The financial market is a broad term that refers to a marketplace where individuals, businesses, and governments can engage in various financial transactions. It is a platform where various financial instruments, such as stocks, bonds, currencies, commodities, and derivatives, are traded.
The nature of the financial market is dynamic and complex, driven by the interaction of numerous participants, including investors, traders, financial institutions, regulators, and policymakers. It plays a crucial role in facilitating the flow of funds between those who have surplus funds (savers) and those who require funds (borrowers).
Concept and Nature of Financial Market
Here are some key aspects that define the concept and nature of the financial market:
- Investment and Capital Allocation: The financial market enables investors to allocate their capital to different financial instruments based on their risk appetite, return expectations, and investment objectives. This capital allocation supports economic growth by providing funding for businesses and projects.
- Price Determination: The financial market serves as a platform for price discovery, where supply and demand forces interact to determine the prices of financial instruments. These prices reflect market sentiment, economic factors, and other relevant information.
- Liquidity: The financial market enhances liquidity by providing a platform for buying and selling financial assets. Participants can readily convert their investments into cash, facilitating efficient capital allocation and risk management.
- Risk Management: The financial market offers various risk management tools, such as derivatives and insurance contracts, which allow participants to hedge against price volatility, interest rate fluctuations, currency risks, and other uncertainties.
- Information Flow: The financial market thrives on information dissemination. Timely and accurate information regarding financial instruments, companies, economic indicators, and market trends is vital for informed investment decisions.
- Regulation and Oversight: Financial markets are subject to regulatory frameworks and oversight by government authorities and regulatory bodies. These regulations aim to ensure fair practices, transparency, and stability in the market, protecting investors and maintaining market integrity.
- Market Efficiency: The financial market aims to be efficient, with prices reflecting all available information. Efficient markets facilitate fair valuation of assets, enable quick execution of transactions, and ensure that investment returns are aligned with the underlying risks.
- Global Connectivity: Financial markets have become increasingly interconnected, thanks to advancements in technology and globalization. Investors can access markets worldwide, and financial instruments can be traded across borders, fostering international capital flows and investment opportunities.
Functions of Financial Markets
Financial markets perform several important functions that contribute to the efficient functioning of the overall economy. Let’s explore these functions along with their subtopics:
1 .Mobilization of Savings and Channelizing them into Productive Uses:
- Encouraging Savings: Financial markets incentivize individuals and institutions to save their surplus funds by offering investment opportunities that generate returns.
- Efficient Allocation of Capital: Financial markets enable the channeling of savings into productive investments, allowing businesses to access the necessary capital for expansion and growth.
- Capital Formation: The process of mobilizing savings and directing them towards productive investments leads to capital formation, which drives economic development.
2. Facilitate Price Discovery:
- Market Forces: Financial markets provide a platform for buyers and sellers to interact, allowing the forces of supply and demand to determine the prices of financial assets.
- Information Transparency: Efficient financial markets ensure that relevant information is readily available to market participants, facilitating accurate price discovery.
3. Provide Liquidity to Financial Assets:
- Secondary Market Trading: Financial markets offer a secondary market where investors can buy and sell financial assets, providing liquidity and enabling investors to convert their investments into cash quickly.
- Market Makers: Market makers play a crucial role by providing liquidity in the market, ensuring that there are willing buyers and sellers for various financial instruments.
4. Reduce the Cost of Transactions:
- Economies of Scale: Financial markets bring together a large number of buyers and sellers, leading to economies of scale and reducing transaction costs.
- Efficient Market Infrastructure: Technological advancements and well-developed market infrastructure, such as electronic trading platforms and clearing systems, help streamline transactions, making them faster and more cost-effective.
