A financial market is a market for creation and exchange of financial assets. 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 help the savers and the investors by mobilizing funds between them. Thus, financial markets and banks act as intermediaries in this allocative function of matching the demand and supply of funds. Other topics covered in this chapter are Meaning of Financial Market, Function of Financial Market, Money Market, Money Market Instruments, Capital Market, Primary Market, Methods of Floatation, Secondary Market, Stock Exchange, Functions of Stock Exchange, Trading and Settlement Procedure, Dematerialisation and Depositories, National Stock Exchange of India, Bombay Stock Exchange and Securities and Exchange Board of India (SEBI).
Treasury Bill is an instrument of short-term debt, issued by the RBI on behalf of central Government to meet short-term requirement of funds.
The National Stock Exchange is the latest, most modern and technology driven exchange. It was incorporated in 1992 and was recognized as a stock exchange in April 1993. It provides trading in two main segments:
Investing public can expect a safe and fair deal in the stock market due to these two main reasons:
The common name for beneficiary account is ‘Demat Account’. A beneficiary owner is an owner who enjoys the benefits of ownership even though the property is titled with the name of someone else. In also means that, any individual or groups of individuals who has the power to vote or influence the transaction decision such as company shares either directly or indirectly.
The two details that need to be provided by the investor to the broker while filling a client registration form are:
Financial Market plays an important role in the allocation of scarce resources in an economy by performing four important functions:
Mobilization of saving 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.
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.
Providing liquidity to financial assets: Financial market facilitates 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 of the buyers and sellers at the time of trading in the market, by providing them valuable information.
Money market is a market where transactions are made in short-term securities or it is meant for those securities where the payment period is upto one year. Since, their maturity period is very short, they are also termed as near money. These securities include call money, treasury bills, commercial bills, certificate of deposit, commercial paper, etc. Short-term financial instruments satisfy the requirement of short-term or working capital needs of commercial establishments.
Features of Money Market are:
Difference between capital market and money market:
| Basis | Capital Market | Money Market |
|---|---|---|
| Meaning | It is a market dealing in securities for long-term funds. | It is a market dealing in securities of short-term funds. |
| Duration | Period of maturity is more than one year. | Period of maturity ranges from one day to one year. |
| Liquidity | Only actively traded securities enjoy liquidity. | In this market, there is a formal arrangement of creating liquidity. |
| Safety Element | The transactions are made in the instruments issued by the financial institutions and financially strong companies. | In this market, securities of every company (big or small, financially weak or strong) are bought and sold. Hence, there is more risk involved. |
| Instructions | Main instruments traded are shares, debentures, bonds, preference shares, etc. | Instruments traded are t-bills, commercial bills, Certificate of deposits, etc. |
| Expected Returns |
The expected rate of return is less due to short duration. |
The expected returns are high and there is even a possibility of capital gain. |
Stock Exchange performs the following functions:
Provides Liquidity and Marketability to Existing Securities: It provides a ready and continuous market where securities are bought and sold. It gives investors the chance to disinvest or reinvest. Thus, regular dealing provides both liquidity and marketability to existing securities.
Pricing of Securities: It helps in determining the prices of various securities that reflect their real worth. It enables correct pricing of securities through the interplay of demand and supply. The stock market index like SENSEX, reflects the market direction and indicate day-to-day fluctuations in share prices.
Safety of Transactions: It is well regulated and its dealings are well-defined according to the existing legal framework. This ensures that the investing public gets a fair deal in the market.
Contributes to Economic Growth: In stock exchange, the process of disinvestment and reinvestment channelize the saving into productive investment avenues. This leads to capital formation and economic growth.
Spreading Equity Cult: It is an organised market, which takes various steps to guide and educate investors, publishes information about companies listed on the exchange and ensures better and safe trading practices. These practices have played a vital role in increasing the number of people investing in equity, thus leading to wider ownership of equity.
