Financial market

Concept of Financial Market

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.

Households (savers) Banks or financial markets (Allocative function) Business firm(Investors)

Financial intermediation by banks and financial markets

If the allocative function of directing funds available for investment into

most productive investment opportunity is
performed well, it leads to

higher rate of return to households.

• allocation of scarce resources to those firms, which have the highest

productivity

A financial market is a market for creation and exchange of financial

assets. This market exists wherever a financial
transaction occurs. Financial transaction could be in the form of
creation of financial assets or the purchase/sale of existing
financial assets.
Functions of Financial Market

Financial market plays an important role in the allocation of scarce

resources in an economy by performing four important
functions

1. Mobilisation of Savings and Channelising Them into the most

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

2. 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.

3. Providing Liquidity to Financial Assets Financial market facilitates

easy purchase and sale of financial assets which provide liquidity, i.e.
these financial assets can be easily converted into cash whenever
required.

4. Reducing the Cost of Transactions Financial market helps in saving

time, effort and money of the buyers and sellers at the time of trading
in the market, by providing them valuable information.

Types of Financial Market

On the basis of maturity of financial instruments traded, financial

markets can be classified into money market and
capital market.
Money Market

Money market is a market for short-term funds, which deals in

monetary assets whose period of maturity is upto one year.
It is a market where low risk, unsecured and short-term debt
instruments that are highly liquid, are issued and actively traded
everyday, over the telephone and through the internet
The major participants in the money market are Reserve Bank of
India, commercial banks, non-banking finance companies, state
governments, large corporate houses and mutual funds.

Money Market Instruments

Various instruments available in the money market are

1. Treasury Bills (T-Bills)

• It is a short-term borrowing instrument issued by the RBI on behalf of
Government of India.
• It is also known as zero coupon bond.
• It has a maturity of less than one year.
• It is in the form of a promissory note.
• It is highly liquid and have negligible risk.
• It is available in denominations of 25,000 and its multiples.
• 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.

2. Commercial Paper
• It 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, having a maturity of 15 days to
one year.
• It is a negotiable instrument, transferable by endorsement and
delivery
• It is sold at discount and redeemed at par.
• It is also used as an alternative to bank borrowing. It is used by
companies for bridge financing,

3. 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).
Cash Reserve Ratio is the minimum balance of cash to be maintained
by banks, according to RBI guidelines.
• It is short-term finance repayable on demand.
• Maturity of call money is 1 day to 15 days.
• The interest paid on call money is called the call rate.

There is an inverse relationship between call rates and return on other

short-term money market instruments. Increase in call rates make the
demand for call money decrease, and increase in demand for other
short-term instruments, as they become cheaper in relation to call
money.

4. Certificate of Deposit

•It is issued by commercial banks or developmental financial

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 mobilise large amounts of money in a short time period

5. 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 & 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.

Capital Market

Capital market is a market for medium and long-term funds. This

market facilitates the institutional arrangements through which
long-term funds, both debt and equity are raised and invested. The
capital market consists of development banks, commercial banks and
stock exchanges.

Types of Capital Market

There are two types of capital market

I. Primary Market
It is also known as the new issues market, as this market deals with
the new securities issued for the first time. In this market, companies
issue securities directly to the investors for the purpose of establishing
new business or for modernising and expanding the existing business.
Methods of Flotation of New Issues in Primary Market
There are various methods by which securities are issued in the
primary market. They are

1. Offer Through Prospectus/IPO Under this method, a company

invites public to subscribe for its shares through issue of prospectus,
which makes a direct appeal to investors to invest in the company,
through an advertisement in the newspapers and magazines.

2. Offer for Sale Under this method, securities are not issued directly
to the public, but are offered for sale through intermediaries like
issuing houses or stock brokers. For this, the company sells the
securities enbloc to brokers at an agreed price, who, then resells them
to the investing public.

3. Private Placement It is the allotment of securities by a company to

institutional investors and some selected individuals. It is considered
beneficial because it helps to raise funds more quickly than a public
issue and the cost of flotation is saved.

4. Right Issue 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 The shareholders are offered the 'right' to
buy new shares in proportion to the number of shares they already
possess. This right is called the pre-emptive right of the existing
shareholders.