The money market is a vital component of the financial system, facilitating short-term borrowing, lending, and investment in highly liquid and low-risk financial instruments. It serves as a platform for participants, including banks, corporations, and governments, to meet their immediate funding needs, manage liquidity, and invest surplus funds. Key functions of the money market include efficient allocation of short-term funds, price discovery, liquidity provision, and reduced transaction costs. Common money market instruments include Treasury Bills, Commercial Paper, Certificates of Deposit, Repurchase Agreements, and bank instruments. With high liquidity and low credit risk, the money market plays a critical role in supporting the smooth operation of the financial system and the overall economy.
The money market has several key features that distinguish it from other financial market segments. These features include:
- Short-term instruments: The money market deals with short-term financial instruments that have a maturity of one year or less. These instruments provide a means for borrowers and lenders to meet their short-term funding requirements.
- High liquidity: The money market instruments are highly liquid, meaning they can be easily bought and sold with minimal impact on their prices. Participants can quickly convert their investments into cash without significant transaction costs or delays.
- Low risk: Money market instruments are generally considered to be low-risk investments due to their short-term nature and high credit quality. They are often issued by governments, financial institutions, and large corporations with strong creditworthiness.
- Fixed-income securities: Most money market instruments are fixed-income securities, which means they pay a predetermined interest rate over their short-term tenure. These instruments provide a steady income stream to investors.
- Regulation and oversight: The money market is subject to regulation and oversight by financial authorities to ensure transparency, fairness, and stability. Regulatory bodies establish rules and guidelines to protect investors and maintain the integrity of the market.
- Wholesale market: The money market primarily serves institutional investors, such as banks, corporations, mutual funds, and government entities. It is referred to as a wholesale market as transactions are conducted in large denominations and primarily involve sophisticated participants.
- Diverse range of instruments: The money market offers a diverse range of instruments, including Treasury Bills, Commercial Paper, Certificates of Deposit, Repurchase Agreements, Treasury Notes, and short-term bonds. Each instrument has its specific features and serves different needs of borrowers and investors.
- Price determination: The money market plays a crucial role in price discovery for short-term financial instruments. The interaction of supply and demand in the market determines the interest rates and yields on these instruments.
- Supplementary market to capital market: The money market acts as a complementary market to the capital market, which deals with long-term securities. It provides a platform for participants to manage their short-term cash flows and invest surplus funds until they are needed for long-term purposes.
- Facilitates monetary policy implementation: Central banks often use the money market as a tool to implement monetary policy. By buying or selling money market instruments, central banks can influence the liquidity in the banking system and regulate interest rates.
Instruments of Money Market
The money market consists of various instruments that facilitate short-term borrowing, lending, and investment activities. These instruments provide a means for participants to manage their liquidity needs and generate returns over a short time horizon. Some common instruments of the money market include:
- Treasury Bills (T-Bills): These are short-term debt instruments issued by the government to finance its short-term funding requirements. T-Bills have maturities ranging from a few days to one year and are typically considered to be risk-free investments.
- Commercial Paper (CP): CP is an unsecured promissory note issued by corporations to raise short-term funds. It is typically issued by companies with high credit ratings and serves as an alternative to traditional bank loans. CP usually has a maturity of 1 to 270 days.
- Certificates of Deposit (CDs): CDs are time deposits offered by banks and financial institutions. They have a fixed maturity date and pay a specified interest rate. CDs are often issued in large denominations and can be traded in the secondary market before maturity.
- Repurchase Agreements (Repo): Repo transactions involve the sale of securities with an agreement to repurchase them at a later date. These transactions help institutions manage their short-term liquidity needs by using securities as collateral.
- Commercial Bills: Commercial bills are short-term, discounted debt instruments issued by corporations to meet their working capital requirements. They are often used for financing trade-related activities and have maturities of up to 180 days.
- Banker’s Acceptance (BA): BAs are negotiable instruments used to finance international trade transactions. They are created when a bank accepts a time draft drawn on it by an exporter or importer. BAs provide a guarantee of payment at maturity and can be traded in the secondary market.
