Revision Notes

Class 12 - Business Studies

Chapter 10 - Financial Markets

INTRODUCTION: FINANCIAL MARKET

● Financial market is a market which facilitates creation of assets and exchange
of securities to provide short, medium and long term business finance.
● It mobilizes funds between savers and investors.
● It locates funds into the most productive investment opportunities.
● There are two types of Financial Markets:
○ Money Market
○ Capital Market

FUNCTIONS OF FINANCIAL MARKET

● Mobilisation of savings and channeling them into the most productive
uses: A financial market performs the allocative function by linking the savers
and investors, thus mobilising savings and channelising them to make the most
use of these idle savings.
● Facilitating price discovery: The interaction between the households
(supplier of funds) and business firms helps to establish a price for the traded
financial asset in the market.
● Providing liquidity to financial assets: Financial assets can be easily
converted into cash as financial markets provide facility of purchase and sale
of financial assets.
● Reducing the cost of transactions: Financial markets provide information
about the traded securities and save time, effort and money of both the buyers
and sellers of a financial asset.

A. MONEY MARKET:
It is a market which deals in short term securities and whose maturity period is
less than one year.

Money Market Instruments

Instruments Issued By Duration Purpose
Treasury Bill RBI on behalf of the 14 to 365 days To fulfill short
central government. term needs.

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 Commercial Large and 15 to 365 days Seasonal and
Paper creditworthy working capital
company needs.
Call money Inter-bank 1 to 15 days To maintain CRR.
transaction
Certificate of Commercial bank 91 to 365 days Helps tight
deposits and financial liquidity period.
institution.
Commercial Bill Seller to buyer Upto 1 year Meet working
capital
requirements.

B. CAPITAL MARKET:
It is a market which deals in medium and long term securities with a maturity
period of more than one year.

Distinction between Capital Market and Money Market

Basis Money Market Capital Market
Participants RBI, banks, financial Financial institutions,
institutions and finance banks, corporate entities,
companies. foreign investors.
Instruments Treasury bills, trade bills Equity shares, debentures,
reports, commercial paper and bonds and preference
certificates of deposit. shares.
Investment Requires a huge investment Requires a small
outlet outlet. e.g., treasury bills require investment outlet as unit
a minimum amount of ₹25,000 value of securities is very
and its multiples thereof. low i.e., ₹10 or ₹100.
Duration Deals in short- term securities Deals in medium and long-
with maturity period of less than term securities with a
one year or even a single day. maturity period of more
than one year.
Liquidity Instruments are highly liquid as Instruments are liquid as
there is a ready market for the they can be easily traded in
sale, purchase or discounting of stock exchange but
instruments. comparatively less liquid.
Safety Instruments are safe because of Instruments are risky
shorter duration of investment. because of the longer
duration of investment

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 both in terms of returns
and repayment.
Expected Money market securities yield Capital market securities
Return comparatively less return on yield higher returns due to
investment due to shorter longer duration.
duration.

Capital market is of further two types:

a. Primary Market
b. Secondary Market

PRIMARY MARKET
● Primary market deals with the securities which are issued for the first time in
the market and is also known as new issues market.
● Banks, financial institutions, insurance companies, mutual funds and
individuals are the main participants in the primary market.

Methods of Floatation
● Offer through prospectus: The public companies issue prospectus to raise
funds from the public by issuing financial instruments like shares, debentures,
etc., through an advertisement in the newspaper and magazines.
● Offer for sale: Public companies offer securities for sale to the brokers or
issuing houses at an agreed price and in turn, these intermediaries resell them
to the investors.
● Private placement: Private placement means issue and allotment of shares to
the selected individuals and companies privately and not to the general public
through public issue.
● Rights issue: Rights issue refers to issue of new shares to the existing
shareholders in accordance to the terms and conditions of the company.
● e-IPOs: A company can raise funds by issuing capital to the public through
the online system of stock exchange and this is called an initial public offer
(IPO).

SECONDARY MARKET
● Secondary market is a market which deals with the sale and purchase of
existing securities. It is also called the stock market or stock exchange.
● SEBI prescribes the framework within which all the securities are traded,
cleared and settled.
● It provides opportunities of disinvestment and reinvestment to investors by
exchange of securities.