Providing Scope for Speculation: It is generally accepted that a certain degree of speculation is necessary to ensure liquidity and price continuity in the stock market. Thus, it provides sufficient scope for speculation in a restricted and controlled manner within the provisions of law.
The Securities and Exchange Board of India (SEBI) was established by the Government of India on 12th April, 1988 with an objective to protect the interest of investors and to promote the development of and regulate the securities market.
The SEBI has many objectives, some of them are discussed below:
The National Stock Exchange (NSE) is the latest, most modern and technology driven exchange. It was incorporated in 1992 and was recognised as a stock exchange in April 1993.
NSE was set up with the following objectives:
Once the trade has been executed, within 24 hours the broker issues a Contract Note. This note contains details of the number of shares bought or sold, the price, the date and time of deal, and the brokerage charges. This is an important document as it is legally enforceable and helps to settle disputes/claims between the investors and the broker. A unique Order Code number is assigned to each transaction by the stock exchange and is printed on the contract note.
Various instruments available in the money market are:
1. Treasury Bills (T-Bills): It is a short-term borrowing instrument issued by the Government of India. RBI, issue it on behalf of Government of India.
2. Commercial Paper: Commercial paper is issued by large creditworthy companies to raise short-term funds at lower rates of interest than the market rate.
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.
4. Certificate of Deposit: Certificate of deposits are issued by commercial banks or developmental financial institutions to individuals, institutions, corporations and companies.
5. Commercial Bill: It is a bill of exchange used by business firms to meet their working capital needs.
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. An ideal capital market is one, where finance is available at a reasonable cost. The process of economic development is facilitated by the existence of a well functioning capital market. There are two types of capital market Primary Market and Secondary Market. Primary market facilitates capital formation in the economy by Channelising public saving into productive investments. And 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 it is sold by existing investor to other investors. It provides liquidity and marketability to existing securities.
The history of stock market in India goes back to the end of the eighteenth century when long-term negotiable securities were first issued. In 1850 the Companies Act was introduced for the first time bringing with it the feature of limited liability and generating investor interest in corporate securities. The first stock-exchange in India was set-up in 1875 as The Native Share and Stock Brokers Association in Bombay. Today it is known as the Bombay Stock Exchange (BSE). This was followed by the development of exchanges in Ahmedabad (1894), Calcutta (1908) and Madras (1937). It is interesting to note that stock exchanges were first set up in major centers of trade and commerce.
Until the early 1990s, the Indian secondary market comprised regional stock exchanges with BSE heading the list. After the reforms of 1991, the Indian Secondary market acquired a three tier form. This consists of:
Regional Stock Exchange: There are 21 Regional Stock Exchange (RSE). The first Regional Stock Exchange was Ahmedabad Stock Exchange (ASE) that came into existence in 1894. Next the Calcutta Stock Exchange (CSE) came into existence in 1908. In early sixties, there were only few recognised RSEs that are Calcutta, Madras, Ahmedabad, Delhi, Hyderabad and Indore. The latest stock exchange is Coimbatore Stock Exchange and Meerut Stock Exchange.
National Stock Exchange: The National Stock Exchange is the latest, most modern and technology driven exchange. It was incorporated in 1992 and was recognised as a stock exchange in April 1993. It started operations in 1994, with trading on the wholesale debt market segment. The NSE was set up by leading financial institutions, banks, insurance companies and other financial intermediaries.
Over the Counter Exchange of India (OTCEI): Over The Counter Exchange of India (OTCEI) was incorporated in 1990 under the companies act 1956 and it was recognised as a stock exchange under the Securities Contracts Regulation Act, 1956. It started its operations in the year 1992 and it is modeled along the lines of NASDAQ, which is OTC Exchange in USA. And the objective of OTCEI was to provide easy access to the capital market to the small and medium companies. OTCEI is a fully computerized and single window exchange system.
The Securities and Exchange Board of India (SEBI) was established by the Government of India on 12th April, 1988 with an objective to protect the interest of investors and to promote the development of and regulate the securities market.