- Treasury Notes: Treasury notes are medium-term debt instruments issued by the government with maturities ranging from one to ten years. They pay fixed or floating interest rates and are commonly used by institutional investors for short to medium-term investment purposes.
- Money Market Mutual Funds (MMMFs): MMMFs pool funds from individual and institutional investors to invest in a diversified portfolio of money market instruments. They offer investors an opportunity to earn competitive returns while maintaining high liquidity.
- Short-term Bonds: Short-term bonds are debt securities issued by corporations or governments with maturities typically ranging from one to five years. They pay fixed or floating interest rates and provide investors with a slightly longer-term investment option within the money market.
The capital market is a financial market where long-term securities like stocks and bonds are bought and sold. It allows companies and governments to raise funds for their investment needs, while investors can buy and sell these securities. The capital market consists of the primary market, where new securities are issued, and the secondary market, where already issued securities are traded. It plays a crucial role in promoting economic growth by facilitating the flow of capital and providing opportunities for investors to generate returns over the long term.
Types of Capital Market
The capital market can be broadly classified into two main types:
The primary market refers to the market where new securities are issued for the first time. In this market, companies, governments, and other entities raise capital by issuing new stocks or bonds to investors. The primary market provides an avenue for businesses to raise funds for expansion, capital expenditure, or debt refinancing. Examples of primary market activities include initial public offerings (IPOs), rights issues, and bond issuances.
Methods of Floatation of Securities in Primary Market
The flotation of securities in the primary market can be accomplished through various methods. Here are some common methods:
- Initial Public Offering (IPO): In an IPO, a company offers its shares to the public for the first time. The company hires investment banks to underwrite the offering and sell the shares to investors. This method allows the company to raise capital by selling a portion of its ownership to public investors.
- Rights Issue: A rights issue is an offering of additional shares to existing shareholders of a company. It gives existing shareholders the right to purchase new shares at a discounted price. This method allows companies to raise capital from their existing investor base.
- Private Placement: In a private placement, securities are offered and sold to a selected group of investors, such as institutional investors, venture capitalists, or high net worth individuals. This method is typically used by companies that do not want to go through the lengthy and expensive process of an IPO.
- Preferential Allotment: Preferential allotment involves issuing securities to a specific group of investors at a predetermined price. This method is commonly used when companies want to raise capital from strategic investors, such as institutional investors or promoters.
- Offer for Sale (OFS): In an offer for sale, existing shareholders, such as promoters or large investors, sell their shares to the public through the primary market. This method allows existing shareholders to divest their holdings and provides an opportunity for the public to purchase shares.
- Public Issue Through a Prospectus: A public issue through a prospectus is a method of floating securities in the primary market. It involves the preparation and publication of a detailed prospectus that provides information about the company and the securities being offered. Interested investors can subscribe to the securities by submitting their applications and payment. This method allows companies to raise capital from the public and offers investors the opportunity to become shareholders. It ensures transparency, investor protection, and compliance with regulatory requirements. Overall, public issues through prospectus facilitate the flow of funds from investors to companies and enable both parties to benefit from the transaction.
The secondary market, also known as the stock market or the securities market, is where previously issued securities are bought and sold among investors. In this market, investors trade existing stocks, bonds, derivatives, and other financial instruments. The secondary market provides liquidity to investors, allowing them to buy or sell securities based on their investment objectives and market conditions. Examples of secondary market platforms include stock exchanges like the National Stock Exchange(NSE) and Bombay Stock Exchange(BSE).
A stock exchange is a regulated marketplace where securities such as stocks, bonds, and derivatives are bought and sold. It provides a platform for investors, both individuals, and institutions, to trade these securities. The stock exchange facilitates the buying and selling of securities by providing a transparent and efficient marketplace.
Functions of Stock Exchange:
- Economic Barometer: Stock exchanges serve as an economic barometer by reflecting the overall health and performance of the economy. Fluctuations in stock prices and market indices can indicate changes in economic conditions.
- Pricing of Securities: Stock exchanges provide a platform for fair and transparent pricing of securities. The forces of supply and demand determine the prices of stocks and other securities, ensuring efficient price discovery.
- Safety of Transactions: Stock exchanges ensure the safety and integrity of transactions. They establish rules and regulations that govern trading activities, promoting transparency and protecting investors from fraudulent practices.
- Contribution to Economic Growth: Stock exchanges play a crucial role in channeling funds from savers to productive investments. By providing companies with access to capital, stock exchanges facilitate economic growth and development.
- Spreading of Equity Cult: Stock exchanges encourage the ownership of shares and the participation of individuals in the equity market. This helps in spreading an equity culture, where individuals become shareholders and benefit from the growth and profitability of companies.
- Scope for Speculation: Stock exchanges provide a platform for speculative activities, allowing traders to take positions based on anticipated price movements. While speculation can introduce volatility, it also adds liquidity and depth to the market.
- Liquidity: Stock exchanges offer liquidity to investors by providing a secondary market for securities. Investors can buy or sell their securities on the exchange, allowing them to convert their investments into cash quickly.
- Better Allocation of Capital: Stock exchanges promote the efficient allocation of capital by connecting companies in need of funds with investors seeking investment opportunities. This enables the flow of capital to productive enterprises, fostering economic efficiency.
- Promotes the Habits of Savings and Investment: Stock exchanges encourage individuals to save and invest their money in securities. By providing avenues for investment, stock exchanges promote the habits of savings and investment among the general public.
Trading Procedure on a Stock Exchange:
- Selection of Broker: The first step in trading on a stock exchange is to select a registered stockbroker. Investors can choose a broker based on their reputation, service quality, brokerage fees, and other factors.
- Opening a Demat Account with Depository: To trade in the electronic format, investors need to open a Demat (Dematerialized) account with a depository. This account holds the investor’s securities in electronic form, eliminating the need for physical share certificates.
- Placing the Order: Once the Demat account is opened, investors can place their buy or sell orders through their stockbroker. They need to specify the quantity, price, and type of order (such as market order or limit order).
- Executing the Order: The stockbroker receives the order and executes it on the stock exchange. The execution can be done through various trading platforms, including online trading portals or the broker’s trading terminal.
- Settlement: After the order is executed, the settlement process begins, where the transfer of securities and funds takes place. There are two types of settlements: a) On-the-Spot Settlement: In on-the-spot settlement, also known as T+2 settlement, the securities and funds are settled within two trading days from the transaction date. The shares are credited to the buyer’s Demat account, and the funds are transferred from the buyer to the seller. b) Forward Settlement: In forward settlement, the settlement date is predetermined and agreed upon by the buyer and seller at the time of trade. The settlement period can be longer than the T+2 settlement, ranging from a few days to several weeks.
Constituents of Depository System:
- The Depository: The depository is the central entity that holds securities in electronic form. It acts as a safekeeper of securities and facilitates their transfer and settlement. In India, the two main depositories are the National Securities Depository Limited (NSDL) and the Central Depository Services Limited (CDSL).
- The Depository Participants (DPs): Depository participants are intermediaries authorized by the depository to offer depository services to investors. They serve as a link between the investors and the depository. DPs can be banks, financial institutions, brokers, or other entities registered with the depository.
- Demat Account: A demat account is a digital account that holds an investor’s securities in electronic form. It is similar to a bank account, but instead of holding money, it holds shares, bonds, mutual funds, and other securities. Investors need to open a demat account with a DP to avail of the benefits of the depository system.
- The Issuing Company: The issuing company refers to the entity that originally issues the securities, such as shares or bonds, and offers them to the public. Once the securities are issued, they can be held in physical or electronic form. In the case of the depository system, the issuing company facilitates the conversion of physical securities into electronic form.
