Kerala Plus Two Business Studies Notes Chapter 10 Financial Markets
Financial Market is a market for creation and exchange of financial assets such as Shares, Debentures, Treasury Bills, Commercial Paper, etc. It helps in mobilisation and channelising the savings into most productive uses.
A financial market also helps in price discovery and provides liquidity to financial assets.
Functions of Financial Market
- Mobilisation of Savings: Financial markets mobilise savings of investors and channelise it into the most productive use.
- Facilitating Price Discovery: Financial Market helps in the determination of prices of the financial assets.
- Providing Liquidity: Financial market facilitates easy purchase and sale of financial assets. Thus, it provides liquidity.
- Reducing the Cost of Transactions: Financial market provides valuable information about securities which helps in saving time, efforts and money and thus it reduces cost of transactions.
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 enables in raising short term fund for meeting day-to-day requirements. The major participants in the money market are the Reserve Bank of India, Commercial Banks, Non-Banking Finance Companies, State Governments, Large Corporate Houses and Mutual Funds.
Money Market Instruments
1) Treasury Bill: They are issued by the RBI on behalf of the Central Government to meet its short¬term requirement of funds. They are issued at a discount on the face value of the instruments and repayable at par. They are issued in the form of promissory notes. They are also known as Zero Coupon Bonds as no interest is paid on such bills. They are highly liquid. The maturity period of these bills may be between 14 to 364 days.
2) Commercial Paper: Commercial paper is a short-term unsecured promissory note, negotiable and transferable by endorsement and delivery with a maturity period of 15 days to one year. It is sold at a discount and redeemed at par.
3) Call Money: Call money is short term finance repayable on demand, with a maturity period of one day to fifteen days, used for inter-bank transactions.
4) Certificate of Deposit: Certificates 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.
5) Commercial Bill: A commercial bill is a Bill of Exchange used to finance the working capital requirements of business firms. When goods are sold in credit, the seller draws the bill and the buyer accepts it. The seller can discount the bill before its maturity with the bank. When a trade bill is accepted by a commercial bank it is known as commercial bills.
Capital Market
It is a market for long term funds where debt and equity are traded. It consists of development banks, commercial banks and stock exchanges. The capital market can be divided into:
- Primary Market.
- Secondary Market
Primary Market
The primary market is also known as the new issues market. It deals with new securities being issued for the first time. A company can raise capital through the primary market in the form of equity shares, preference shares, debentures, loans and deposits. Funds raised may be for setting up new projects, expansion, diversification, etc. of existing enterprises. The investors in this market are banks, financial institutions, insurance companies, mutual funds and individuals.
Methods of flotation
There are various methods of floating new issues in the primary market. They are:
1. Offer through Prospectus: Prospectus is an invitation to the public for the subscription of shares and debentures of a company. The issues may be underwritten and also are required to be listed on at least one stock exchange.
2. Offer for Sale: Under this method new securities are not offered directly to the public. Initially the entire lots of securities are sold to an intermediary at a fixed price. The intermediary sells these securities to the public at a higher price.
3. Private Placement: Private placement is the allotment of securities by a company to institutional investors or some selected individuals. It is less expensive and saves time.
4. Rights Issue: According to the Companies Act, if a public company wants to issue additional shares, it must first be offered to the existing shareholders, in proportion to the amount paid up on their shares. This right is known as ‘Pre-emptive right’ and such an issue is called right issue.
5. Electronic Initial Public Offer (e-IPOs): It is a method of issuing securities through on-line system of stock exchange. Such a company has to enter into an agreement with the stock exchange. This is called an e-initial public offer.
Difference between capital market and money market
Capital Market:
- Market deals only long term fund.
- It arranges large amount of fund.
- Return is high.
- The instruments used are equity shares, preference shares, debentures and bonds.
- SEBI is the market regulator.
- Capital market instruments are highly risky.
Money Market:
- Market deals only short term fund.
- It arranges small amount of fund.
- Return is law.
- The instruments used are call money, treasury bills, trade bills, commercial paper and certificate of deposit.
- RBI is the market regulator.