5. e-IPO When the public issue is made through an online system of

stock exchange, it is known as e-IPO, i.e. electronic Initial Public Offer.
For such issue, following functions are to be performed
•The company doing so, has to enter into an agreement with the stock
exchange and has to appoint a SEBI registered broker to accept
applications and place orders with the company.
•Appoint a registrar having electronic connectivity with the exchange
• Securities have to be listed on atleast one exchange, other than the
exchange through which it has offered its securities.
•The lead manager coordinates with all the intermediaries connected
with the issue.

II. Secondary Market

Secondary market is also known as the stock market or stock
exchange. In this market, securities are not directly issued by the
company to investors but they are sold by existing investor to other
investors. It provides liquidity and marketability to existing securities. It
also contributes to economic growth by channelising funds into the
most productive investments, through the process of disinvestment
by existing investors and reinvestment by new investors.

Stock Exchange
A stock exchange is an institution which provides a platform for buying
and selling of existing securities. "Stock exchange means anybody of
individuals, whether According to Securities Contracts Regulation Act,
1956, incorporated or not, constituted for the purpose of assisting,
regulating or controlling the business of buying and selling or dealing
in securities."

Functions of Stock Exchange

1. Providing Liquidity and Marketability to Existing Securities It

provides a ready and continuous market where securities are bought
and sold.
2. Pricing of Securities It helps in determining the prices of various
securities and day-to-day fluctuations in share prices.
3. Safety of Transactions Stock exchange ensures that the investing
public gets a safe and fair deal in the market.
4. Contribution to Economic Growth Disinvestment and reinvestment
leads to capital formation and economic growth
through channelising the savings into productive investment avenues.
5. Spreading Equity Cult It guides and educate investors, publish
information about companies listed on exchanges
and ensures better and safe trading practices.
6. Provides Scope for Speculation Speculation is necessary to ensure
liquidity and price continuity in stock market. Thus, it provides
sufficient scope for speculation in a restricted and controlled manner
within the provisions of law.

Trading and Settlement

Procedure on Stock Exchange
Now a days, trading in securities is executed through an online, at
screen based electronic trading system. All securities are bought and
sold electronically in the broker's office through a computer terminal,
which is connected to the computer system of the main stock
exchange. Any member can log on to the site, feed the information
about the shares he wants to buy or sell and the price into the
computer.
Accordingly, the transaction is executed by matching the orders at the
best bid and offer price.

Advantages of Screen Based Trading System

• It ensures transparency as it allows participants to see the prices of
securities in the market.
• It helps in fixing the prices efficiently, because of efficiency of
information being passed on.
• There is a reduction in time, cost and risk of error because of
increased efficiency.
• It enables a large number of participants to trade with each other,
leading to improvement of liquidity of the market.
he.
•All the trading centres spread across the country have been brought
onto one trading platform.

Thus, this system has made the trading of securities easy and
eliminated the problems associated with dealing of shares in physical
form by introducing the dematerialisation with the help of depository

Dematerialisation
Dematerialisation is the process, by which the physical form of
securities are converted into electronic form. When shares are aying
converted into electronic form, they are held in a Demat Account'. For
this, investor has to open a demat account with an organisation, called
a depository.

Depository
Depository is an institution or organisation which holds securities (e.g.
shares, debentures, bonds, mutual funds, etc) in electronic form, in
which trading is done.

It is a technology driven electronic storage system. It has no paper

work relating to share certificates, transfer, forms, etc.
In India, there are two depositories
• National Securities Depositories Limited (NSDL)
• Central Depository Services (India) Limited (CDSL)
Both these depositories operate through intermediaries that are
electronically connected to them and serve as contact
points with the investors and are known as depository participants.

Working of the Demat System

• The Depository Participant (DP) either a bank, broker or financial
services company may be identified.
• An account opening form is filled giving details of PAN card,
photograph and power of attorney.
•The physical certificate is to be given to the DP alongwith a
dematerialisation request form.
• If shares are applied in a public offer, simple details of DP and
Demat Account are to be given and the shares on allotment
would automatically be credited to the Demat Account.
• If shares are to be sold through a broker, the DP is to be unstructed
to debit the account with the number of shares.
•The broker, then, gives instructions to his DP for delivery of shares to
the stock exchange.
• The broker then receives payment and pay the person for the shares
sold.
• All these transactions are to be completed within 2 day i.e., delivery
of shares and payment received from the buyer is on a
T+2 basis, settlement period.