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Difference between Primary and Secondary Market:
Basis Primary Market Secondary Market
Nature of Securities issued for the first Sale and purchase of
Securities time. securities which already
exist.
Process of Issue directly to investors or Ownership changes
Transactions through an intermediary. between brokers.
Capital Promotes direct capital Promotes indirect capital
Formation formation. formation.
Trading of Only buying of securities. Buying and selling of
securities securities.
Price Decided by management of Determined by market
Determination the issuing company. forces of demand and
supply.
Location No geographical boundaries. Located at a specific place.

STOCK EXCHANGE
According to Securities Contract (Regulation) Act 1956, defines stock exchange
as a body of individuals, whether incorporated or not, constituted for the purpose
of assisting, regulating or controlling the business of buying, selling or dealing in
securities.

Functions of a Stock Exchange

● Providing liquidity and marketability to existing securities: Stock
exchange provides a continuous market for sale and purchase of existing
securities.
● Pricing of securities: The forces of demand and supply determine the share
prices for securities in the stock exchange.
● Safety of transaction: Trading within the regulatory framework of SEBI
ensures safety of financial transactions.
● Contributes to economic growth: Process of disinvestment and reinvestment
channelizes savings into most productive investments contributing to capital
formation and economic growth.
● Spreading of equity cult: Providing constant information about securities
traded through stock exchange educates investors.
● Providing scope for speculation: Fluctuations in prices due to demand and
supply forces allows for restricted and controlled speculations.

TRADING AND SETTLEMENT PROCEDURE

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● In traditional time: Outcry or auction system.
● In modern time: Electronic trading system for screen based trading. In this
system transactions are carried on the computer screen and both the parties are
able to see the prices of all shares going up and down all the time during
business hours of the stock exchange.

Advantages
● Ensure transparency
● Increases efficiency of operation and information.
● Large number of participants, which improves liquidity.
● Single trading platform.

Steps in trading and settlement procedure

1. Selection of broker: As a first step, an investor needs to select a broker who
is registered with the stock exchange and sign a trading agreement with
him/her. He also needs to provide information about his PAN number, Birth
date, address, qualifications, occupation, residential status, bank account
information
2. Opening Demat Account: It involves opening a demat account with a
depository participant and a bank account for cash transactions.
3. Placing the order: As next step, the investor has to place an order with the
appointed broker to trade in securities giving him clear instructions regarding
number and price at which securities must be traded.
4. Executing the order: On receipt of order, the broker goes online and executes
the order matching the price and securities needed by the client. On completion
of the transaction he/she issues a contract note to the investor giving all the
details of the transaction.
5. Settlement: After receipt of contract note and a day before the final settlement,
the investor delivers the securities sold or makes payment for securities
purchased, which is called pay in day. On T+2 day the broker delivers payment
or securities to the exchange.

DEMATERIALISATION AND DEPOSITORIES:

Dematerialisation
It refers to the process of cancelling the physical form of securities and converting
them into electronic form. It was introduced under the Depositories Act 1966.

Working of Demat System

● Identify depository participants either bank, broker or financial institution.

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● An account opening form and formalities related to other documentation like
PAN card details, photograph, etc. is completed.
● The physical certificate related to existing securities is given to the depository
along with a dematerialisation form.
● If investors plan to apply for shares in the IPO, then details of depository
participant and demat account has to be provided in the application form. The
allotted shares automatically get credited to the demat account.
● If shares are sold through to a broker then the depository participant is to be
instructed to debit the account with the number of shares the broker then gives
instruction to his depository to deliver the shares to the stock exchange the
broker receives payment from the buyer and paste them to the seller of
securities.
● The entire transaction is completed within a period of 2 days the delivery of
shares and receipt of payment from the buyer is on T + 2 basis settlement
period.

Depository:
It is an organization which provides an electronic storage system to store
electronic forms of securities.
There are two depositories:
● NSDL: National Securities Depositories Limited.
● CDSL: The Central Depository Services Limited.

Depository Participants: Depository participants are intermediaries

electronically connected with the depository. They act as a connect point between
the depository and the investor.

National Stock Exchange of India (NSE)

Incorporated in 1992, National Stock Exchange was recognised as a stock
exchange in April 1993. It operates in the wholesale debt market segment and
capital market segment.