- The Investor: The investor is the individual or entity that holds securities and participates in the capital market. By opening a demat account and availing the services of a DP, investors can hold and manage their securities in electronic form. They can buy, sell, or transfer securities electronically, eliminating the need for physical certificates.
stock exchange indices
In India, there are several stock exchange indices that are used to measure and track the performance of the stock market. The prominent stock exchange indices in India include:
- BSE Sensex: The Bombay Stock Exchange (BSE) Sensex is one of the most widely followed stock market indices in India. It represents the performance of the top 30 companies listed on the BSE based on market capitalization.
- Nifty 50: The Nifty 50 is the benchmark index of the National Stock Exchange (NSE). It comprises the 50 large-cap stocks from various sectors that are actively traded on the NSE.
- BSE 500: The BSE 500 is a broad-based index that covers the top 500 companies listed on the BSE based on market capitalization. It represents a wide range of sectors and provides a comprehensive view of the overall market performance.
- Nifty Bank: The Nifty Bank index tracks the performance of the banking sector stocks listed on the NSE. It includes the major public and private sector banks in India.
- BSE Midcap and BSE Smallcap: These indices represent the midcap and smallcap segments of the market, respectively. BSE Midcap index tracks the performance of mid-sized companies, while BSE Smallcap index represents the small-sized companies listed on the BSE.
- Nifty IT: The Nifty IT index tracks the performance of the IT (Information Technology) sector stocks listed on the NSE. It includes major IT companies in India.
- Nifty Pharma: The Nifty Pharma index measures the performance of pharmaceutical sector stocks listed on the NSE. It includes pharmaceutical companies engaged in the manufacturing and distribution of drugs.
Some Benefits of line stock exchange
Demutualization: Demutualisation refers to the process of transforming a stock exchange from a member-owned organization to a for-profit company owned by shareholders. It involves separating ownership and trading rights from the membership of the exchange. Here are some benefits of demutualization
a) Increased efficiency: Demutualisation allows for more efficient decision-making and governance structures. It enables exchanges to adapt and respond quickly to changing market dynamics and technological advancements.
b) Enhanced transparency: Demutualisation promotes transparency in the operations of stock exchanges. The separation of ownership from trading rights reduces conflicts of interest and fosters a more transparent and accountable environment.
c) Access to capital: By transforming into for-profit entities, demutualized exchanges can access capital markets for funding their growth initiatives. This allows them to invest in advanced technology, expand their product offerings, and improve market infrastructure.
Dematerialization: Dematerialization involves the conversion of physical securities into electronic or digital forms, eliminating the need for paper certificates. Here are some benefits of dematerialization:
a) Enhanced efficiency: Dematerialisation eliminates the risks and inefficiencies associated with physical securities, such as loss, theft, forgery, and delays in transfer. Electronic transactions are processed more quickly, reducing settlement times and improving overall market efficiency.
b) Cost savings: Dematerialisation reduces administrative and operational costs for handling and storing physical certificates. It eliminates the need for printing, transportation, and storage of paper documents, leading to significant cost savings for investors and market participants.
c) Increased liquidity: The electronic transfer and trading of dematerialized securities make it easier and faster for investors to buy, sell, and transfer ownership. This improves market liquidity and enhances market depth, attracting more participants and facilitating smoother trading.
d) Investor convenience: Dematerialisation allows investors to hold securities in electronic form in a demat account. It simplifies portfolio management, eliminates the risk of physical certificate loss or damage, and enables seamless transfer of securities.
SEBI (Securities and Exchange Board of India) is the regulatory body for the securities market in India. It was established on April 12, 1992, as a statutory body under the SEBI Act, 1992. Let’s explore the reasons for the establishment of SEBI and its objectives:
Reasons for the establishment of SEBI:
- Investor Protection: The primary reason for establishing SEBI was to safeguard the interests of investors and ensure fair and transparent dealings in the securities market. It aimed to protect investors from fraudulent practices, manipulation, and other malpractices.
