FINANCIAL MARKETS
Any market where securities are traded, including stocks, bonds, shares, forex and derivatives markets, is referred to as financial markets. Financial markets are vital to the smooth operation of capitalist economies by allocating resources and creating liquidity for businesses and entrepreneurs. The markets make it easy for buyers and sellers to trade their financial holdings. Financial markets create securities
products that provide a return for those who have excess funds (Investors/lenders) and make these funds available to those who need additional money (borrowers).
Types of financial markets
Broadly speaking, the financial markets are classified as money market and capital market. While the money market deals with short-term credit, the capital market handles long- term credit.
Distinction between Capital Market and Money Market
The Capital Market differs from the Money Market in many ways.
• Firstly, while the Money Market is related to short-term funds, the capital market is related to long term funds.
• Secondly, while the Money Market deals in securities like treasury bills, commercial paper, trade bills, deposit certificates,
etc., the capital market deals in shares, debentures, bonds and government securities.
• Thirdly, while the participants in the Money Market are Reserve Bank of India, commercial banks, non-banking financial companies, etc., the participants in the capital market are stockbrokers, underwriters, mutual funds, financial institutions, and individual investors.
• Fourthly, while the money market is regulated by the Reserve Bank of India, the capital market is regulated by Securities Exchange Board of India (SEBI).
MONEY MARKET
• The money market is a market for short-term funds, which deals in financial assets whose period of maturity is up to one year.
• It should be noted that the money market does not deal in cash or money as such but simply provides a market for credit instruments such as bills of exchange, promissory notes, commercial paper, treasury bills, etc.
• Money market is not related to any specific market place. Rather it refers to the whole networks of financial institutions dealing in short-term funds, which provides an outlet to lenders and a source of supply for such funds to borrowers.
• The unorganised and organised sectors make up the two main segments of the Indian money market. While the unorganised sector consists of the indigenous bankers and the traditional money lenders, the organised sector comprises the Reserve Bank of India (RBI), the commercial banks and the other financial institutions like LIC, GIC UTI, etc. The RBI, which is in charge of overseeing the smooth operation of the Indian money market, is the highest authority in the sector.
Money Market Instruments
Following are some of the important money market instruments or securities.
Call Money
• Call money is mainly used by the banks to meet their temporary requirement of cash.
• They borrow and lend money from each other normally on a daily basis. It is repayable on demand and its maturity period varies between one day to a fortnight.
The rate of interest paid on call money loans is known as call rate.
• The call money market is also known as interbank call money market as the participants in the call money market are mostly banks who are able to use their temporary cash surplus or meet their temporary cash deficits by mutual transactions through this market.
• Of late, the financial intermediaries like LIC, GIC, and NABARD have also started participating actively in the call money market. To start with, they were allowed to act as lenders but later they were also allowed to borrow.
Treasury Bill Market
• In India, treasury bills are a short-term liability of the Central Government as these are mostly issued by the Reserve Bank of India on behalf of the Central Government for meeting its temporary deficits and financing the expenditure.
Treasury bills are usually of three months’ (91-days) duration issued by the RBI.
There have been two varieties of the 91-day Treasury Bills: regular and ad hoc. The ordinary bills are issued by RBI to enable the government to meet its needs for supplementary short-term finance, and the ad hoc bills are created in favour of RBI to replenish government’s cash balances and provide the medium for employment of temporary surpluses of state governments and semi-government bodies. Ad hoc Treasury bills were discontinued on April 1, 1997.
Despite this, they remain highly liquid and secured because the RBI is always willing to buy or discount them and there is no better guarantee of repayment than the one provided by the government.
Repo Market and Reverse Repo Instruments
A money market tool called a repo facilitates short-term, collateralized lending and borrowing by means of sales and purchases of debt instruments.
Securities are sold by holders to an investor in a repo transaction, with the buyer agreeing to buy the securities back at a later date and at a predetermined rate.
An agreement to resell the securities at a specific rate and date may also be included in the purchase of the securities. These exchanges are referred to as reverse repo exchanges.
Earlier, repos were allowed only in treasury bills. But gradually, the RBI allowed repo transactions in all government securities and treasury bills, and so also in public sector bonds and private corporate securities to broaden the repo market.
Trade Bills/Commercial Bills
Normally the traders buy goods from the wholesalers or manufacturers on credit. The sellers get payment after the end of the credit period. But if any seller does not want to wait or in immediate need of money, he/she can draw a bill of exchange in favour of the buyer. When the buyer accepts the bill, it becomes a negotiable instrument and is termed as bill of exchange or trade bill.
This trade bill can now be discounted with a bank before its maturity. On maturity the bank gets the payment from the drawee i.e., the buyer of goods. When trade bills are accepted by Commercial Banks it is known as Commercial Bills. So, a trade bill is an instrument, which enables the drawer of the bill to get funds for a short period to meet the working capital needs.
Commercial Paper
Commercial Paper (CP) is a popular instrument for financing working capital requirements of companies.
• The CP is an unsecured instrument issued in the form of a promissory note. This instrument was introduced in 1990 to enable the corporate borrowers to raise short- term funds.
• It can be issued for a period ranging from 15 days to one year.
• Commercial documents can be delivered and endorsed for transfer. The main participants in the commercial paper market are the well known businesses, or “Blue Chip” companies.
Certificate of Deposit
• Certificate of Deposit (CDs) are short-term instruments issued by Commercial Banks and Special Financial Institutions (SFIs), which are freely transferable from one party to another.