The SEBI has many objectives, some of them are discussed below:
Functions of SEBI are discussed below:
1. Regulatory Functions
2. Development Functions
3. Protective Functions
a. Which market is being reflected in the above case?
Ans. The market that has been reflected in the above case is Primary Market. Primary Market is also known as the new issues market, as this market deals with the new securities issued for the first time.
b. State which method of floatation in the above identified market is being highlighted in the case?
Ans. The floatation method that has been highlighted in this case is 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.
c. Explain any two other methods of floatation.
Ans. Methods of flotation are:
1. Offer Through Prospectus: 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. Private Placement: Private placement is the allotment of securities by a company to institutional investors and some selected individuals. It is considered beneficial because:
Following are the steps involved in the screen-based trading for buying and selling of securities:
If an investor wishes to buy or sell any security he has to first approach a registered broker or sub-broker and enter into an agreement with him. The investor has a sign a broker-client agreement and a client registration form before placing an order to buy or sell securities. He has also to provide certain other details and information. These details includes:
a. PAN Number
b. Date of birth and address
c. Educational qualification and occupation
d. Residential status (Indian/ NRI)
e. Bank account details
f. Depository account details
g. Name of any other broker with whom registered
h. Client code number in the client registration form
The broker then opens a trading account in the name of the investor.
The investor has to open a ‘Demat’ account or ‘beneficial owner’ (BO) account with a depository participants (DP) for holding and transferring securities in the demat form. He will also have to open a bank account for cash transactions in the securities market.
The investor then places an order with the broker to buy or sell shares. Clear instructions have to be given about the number of shares and the price at which the shares should be bought or sold. The broker will then go ahead with the deal at the above mentioned price or the best price available. An order confirmation slip is issued to the investor by the broker.
The broker then will go on-line and connect to the main stock exchange and match the share and best price available.
When the shares can be bought or sold at the price mentioned, it will be communicated to the broker’s terminal and the order will be executed electronically. The broker will issue a trade confirmation slip to the investor.
After the trade has been executed, within 24 hours the broker issues a Contract Note. This note contains details of the number of shares bought or sold, the price, the date and time of deal, and the brokerage charges. This is an important document as it is legally enforceable and helps to settle disputes/claims between the investor and the broker. A unique order code number is assigned to each transaction by the stock exchange and is printed on the contract note.
Now, the 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 the pay-in day.
Cash is paid or securities are delivered on pay-in-day as the deal has to be settled and finalized on the T+2 day. The settlement cycle is on T+2 day on a rolling settlement basis, w.e.f. 1 April 2003.
On the 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 within 24 hours of the pay-out day since he has already received payment from the exchange.
The broker can make delivery of shares in demat form directly to the investor’s demat account. The investor has to give details of his demat account and instruct his depository participant to take delivery of securities directly in his beneficial owner account.
A financial market is a platform where the trading of financial securities like bonds, stocks, currencies, and derivatives takes place. It helps in the efficient allocation of resources by linking surplus and deficit sectors of the economy.
The money market deals with short-term funds and instruments, typically for a period of one year or less (e.g., treasury bills, certificates of deposit), while the capital market handles long-term securities (e.g., equity shares, bonds) for a duration of more than one year.
A stock exchange is a regulated marketplace where stocks, bonds, and other securities are traded. It facilitates the buying and selling of financial instruments and plays a key role in maintaining liquidity in the financial system.
The financial market performs various critical functions:
The NSE is India’s leading stock exchange, established in 1992. It provides a platform for investors to trade equities, derivatives, and other securities electronically. Some of its key roles include:
The money market is characterized by:
The Securities and Exchange Board of India (SEBI) plays a pivotal role in the regulation and development of financial markets. Its primary functions include:
The capital market is a major component of the financial system, dealing with long-term investments. It consists of two segments:
Trading on a stock exchange follows a systematic process: