10.12 Financial Markets


Summary

  1. Financial Market is a market for creation and exchange of financial assets.
  2. It helps in mobilisation (moving) and channelising the savings into most productive uses.
  3. Financial markets also help in price discovery and provide liquidity to financial assets.

10.1

Concept of Financial Markets

What are the two sectors of an economic system?

  1. Households which save funds,
  2. Business firms which invest these funds.
How does a financial market help the savers and the investors?

  1. By mobilizing funds between them.
  2. In doing so it performs what is known as an allocative function. It allocates or directs funds available for investment into their most productive investment opportunity.
What are the two consequences of proper allocative function?

  1. The rate of return offered to households would be higher
  2. Scarce resources are allocated to those firms which have the highest productivity for the economy.
Which are the two major alternative mechanisms through which allocation of funds can be done?

  1. Banks
  2. Financial markets.
Households can deposit their surplus funds with banks, who in turn could lend these funds to business firms. Alternately, households can buy the shares and debentures offered by a business using financial markets.
The process by which allocation of funds is done is called financial inter-mediation.
Banks and financial markets are competing intermediaries in the financial system, and give households a choice of where they want to place their savings.
A financial market is a market for the creation and exchange of financial assets. Financial markets exist wherever a financial transaction occurs. Financial transactions could be in the form of creation of financial assets such as the initial issue of shares and debentures by a firm or the purchase and sale of existing financial assets like equity shares, debentures and bonds.

 

Money Market

  1. Money Market is a market for short-term funds.
  2. It deals in monetary assets whose period of maturity is less than one year.
  3. The instruments of money market includes:
    1. Treasury bills,
    2. Commercial paper,
    3. Call money,
    4. REPO’s,
    5. Certificate of deposit,
    6. Commercial bills,
    7. Participation certificates
    8. Money market mutual funds.

Capital Market

  1. Capital Market is a place where long-term funds are mobilised by the corporate undertakings and Government.
  2. What is the duration of the securities of the capital markets?
    1. Medium term securities
    2. Long term securities.
  3. Who can participate in the capital markets?
    1. Commercial firms,
    2. Development banks,
    3. Financial institution,
    4. Foreign investors,
  4. What are the instruments of capital market?
    1. Equity shares,
    2. Preference shares
    3. Bonds,
    4. Debentures.
  5. What is the investment outlay (expense) in the capital market?
  6. Which market is safer – money market or capital market? Why?
    Money market is safer than capital market? It is because money market is short term investment with a maturity period of maximum 1 year. Besides, capital markets are risky as they are long term sources of funds.
  7. Capital Market may be divided into:
    1. Primary market – Deals with new securities which were not previously tradable to the public.
    2. Secondary market – A place where existing securities are bought and sold.

1. Primary Market

  1. What are the methods of flotation (floatation) in the primary market?
    1. Offer through Prospectus
      1. Most commonly used method of raising funds by public companies,
      2. Makes a direct appeal to raise capital through advertisements in newspapers and magazines (Companies use underwriters and brokers for this).
      3. The issue (of prospectus) is required to be listed on at least one stock exchange.
      4. Should be in accordance with:
        1. The provisions of Companies Act
        2. SEBI disclosure,
        3. Investor’s protection guidelines.
    2. Offer for Sale
      1. Not issued directly to the public,
      2. Issued first to intermediaries (brokers and issue houses) at a fixed price.
      3. These intermediaries resell these securities to the investing public at a higher price.
    3. Private Placement
      1. Securities are sold to selected institutional investors and individuals.
      2. This helps to raise capital more quickly as compared to public issue.
      3. This method is economical because it does not need to fulfill many mandatory public issues.
      4. This is ideal for those companies who cannot afford a public issue.
    4. Rights Issue
      1. Companies can offer new shares to their existing shareholders in proportion of shares already held by them.
      2. This method gives pre-emptive rights to its existing shareholders to subscribe to new issue of shares according to the terms and conditions of the company.
    5. e-IPOs (Electronic Initial Public Offer)

2. Secondary Market (Stock Exchange / Share Market)

  1. What are stock exchanges?
    Stock Exchanges are the organisations which provide a platform for buying and selling of existing securities.
  2. What are the functions of stock exchanges?
    1. Stock exchanges provide liquidity and marketability to existing securities as they provide a platform for sale and purchase of securities.
    2. Stock exchanges help in determination of price of securities.
    3. Stock exchanges contribute to economic growth through allocative functions.
    4. Stock exchanges ensure safety of transaction as all the transactions are electronic and they take place under the knowledge of SEBI.
    5. Stock exchanges help spread equity cult. They do whatever is possible to induce as many people as investors in stocks of companies.
      1. Example 1 – Education of investors
      2. Example 2 – Transparency of transactions.
    6. Stock exchanges provide scope for speculation.
  3. What is the trading process on a stock exchange?
    1. Selection of brokers,
    2. Opening the demat account,
    3. Placing the order,
    4. Connecting to the stock exchange,
    5. Executing the order,
    6. Issuing of contract note,
    7. Delivery of cash/securities → Pay-in Day
    8. Settlement before T+2 (Transaction day + 2 more days = 3 days).
    9. Delivery of security / cash → Pay-out Day
    10. Delivery of securities in demat form (electronic form)
  4. The National Stock Exchange of India is the latest, most modern and technology driven exchange and was incorporated in 1992.
  5. OTCEI was incorporated in 1992 to provide listing facility for small companies with paid up capital of less than 3 crores.
  6. SEBI (Securities and Exchange Board of India) was established in 1988 and was given statutory status through an Act in 1992.
  7. The SEBI was set-up to:
    1. Protect the interests of investors,
    2. Development and regulation of securities market.

Glossary

  • Financial Market
  • Money Market
  • Treasury Bills
  • Commercial Paper
  • Call Money
  • Certificate of Deposit
  • Commercial Bill
  • Money Market
  • Mutual Fund Capital
  • Market
  • Primary Market
  • Secondary Market
  • Stock Exchange
  • SEBI,
  • NSE
  • OTCEI

Biju John is an educational writer, educator and the author of OM - The Otherwise Men. He gives live classes on Skype and Facebook. You can attend his 3 Day Classes (English & Business Studies) in Delhi, Bangalore, Qatar and Dubai. His Contact number is 91 9810740061.

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