• The maturity period of CDs ranges from 91 days to one year. These can be issued to individuals, co-operatives and companies.
Collateralized Borrowing and Lending Obligation (CBLO)
• A collateralized borrowing and lending obligation (CBLO) is a money market instrument that represents an obligation between a borrower and a lender concerning the terms and conditions of a loan.
• CBLOs enable access to the short-term money markets for individuals prohibited from using India’s interbank call money market.
• The Reserve Bank of India (RBI) and the Clearing Corporation of India Ltd. (CCIL) are in charge of these instruments. Institutions that are members of CCIL have little to no access to the interbank call money market in India.
• It functions similarly to a bond, with the borrower selling it to the lender for interest, and the lender purchasing the CBLO.
Mutual Funds
• Money Market Mutual Funds (MMMFs) were first introduced in India in April 1991 with the goal of giving investors another short-term option and making money market instruments more accessible to the general public.
• Instruments for the short-term money market make up the portfolio of MMMFs. Investment in such funds provide an opportunity to investors to obtain a yield close to short-term money market rates coupled with adequate liquidity.
CAPITAL MARKET
• Capital Market may be defined as a market dealing in medium and long-term funds.
• It is an institutional arrangement for borrowing medium and long-term funds and provides facilities for marketing
and trading of securities. So, it constitutes all long- term borrowings from banks and financial institutions, borrowings from foreign markets and raising of capital by issuing various securities such as shares, debentures, bonds, etc.
The market where securities are traded is known as the Securities market. It consists of two different segments namely primary and secondary market.
Primary Market
The Primary Market consists of arrangements, which facilitate the procurement of long- term funds by companies by making fresh issue of shares and debentures.
It is usually done through private placement to friends, relatives and financial institutions or by making public issue.
In any case, the companies have to follow a well- established legal procedure and involve a number of intermediaries such as underwriters, brokers, etc. who form an integral part of the primary market.
Secondary Market
The secondary market known as stock market or stock exchange plays an equally important role in mobilising long-term funds by providing the necessary liquidity to holdings in shares and debentures.
It provides a place where these securities can be encashed without any difficulty and delay. It is an organised market where shares, and debentures are traded regularly with high degree of transparency and security.
Distinction between the primary market and secondary market
Function: While the main function of the primary market is to raise long-term funds through fresh issue of securities, the main function of the secondary market is to provide a continuous and ready market for the existing long-term securities.
Participants: While the major players in the primary market are financial institutions, mutual funds, underwriters and individual investors, the major players in the secondary market are all of these and the stockbrokers who are members of the stock exchange.
Listing Requirement: While only those securities can be dealt with in the secondary market, which have been approved for the purpose (listed), there is no such requirement in case of primary market.
Determination of prices: In case of primary market, the prices are determined by the management with due compliance with SEBI requirement for new issue of securities. But in the case of the secondary market, the price of the securities is determined by forces of demand and supply of the market and keeps on fluctuating.
Instruments of Capital Market
• Equity Securities: An equity security represents ownership interest held by shareholders in an entity (a company, partnership, or trust), realized in the form of shares of capital stock, which includes shares of both common and preferred stock. Holders of equity securities are typically not entitled to regular payments although equity securities often do pay out dividends. Equity securities do entitle the holder to some control of the company on a pro rata basis, via voting rights. In the case of bankruptcy, they share only in residual interest after all obligations have been paid out to creditors
• Debt Securities: A debt security represents borrowed money that must be repaid, with terms that stipulate the size of the loan, interest rate, and maturity or renewal date. Debt securities, which include government and corporate bonds, certificates of deposit (CDs) etc., generally entitle their holder to the regular payment of interest and repayment of principal (regardless of the issuer’s performance), along with any other stipulated contractual rights (which do not include voting rights).
• Derivative Securities: A derivative is a type of financial contract whose price is determined by the value of some underlying asset, such as a stock, bond, or commodity.
• Asset-Backed Securities: An asset-backed security represents a part of a large basket of similar assets, such as loans, leases, credit card debts, mortgages, or anything else that generates income. Over time, the cash flow from these assets is pooled and distributed among the different investors.
Structure of Indian Securities Markets
• The market in which securities are issued, purchased by investors and subsequently transferred among investors is called the securities market. The securities market has two interdependent and inseparable segments, viz., the primary market and secondary market.
• The primary market, also called the new issue market, is where issuers raise capital by issuing securities to investors.
• The secondary market, also called the stock exchange facilitates trade in already-issued securities, thereby enabling investors to exit from an investment. The risk in a security investment is transferred from one investor (seller) to another (buyer) in the secondary markets.
• The primary market creates financial assets and the secondary market makes them marketable.
Who are the Issuers in Indian Securities Markets?
Issuers are organizations that raise money by issuing securities. They may have short-term and long-term need for capital, and they issue securities based on their need, their ability to service the securities. Some of the common issuers in the Indian Securities Markets are:
Companies issue securities to raise short- and long-term capital for conducting their business operations.
Central and state governments issue debt securities to meet their requirements for short- and long-term funds to meet their deficits.
Local governments and municipalities may also issue debt securities to meet their development needs.
Government agencies do not issue equity securities.
Financial institutions and banks may issue equity or debt securities for their capital needs beyond their normal sources of funding from deposits and government grants.
Public sector companies which are owned by the government may issue securities to public investors as part of the disinvestment program of the government, when the government decides to offer its holding of these securities to public investors.
Mutual funds issue units of a scheme to investors to mobilise money and invest them on behalf of investors in securities.