs). These firms have a high credit rating, owing
to which commercial papers are unsecured, with company’s credibility acting as security for the
financial instrument.

Corporates, primary dealers (PDs) and All-India Financial Institutions (FIs) can issue CPs.

CPs have a fixed maturity period ranging from 7 days to 270 days. However, investors can trade
this instrument in the secondary market. They offer relatively higher returns compared to that
from treasury bills.
Types of Money Market Instruments
3. Certificates of Deposits (CD)

CDs are financial assets that are issued by banks and financial institutions. They offer fixed interest rate
on the invested amount. The primary difference between a CD and a Fixed Deposit is that of the value of
principal amount that can be invested. The former is issued for large sums of money ( 1 lakh or in
multiples of 1 lakh thereafter).

Because of the restriction on minimum investment amount, CDs are more popular amongst organizations
than individuals who are looking to park their surplus for short term, and earn interest on the same.

The maturity period of Certificates of Deposits ranges from 7 days to 1 year, if issued by banks. Other
financial institutions can issue a CD with maturity ranging from 1 year to 3 years.
Types of Money Market Instruments
4. Call Money.

The money borrowed or lent on demand for a short period which is generally one day.
Sundays and other holidays are excluded for this purpose. Mostly Banks use call money.
When one bank faces temporary shortage of cash then the bank with surplus cash lends
to bank in shortage for one or two days.

Call money is called interbank call money market. But even other organisations such as
insurance companies, mutual fund companies, etc deals with call money The maturity
periods of call money are extremely short and varies from one day to fifteen days and its
liquidity is just next to cash.
Types of Money Market Instruments

5. Commercial Bills

Commercial bills, also a money market instrument, works more like the
bill of exchange. Businesses issue them to meet their short-term money
requirements.

These instruments provide much better liquidity. As the same can be

transferred from one person to another in case of immediate cash
requirements
 CAPITAL MARKET
Capital market is a market for medium and long term funds. It includes all
the organisations, Institutions and instruments that provide long term and
medium term funds. It does not include the Institutions and instruments
which provide finance for short period (up to one year). The common
instruments used in capital market are shares, debentures, bonds, mutual
funds, public deposits, etc.
 Features of Capital Market

• Serves as a link between Savers and Investment Opportunities:

The capital market serves as a crucial link between the saving and investment process as it transfers
money from savers to entrepreneurial borrowers.
• Long term Investment:

It helps the investors to invest their hard-earned money in long-term investments.

• Helps in Capital formation:

The capital market offers opportunities for those investors who have a surplus amount of money and
want to park their money in some type of investment and also take the benefit of the power of
compounding.
 Features of Capital Market
• Helps Intermediaries:

While transferring shares and money from one investor to another, it takes help from
intermediaries like brokers, banks, etc. thus helping them in conducting their business.
• Rules and Regulations

The capital markets operate under the regulation and rules of the Government thus making it a
safe place to trade.
• Over-the-counter (OTC) market
OTC market are financial instruments like currencies and stocks that are traded directly between
two parties.
 Types of capital market
A. The Primary Market
• The primary market is where securities are created. It's in this market that firms sell (
float) new stocks and bonds to the public for the first time. An initial public offering, or
IPO, is an example of a primary market. These trades provide an opportunity for
investors to buy securities from the bank that did the initial underwriting for a particular
stock. An IPO occurs when a private company issues stock to the public for the first
time.
• This is the first opportunity that investors have to contribute capital to a company
through the purchase of its stock. A company's equity capital is comprised of the funds
generated by the sale of stock on the primary market
 Method of Floatation of Securities in Primary Market

1. Offer through Prospectus

• Offer through prospectus is the most popular method of raising funds by public companies in the
primary market. After a prospectus is issued, the public subscribes to shares, debentures, etc. This
involves inviting subscription from the public through the issue of the prospectus. A prospectus
makes a direct appeal to investors to raise capital, through an advertisement in newspapers and
magazines. As per the response, shares are prearranged to the public. If the subscriptions are very
high, the allocation will be done on lottery or pro-rata basis.
• It provides such information as the reason for which the fund is being raised, the company’s
background and upcoming projection, it’s a precedent financial performance, etc.
 Method of Floatation of Securities in
Primary Market
2. Offer for Sale
• Institutional investors like business enterprise funds, private equity funds, etc., invest in an unlisted
company when it is very small or at an early stage. Under this method, securities are not issued
directly to the public but are offered for sale through intermediaries like issuing houses or stock
brokers.
• Consequently, when the company becomes big, these investors sell their shares to the public,
through the issue of the offer document and the company’s shares are listed in the stock exchange.
This is called an offer for sale. The advantage of this technique is that the company need not be
bothered about the printing and advertisement of the prospectus, allocation of shares, etc.
 Method of Floatation of Securities in
Primary Market
3. Private Placement
• A private placement is the allotment of securities by a company to institutional investors and
some selected individuals. Public offers are an exclusive concern. The subsidiary cost of
IPO’s lean to be very high. This is why some companies favor not to go down this route. It
helps to raise capital more quickly than a public issue. They offer investment opportunities to
a select few individuals. The private placement is the contradictory of a public issue, in which
securities are made accessible for sale on the open market.
• So the company will sell its shares to economic institutes, banks, insurance companies, and
some select individuals. This will help them raise the funds competently, rapidly and
efficiently. Such companies do not sell or offer their securities to the public at large. Financial
institutions, mutual funds, investment bank, etc. subscribe to placement orders
 Method of Floatation of Securities in
Primary Market
4. Rights Issue
• Usually, when a company is looking to expand or are in need of supplementary funds, they first
turn to their present investors. This is a privilege given to existing shareholders to subscribe to a
new issue of shares according to the terms and conditions of the company. So the present
shareholders are given a prospect to further invest in the company. They are given the “right” to
buy new shares before the public is offered the chance.
• Such shares are marketable in the market by the owners. Successful companies assume this
technique for fundraising. The rights issue is advantageous to the company as the cost of issue is
minimum
 Method of Floatation of Securities in
Primary Market
5. e-IPOs
• It stands for Electronic Initial Public Offer. A company proposing to issue capital to the
public through the online system of the stock exchange has to enter into an agreement
with the stock exchange. When a company wants to offer its shares to the public it can
now also do so online. This is called an Initial Public Offer (IPO). An agreement is signed
between the company and the related stock exchange known as the e-IPO. Issuing
company also require to assign registrar to have electronic connectivity with the exchange
 Secondary Market
The secondary market is where investors buy and sell securities they
already own. It is what most people typically think of as the "stock
market," though stocks are also sold on the primary market when they are
first issued.
In secondary markets, investors exchange with each other rather than
with the issuing entity.
Through massive series of independent yet interconnected trades, the
secondary market drives the price of securities toward their actual value.
 Difference
Basis Primary Market Secondary Market

Meaning The market place for new shares is called The place where formerly issued
primary market. securities are traded is known as
Secondary Market.
Another name New Issue Market (NIM) After Market

Type of Purchasing Direct Indirect

Financing It supplies funds to budding enterprises It does not provide funding to

and also to existing companies for companies.
expansion and diversification.
 Difference
Basis Primary Market Secondary Market
How many times a security can Only once Multiple times
be sold?
Buying and Selling between Company and Investors Investors
Who will gain the amount on the Company Investors
sale of shares?
Intermediary Underwriters Brokers
Price Fixed price Fluctuates, depends on the
demand and supply force
Difference between money market and
capital market
BASIS FOR COMPARISON MONEY MARKET CAPITAL MARKET
Meaning A segment of the financial A section of financial market
market where lending and where long term securities are
borrowing of short term issued and traded.
securities are done.
Nature of Market Informal Formal
Financial instruments Treasury Bills, Commercial Shares, Debentures, Bonds,
Papers, Certificate of Deposit, Retained Earnings, Asset
Trade Credit etc. Securitization, Euro Issues etc.
Risk Factor Low Comparatively High
 Difference between money market and
capital market
Institutions Central bank, Commercial Commercial banks, Stock
bank, non-financial exchange, non-banking
institutions, bill brokers, institutions like insurance
acceptance houses, and so on. companies etc.
Liquidity High Low
Purpose To fulfill short term credit needs To fulfill long term credit needs
of the business. of the business.
Time Horizon Within a year More than a year
Merit Increases liquidity of funds in the Mobilization of Savings in the
economy. economy.
 Stock Exchange

