What is a financial market?
A financial market is a market where money and financial papers (shares, bonds, bills) are bought and sold. It links savers (households who have extra money) with users (businesses and government who need money).
Functions of a financial market
- Moves savings to the best use (allocative function): money goes where it earns the most.
- Helps set prices: demand and supply decide the interest rate and share price.
- Gives liquidity: a paper can be sold and turned into cash.
- Cuts the cost of dealing: savers and users find each other easily and get information cheaply.
There are two big parts: the money market (short term) and the capital market (long term).
Money market
The money market deals in short-term funds, repaid within one year. The main players are RBI, commercial banks, big companies, mutual funds and the government. There is no single building; deals happen by phone and computer.
Money market instruments
- Treasury bill (T-bill): a short loan to the Government of India for 91, 182 or 364 days. It is sold at a discount and repaid at face value (zero-coupon bond). Very safe.
- Commercial paper (CP): an unsecured promissory note issued by a big, well-rated company for 15 days to one year, often to meet working capital needs or for bridge financing.
- Call money: a loan between banks, repayable on demand, usually for 1 to 15 days. It helps banks keep the cash reserve they must hold. The rate is the call rate.
- Certificate of deposit (CD): a short-term deposit with a bank or financial institution, issued in bearer form, when the bank itself needs funds.
- Commercial bill: a bill of exchange drawn by a seller on a buyer when goods are sold on credit. The seller can get it discounted at a bank and get cash before the due date.
Capital market: primary and secondary
The capital market deals in medium- and long-term funds (more than one year) through shares, debentures, bonds and long loans. It includes banks, financial institutions, mutual funds and the stock exchanges.
Capital market vs money market
| Point | Money market | Capital market |
|---|---|---|
| Time | Up to 1 year | More than 1 year |
| Players | Mostly RBI, banks, big firms | Also small investors |
| Papers | T-bills, CP, CD, call money | Shares, debentures, bonds |
| Amount per deal | Very large | Can be small |
| Risk and return | Low risk, low return | Higher risk, higher return |
| Liquidity | Very high | Lower, but stock exchange helps |
Primary market (new issue market)
Here a company sells new securities for the first time. The money goes straight to the company, so it creates new capital. Methods: offer through prospectus (public issue / IPO), offer for sale (through an intermediary), private placement (to a few chosen investors), rights issue (to existing shareholders first) and e-IPO (applying online through the exchange).
Secondary market (stock exchange)
Here existing securities are bought and sold between investors. The company gets no new money. It gives investors a way to exit and makes shares liquid.
| Primary market | Secondary market |
|---|---|
| New securities | Old (already issued) securities |
| Company sells to investor | Investor sells to investor |
| Helps capital formation directly | Helps indirectly, gives liquidity |
| No fixed place | Fixed, recognised exchange |
| Price set by the company | Price set by demand and supply |
Stock exchange: functions and trading
A stock exchange is a recognised body that provides a safe, rule-based place to buy and sell existing securities. Examples: National Stock Exchange (NSE) and BSE.
Functions of a stock exchange
- Liquidity and marketability: you can turn shares into cash any trading day.
- Fair price discovery: prices come from the demand and supply of many buyers and sellers.
- Safety of deals: strict rules and a clearing system protect both sides.
- Helps economic growth: savings flow into the most profitable companies.
- Spreads the equity habit: more people learn to invest.
- Scope for speculation within limits: some healthy speculation keeps the market active.
Trading procedure (screen-based)
- Choose a broker registered with SEBI.
- Open a demat account and a trading account through a depository participant; PAN and KYC are needed.
- Place an order (buy or sell, how many, at what price).
- Order is matched on the exchange's online system; the broker sends a contract note within 24 hours.
- Settlement: money and shares are exchanged. In India settlement is now T+1 (one working day after trade day).
Depository and demat
Dematerialisation (demat) means turning paper share certificates into electronic entries. A demat account holds your shares like a bank account holds money.
A depository is the body that keeps these electronic records. India has two: NSDL (National Securities Depository Limited) and CDSL (Central Depository Services Limited). You deal with them through a Depository Participant (DP), such as a bank or a broker.
Benefits of demat
- No loss, theft, damage or forgery of paper certificates.
- Quick transfer; no stamp duty on transfer of demat shares.
- Bonus shares, rights and dividends reach the account easily.
- One account can hold many kinds of securities.
SEBI: objectives and functions
The Securities and Exchange Board of India (SEBI) was set up in 1988 and got legal powers under the SEBI Act, 1992. It is the watchman of the securities market.
Objectives
- Regulate stock exchanges and the securities industry for orderly working.
- Protect the rights and interests of investors.
- Stop wrong practices, balancing self-regulation with law.
- Develop a code of conduct for middlemen such as brokers and merchant bankers.
Functions
- Regulatory: registering brokers, sub-brokers, merchant bankers and mutual funds; making rules for takeovers; levying fees and fines; inspecting exchanges.
- Developmental: training middlemen, promoting fair practices, making it easier to issue shares (for example, e-IPO and underwriting being optional).
- Protective: banning insider trading and price rigging, stopping fraud, making companies disclose true information, educating investors.
Key formulas and definitions
- Money market = funds up to 1 year; Capital market = funds more than 1 year
- Primary market = new issues (money goes to company); Secondary market = old securities (investor to investor)
- T-bill discount = Face value − Issue price
- Settlement cycle in India = T+1
- SEBI functions = Protective + Developmental + Regulatory
- Depositories: NSDL and CDSL; you reach them through a DP
Worked examples
1. A bank is short of cash for 3 days to meet its reserve needs. Which market and instrument will it use?
The money market, through call money. Banks borrow from each other for 1 to 15 days, repayable on demand.
2. The Government issues a 91-day treasury bill of face value ₹100 at ₹98. What does the investor earn?
The investor pays ₹98 now and gets ₹100 after 91 days. Earning = ₹100 − ₹98 = ₹2. This is the discount; there is no separate interest.
3. A new company offers shares to the public for the first time. Priya applies and gets 20 shares. Next year she sells them on NSE to Ravi. Name the market at each stage.
First stage: primary market (IPO), money goes to the company. Second stage: secondary market (stock exchange), money goes from Ravi to Priya; the company gets nothing new.
4. A company already listed wants more capital and first offers new shares to its present shareholders in the ratio 1:4. Which method is this? Rahul holds 400 shares. How many can he apply for?
It is a rights issue in the primary market. Rahul can apply for 400 × 1/4 = 100 new shares.
5. Anu sells 50 shares on a Monday (a working day). When will the money reach her under T+1?
Settlement happens one working day after trade day, so on Tuesday.
6. A company director buys shares secretly because he knows an unannounced big profit is coming. Which SEBI function deals with this?
This is insider trading. SEBI's protective function bans it and SEBI can punish the director.
Common mistakes
- Thinking the company gets money when its shares are sold on the stock exchange. It gets money only in the primary market.
- Calling a treasury bill a loan to a company. It is a short loan to the Government.
- Mixing up depository and depository participant. NSDL/CDSL are depositories; a bank or broker is the DP.
- Saying the money market deals in shares. Shares belong to the capital market.