Financial Markets — Notes

A financial market is where financial assets (shares, debentures, bonds, bills) are created and exchanged. Households are usually the suppliers of funds and firms the users; the market allocates savings to their most productive uses.

Functions

1. Mobilisation of savings and channelling them into productive uses.
2. Price discovery: demand and supply decide the price of financial assets.
3. Liquidity: assets can be turned into cash quickly.
4. Reducing the cost of transactions: information and an organised market save time, effort and money.

The money market deals in short-term funds with maturities of up to one year. Participants: RBI, commercial banks, large companies, mutual funds, NBFCs.

• Treasury bill: borrowing of the Central Government, issued by the RBI; zero-coupon (issued at a discount, repaid at face value); 91, 182 or 364 days.
• Commercial paper: unsecured promissory note of a large, creditworthy company; negotiable, transferable by endorsement and delivery; 15 days to one year; used for working capital and bridge financing.
• Call money: interbank finance, repayable on demand, one to 15 days; helps banks meet their reserve requirement; price = call rate.
• Certificate of deposit: unsecured, negotiable, bearer instrument issued by commercial banks and development financial institutions.
• Commercial bill: a trade bill accepted by a commercial bank; can be discounted for cash; finances working capital.

The capital market deals in medium- and long-term funds through shares, debentures and bonds; participants include development banks, commercial banks, mutual funds and stock exchanges.

Money vs capital market: duration, instruments, investment outlay (large vs small), liquidity and safety (higher vs lower), expected return (lower vs higher).

Primary (new issues) market: new securities sold for the first time; money goes to the company; direct contribution to capital formation; no fixed place; price set by the company.

Secondary market (stock exchange): existing securities traded between investors; fixed place; price by demand and supply; helps capital formation indirectly by giving liquidity.

1. Offer through prospectus: the public is invited to subscribe through a prospectus; issues are often underwritten.
2. Offer for sale: the issue is sold to intermediaries (issuing houses, brokers) at an agreed price, who resell it to the public.
3. Private placement: allotment to institutional investors and select individuals; saves time and cost.
4. Rights issue: new shares offered to existing shareholders in proportion to their holding.
5. e-IPO: an online public offer using the network of a stock exchange; applications are collected by registered brokers.

A stock exchange provides a platform for buying and selling existing securities.

Functions: liquidity and marketability; pricing of securities; safety of transactions; contribution to economic growth; spreading of the equity cult; limited scope for speculation.

Trading and settlement: (1) open a trading account with a broker and a demat account with a depository participant; (2) place the order; (3) the order is matched and executed on the exchange's online system; (4) the broker issues a contract note; (5) settlement: funds and securities are exchanged on a short rolling cycle.

Dematerialisation: securities are held as electronic entries. Depositories: NSDL and CDSL, reached through depository participants. Benefits: no theft, forgery or loss of certificates; quick and cheap transfer.

Set up in 1988; statutory body under the SEBI Act, 1992.

Objectives: regulate stock exchanges and the securities industry; protect the rights and interests of investors; prevent trading malpractices; regulate and develop a code of conduct for intermediaries.

Protective functions: prohibit insider trading, price rigging and fraudulent or unfair trade practices; educate investors; promote fair practices.

Developmental functions: training of intermediaries; promoting research; flexible steps such as internet trading through registered brokers.

Regulatory functions: register and regulate brokers, sub-brokers, merchant bankers, mutual funds and others; frame rules and regulations; regulate takeovers; inspect and audit stock exchanges; levy fees.