Objectives of NSE
● To provide a nationwide trading facility for securities.
● To set up a communication network to provide equal access to investors.
● To set up an electronic trading system to provide a fair, efficient and
transparent securities market.
● To ensure that the settlement cycles are short.
● To enable book entry settlements.
● To meet international benchmarks and standards.

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Market segments of NSE
Exchange provides trading in following segment:
● Wholesale debt market segment
● Capital market segment

Over the Counter Exchange of India (OTCEI)

It is the counter market where buyers and sellers seek each other to purchase/sell
securities of small and medium companies as per terms and conditions. OTCEI
was incorporated in 1992 under the Companies Act, 1956.

Advantages of OTC Market

● Trading platform to small companies.
● Cost effective method for businesses.
● Trade in both primary and secondary markets.
● Gives freedom of choice to investors.
● Transparent system of trading.
● Free flow of information.

BSE (Bombay Stock Exchange Limited)

It was Asia's first stock exchange and was established in 1875. It provides a
platform for raising capital which has contributed to the growth of the corporate
sector. Permanent recognition to BSE was granted as per the Securities Contract
(Regulation) Act, 1956.

Objectives of BSE
● Efficient and transparent market for trade.
● Trading platform for equities.
● Ensure active trade.
● Services to capital market participants.
● Conform to international standards.

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

● SEBI was established by the Government of India on 12th April, 1988 and
given statutory powers in 1992 being passed by the Indian Parliament.
● SEBI has its headquarters at the business district of Bandra-Kurla complex in
Mumbai and it has regional offices in New Delhi (northern), Kolkata (eastern),
Chennai (southern), and Ahmedabad (western).
● SEBI works as an interim administrative body which aims to promote growth
of the securities market as well as protects the interest of the investors.

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Reasons for the Establishment of SEBI
● To control unfair trade practices and malpractices in trading securities such as
rigging of prices, violation of rules, unofficial private placements, etc.
● To protect the interest of the investors.

Purpose and Role of SEBI

● Issuers: To the issuers, it provides a market for raising finance in an easy, fair,
cost effective and efficient manner.
● Investors: To the investors, to protect the interest of the investors by disclosing
accurate information on a continuous basis.
● Intermediaries: To the intermediaries, to offer a competitive and professional
market with efficient infrastructure.

Objectives of SEBI
● To regulate the stock exchange and the securities industry in order to promote
orderly functioning of capital markets.
● To protect the rights as well as the interests of the investors.
● To prevent and keep a check on any unfair trading malpractices
● To maintain and create a balance between self and statutory regulations.
● To attend investor’s complaints, liaise with the issuers, intermediaries and
other stock exchanges in the region through its regional offices.

Functions of SEBI
SEBI performs the task of regulation and development of the securities market.
The functions performed by SEBI are:
1. Regulatory Functions
a. Registration of brokers, sub-brokers and other intermediaries.
b. Registration of collective investment schemes.
c. Regulation of Stock Bankers, underwriters, portfolio exchanges, and
merchant bankers.
d. Regulation of takeover bids by companies.
e. Undertakes inspection, conducts enquiries and audits of stock exchange and
intermediaries.
f. Changing fee or other charges for carrying out the purposes and operations
of the Act.
g. Performing and exercising powers under Securities Contracts (Regulation)
Act 1956, delegated by the Government of India.

2. Development Functions
a. Educating and training investors and intermediaries of the securities market.

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 b. Conduct research and publish information related to trading of securities.
c. Taking measures for the development of the capital market through the
adoption of a flexible approach.

3. Protective Functions
a. Prohibiting fraudulent and unfair trade practices.
b. Controlling insider trading and imposing penalties for malpractices.
c. Educate and protect the investors.
d. Promoting fair trade practices and a strict code of conduct in the securities
market.

THE ORGANISATION STRUCTURE OF SEBI

SEBI has five operational departments headed by the Executive Director. It is
advised or assisted in policy formation by two advisory committees –
● The primary market advisory committee
● The secondary market advisory committee

Objectives of Advisory Committees

● To advise SEBI on matters related to regulations.
● To advise SEBI on development and regulation of the primary market.
● It advises SEBI on disclosure requirements for the companies as per the
provisions mentioned in the Act.
● To advise SEBI in the legal framework for making dealing in the primary
market simple and transparent.

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