A stock exchange is an important factor in the capital market. It is a secure

place where trading is done in a systematic way. Here, the securities are
bought and sold as per well-structured rules and regulations.
A stock exchange is a forum where securities like bonds and stocks are
purchased and traded. This can be both an online trading platform and
offline (physical location).
 Functions of Stock Exchange
1. Marketability of securities
Stock exchanges are the markets for purchasing and selling securities. As they provide a
ready and continuous market for securities, the securities can be converted into cash
without delay.
2. Evaluation of securities
In stock exchanges, prices of securities are determined by investors’ demand and
suppliers’ preferences. Stock exchanges integrate the demand and supply of securities
and determine their prices on a continuous basis. The prices prevailing in the stock
exchanges are called quotations. These quotations enable the investor to evaluate the
value of his shareholding.
 Functions of Stock Exchange
3. Safety of investment
Stock exchanges operate under the rules, bye-laws and regulations duly approved by the
government. The members of stock exchange are bound by them. Stock exchanges
provide the most perfect type of market by making the transactions publicly known to the
investors. Besides this, they avoid over trading and speculation through various regulatory
measures. These factors ensure a great measure of safety and fair dealing to the investors.
4. Capital formation
Capital formation occurs due to savings and investments. Stock exchanges facilitate
capital formation in the country. They create the healthy habit of saving, investing and risk
bearing among the investors
 Functions of Stock Exchange

The prices quoted in stock exchanges indicate the extent of popularity of companies.
Investors are attracted towards profitable companies and come forward to invest their
savings in the corporate securities. Thus, stock exchanges facilitate flow of capital into more
profitable channels.
5. Regulation and Motivation of Companies
Companies wishing to list their shares on a stock exchange should follow certain rules and
regulations. For example, every year, they should submit to stock exchange all relevant data
relating to their financial affairs. So, the listing companies will safegurad their interest by
monitoring their financial performance carefully. Thus, the stock exchanges by quoting the
prices of securities motivate the companies concerned to improve their financial performance
 Features of Stock Exchange

• A market for securities- It is a wholesome market where securities of government,

corporate companies, semi-government companies are bought and sold.
• Second-hand securities- It associates with bonds, shares that have already been
announced by the company once previously.
• Regulate trade in securities- The exchange does not sell and buy bonds and shares
on its own account. The broker or exchange members do the trade on the
company’s behalf.
• Dealings only in registered securities- Only listed securities recorded in the
exchange office can be traded.
 Features of Stock Exchange
• Transaction- Only through authorised brokers and members the
transaction for securities can be made.
• Recognition- It requires to be recognised by the central government.
• Measuring device- It develops and indicates the growth and security of a
business in the index of a stock exchange.
• Operates as per rules– All the security dealings at the stock exchange are
controlled by exchange rules and regulations and SEBI guidelines.
 Trading and Settlement Procedure

1] Selecting a Broker or Sub-broker

When a person wishes to trade in the stock market, it cannot do so in his/her
individual capacity. The transactions can only occur through a broker or a
sub-broker. So according to one’s requirement, a broker must be appointed.
Now such a broker can be an individual or a partnership or a company or a
financial institution (like banks). They must be registered under SEBI. Once
such a broker is appointed you can buy/sell shares on the stock exchange.
 Trading and Settlement Procedure

2] Opening a Demat Account

• Since the reforms, all securities are now in electronic format. There are no issues of physical shares/securities anymore.
So an investor must open a dematerialized account, i.e. a Demat account to hold and trade in such electronic securities.
• So you or your broker will open a Demat account with the depository participant. Currently, in India, there are two
depository participants, namely Central Depository Services Ltd. (CDSL) and National Depository Services Ltd.
(NDSL).
3] Placing Orders
• And then the investor will actually place an order to buy or sell shares. The order will be placed with his broker, or the
individual can transact online if the broker provides such services. One thing of essential importance is that the order
/instructions should be very clear. Example: Buy 100 shares of XYZ Co. for a price of Rs. 140/- or less.
• Then the broker will act according to your transactions and place an order for the shares at the price mentioned or an
even better price if available. The broker will issue an order confirmation slip to the investor
 Trading and Settlement Procedure

4] Execution of the Order

• Once the broker receives the order from the investor, he executes it. Within 24 hours of this, the broker must issue a Contract
Note. This document contains all the information about the transactions, like the number of shares transacted, the price, date
and time of the transaction, brokerage amount, etc.
• Contract Note is an important document. In the case of a legal dispute, it is evidence of the transaction. It also contains the
Unique Order Code assigned to it by the stock exchange.
5] Settlement
• Here the actual securities are transferred from the buyer to the seller. And the funds will also be transferred. Here too the
broker will deal with the transfer. There are two types of settlements,
• On the Spot settlement: Here we exchange the funds immediately and the settlement follows the T+2 pattern. So a
transaction occurring on Monday will be settled by Wednesday (by the second working day)
• Forward Settlement: Simply means both parties have decided the settlement will take place on some future date. It can be T+
% or T+9 etc.