Steps in the Trading and Settlement Procedure

1. Approaching a Broker The first step undertaken by an.investor is to
approach a registered broker or sub-broker and enter into an
agreement with him. He has to sign client registration form and
provide the following information
• PAN number (Mandatory)
• Date of birth and address
• Bank account details
•Educational qualification and occupation
• Residential status (Indian/NRI)
•Depository account details Name of any other broker with whom
registered
• Client code number in client registration form
The broker then opens a trading account in the name of the investor

2. Opening a Demat Account The investor, then has to open a demat

account or Beneficial Owner (BO) account with a depository
participant for holding and transferring securities.

3. Placing an Order The investor places an order with the broker to

buy or sell securities. For this, he has to specify the number of shares
and the price at which the shares should be bought or sold. The
broker then issues an order confirmation slip to the investor.

4. Finding a Deal The broker then goes to the online stock exchange
and match the shares with the best prices available,

5. Execution of Order The broker's terminal will be informed when

shares can be bought/sold at the mentioned price and the order will be
executed electronically. After this, he will issue a trade confirmation
slip to the investor.

6. Issuing Contract Note Within 24 hours of execution of order, the

broker issues a Contract Note, containing details of the shares, its
price, date and time of deal and the brokerage charged. A Unique
Order Code number is assigned to each transaction at the stock
exchange and is printed on the note.

7. Delivery of Shares by Investor Investor has to deliver the shares

sold or pay cash for the shares bought. This should be done
immediately after receiving the contract note or before the day when
the broker shall make payment or delivery of shares to the exchange.
This is called pay-in day.

8. Settlement Cycle Cash is paid or securities are delivered on pay-in

day, which is before the T+2 day as the deal has to be settled and
finalised on the T+2 day.

9. Payment to Broker On T+2 day, the exchange will deliver the share
or make payment to the broker. This is called the pay-out day. The
broker, then has to make payment to the investor whithin 24 hours of
the pay-out day.

10. Delivery of Shares by Broker Finally, the broker can make delivery
of shares in demat form directly to the investor's demat account. The
investor has to give details to his depository participant about his
demat account to take delivery of securities directly into his beneficial
owner account.
Securities and Exchange
Board of India (SEBI)
The Securities and Exchange Board of India (SEBI) established by the
Government of India on 12th April, 1988. It got statutory status on 30th
January, 1992. Its main function is to systematise the securities
market.

Establishment of SEBI
Before 1988, there was no regulatory body to control the activities at
stock exchanges. Therefore, many trading malpractices were taking
place.
Some of the malpractices included
•Price 11gging
•Insider trading
•Unofticial private placements
•Non-adlherence of provisions of the Companies Act
•Unofticial premium on new issues
•Delay in delivery of shares
These malpractices needed to be curbed and the investors to be
protected from such malpractices. Thus, with the objective
of orderly and healthy growth of securities market and for protection of
investors, SEBI was established.

Role of SEBI

SEBI was set-up with the main purpose of keeping a check on

malpractices and to protect the interest of investors. It was
set-up to meet the needs of following mentioned groups Issuers For
issuers, it provides a market place in which they can raise finance
fairly and easily.
2. Investors For investors, it provides protection and supply of
accurate and correct information. Intermediaries For intermediaries, it
provides a competitive professional market.

Objectives of SEBI

The overall objective of SEBI is to protect the interests ot uvestors,

promote the development of and regulate the Securities
This may be elaborated as follows
•To regulate stock exchanges and the securities industry to promote
their orderly functioning
• To protect the rights and interests of investors and to guide and
educate them.
• To prevent fraudulent activities and malpractice.
•To regular and develop a code of conduct for intermediaries
with a view to make them competitive and prolessiona.

Functions of SEBI
SEBI performs the following functions
1. Regulatory Functions
Registration of brokers, sub-brokers and other players in the market.
•Registration of collective investment schemes and mutual funds.
•Regulation of stock brokers, portfolio exchanges, underwriters and
merchant bankers and the business in stock exchanges.
•Regulation of takeover bids by companies.
•Levying fee or other charges for carrying out the purposes of the Act.
• SEBI conducts inspections, enquiries and audits of stock exchanges.
• Perform and exercise such power under Securities Contracts
(Regulation) Act 1956, as may be delegated by the Government of
India.
2. Development Functions
Training of intermediaries of the securities market.
•Conducting research and publishing information useful to all market
participants.
•Undertaking measures to develop the capital markets by adopting a
flexible approach.
3. Protective Functions
Prohibition of fraudulent and unfair trade practices.
•Controlling insider trading and imposing penalties for such practices.
• Undertaking steps for investor protection.
• Promotion of fair practices and code of conduct in securities market.