- Market Development: SEBI was set up to promote and develop the securities market in India. It aimed to create a well-regulated market infrastructure that would attract investors, both domestic and international, and facilitate the growth and development of the capital market.
Objectives of SEBI:
- Regulation and Oversight: SEBI’s main objective is to regulate and supervise various participants in the securities market, including stock exchanges, brokers, intermediaries, and listed companies. It formulates rules, regulations, and guidelines to ensure fair practices, transparency, and integrity in the market.
- Investor Protection: SEBI strives to protect the interests of investors by ensuring the availability of accurate and timely information, promoting fair trade practices, and taking measures to prevent fraudulent activities and market manipulation.
- Promoting a Fair and Transparent Market: SEBI aims to create a level playing field for all market participants by preventing insider trading, price manipulation, and other unfair practices. It promotes transparency in disclosures, corporate governance, and financial reporting by listed companies.
- Development and Regulation of Market Intermediaries: SEBI’s objective is to regulate and develop various market intermediaries, such as brokers, depository participants, and mutual funds. It sets standards and guidelines for their functioning, ensuring investor protection and market integrity.
- Capacity Building: SEBI focuses on enhancing the knowledge and skills of market participants by conducting investor education programs, training sessions, and awareness campaigns. It aims to empower investors with the necessary knowledge to make informed investment decisions.
- Promoting Market Integrity: SEBI works towards maintaining market integrity by monitoring and preventing market abuses, ensuring compliance with regulations, and taking enforcement actions against defaulters or violators of securities laws.
Function of SEBI
SEBI (Securities and Exchange Board of India) performs various functions to regulate and develop the securities market in India. Let’s explore its functions in detail:
a) Checking Price Rigging: SEBI ensures that there is no manipulation or rigging of stock prices by closely monitoring trading activities, investigating suspicious transactions, and taking appropriate action against offenders.
b) Prohibiting Insider Trading: SEBI has strict regulations in place to prevent insider trading, which involves trading in securities based on non-public information. It aims to ensure a level playing field for all investors and maintain market integrity.
c) Prohibiting Fraudulent and Unfair Trade Practices: SEBI takes measures to curb fraudulent and unfair trade practices in the securities market. It conducts regular inspections, audits, and investigations to identify and penalize entities engaged in such practices, protecting the interests of investors.
SEBI plays a crucial role in the development and growth of the securities market in India. It focuses on:
a) Promoting Investor Education and Awareness: SEBI conducts investor education programs, awareness campaigns, and initiatives to educate investors about the functioning of the securities market, investment risks, and rights.
b) Enhancing Market Infrastructure: SEBI works towards improving the market infrastructure by setting up stock exchanges, depositories, clearinghouses, and other market intermediaries. It aims to create efficient and robust market systems to facilitate smooth trading and settlement processes.
c) Encouraging Innovation: SEBI encourages innovation in financial instruments, products, and trading mechanisms. It promotes the introduction of new financial instruments and market practices to enhance the depth and breadth of the securities market.
SEBI has extensive regulatory powers to oversee and regulate various entities in the securities market. Its regulatory functions include:
a) Registration and Regulation of Intermediaries: SEBI regulates and registers market intermediaries such as brokers, mutual funds, portfolio managers, depository participants, and credit rating agencies. It sets guidelines and standards for their conduct, compliance, and operations.
b) Supervision and Monitoring: SEBI conducts regular inspections, audits, and surveillance of market participants to ensure compliance with securities laws, regulations, and disclosure requirements.
c) Enforcing Securities Laws: SEBI has the authority to enforce securities laws and regulations. It can take legal action, impose penalties, and initiate prosecution against entities found to be in violation of securities laws.
d) Framing Regulations and Guidelines: SEBI formulates rules, regulations, and guidelines to govern the functioning of the securities market. It periodically reviews and updates these regulations to keep pace with market developments and protect the interests of investors.