- Money market instruments are safe.
Differences between Primary Market and Secondary Market
Primary Market:
- It deals with new securities
- It promotes capital formation directly.
- Investors can only buy. securities.
- Prices of the securi¬ties are determined by the management of the company.
- Companies sell securities directly
Secondary Market:
- It deals with exisitng securities
- It promotes capital formation indirectly.
- Investors can buy and sell the securities.
- Prices are determined by the demand and supply of securities.
- Securities are exchanged between investors
Secondary market
The secondary market is also known as the stock market or Stock exchange. It is a market for the purchase and sale of existing securities. It also provides liquidity and marketability to existing securities
Stock Exchange
According to Securities Contracts (Regulation) Act 1956, stock exchange means any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying and selling or dealing in securities.
Functions of a Stock Exchange:
- Providing Liquidity and Marketability to Existing Securities: Stock Exchange provides
a ready and continuous market for the sale and purchase of securities. - Pricing of Securities: A stock exchange is a mechanism of constant valuation through which the prices of securities are determined. It is based on the forces of demand and supply.
- Safety of Transaction: Stock exchange has its own well-defined rules and regulations. This ensures safety and fair dealings to investors.
- Contributes to Economic Growth: Stock exchange provides a platform by which savings are channelised into the most productive investment proposals, which leads to capital formation and economic growth.
- Providing Scope for Speculation: Stock exchange provides scope within the provisions of Law for speculation in a restricted and controlled manner.
- Economic barometer: A stock exchange serves as a barometer of a country’s economic condition. Price trends in stock exchange indicate whether economy is going through boom or depression.
Trading Procedure on a Stock Exchanges
- Selection of a broker.
- Opening Demat account with the Depository Participant (D.P.).
- Placing order for the purchase or sale of securities with the broker.
- Purchase or sale of securities through on-line.
- Delivery of the contract note to the investor.
- Effecting changes in the Demat account.
- Making payment or receiving of money.
Advantages of electronic trading system (Screen based on line trading)
On line trading means buying and selling of shares and debentures are done through a computer terminal.
- On line trading ensures transparency in dealing.
- It helps in fixing prices of securities efficiently.
- It increases efficiency of operations by reducing time, cost and risk of errors.
- People from all over the country can buy or sell securities through brokers.
- All trading centres have been brought into one trading platform.
Dematerialisation
It is a process by which physical share certificates are converted into an equivalent number of securities to be held in electronic form and credited in the investors’ account. For this, the investor has to open a Demat account with an organisation called a depository.
Working of the Demat System
- A depository participant (DP), either a bank, broker, or financial services company, may be identified.
- An account opening form and documentation (PAN card details, photograph, power of attorney) may be completed.
- The physical certificate is to be given to the DP along with a dematerialisation request form.
- If shares are applied in a public offer, details of DP and demat account are to be given to the depository registrar.
- If shares are to be sold through a broker, the DP is to be instructed to debit the account with the number of shares.
- The broker then gives instruction to his DP for delivery of the shares to the stock exchange.
- The broker then receives payment and pays the person for the shares sold.
- Alt these transactions are to be completed within 2 days, i.e., delivery of shares and payment received from the buyer is on a T + 2 basis, settlement period.
Depository
A depository is an organization where the securities of a shareholder are held in electronic form at the request of the shareholder. All transactions of the investors are settled with greater speed, efficiency and use as all securities are entered in a book entry mode.
Benefits of Depository Services and Demat Account
- Sale and Purchase of shares and stocks of any company make easy.
- Saves time.
- No paperwork.
- Lower transaction costs.
- Ease in trading.
- Transparency in transactions.
- No counterfeiting of security certificate.
- Physical presence of investor is not required in stock exchange.
National Stock Exchange of India (NSE)
NSE is the most modern stock exchange in India. It was incorporated in 1992 and was recognised as a stock exchange in April 1993. It commenced operations in 1994. NSE has set up a nationwide fully automated screen based trading system.
Objectives of NSE
- Establishing a nationwide trading facility for all types of securities.
- Ensuring equal access to investors all over the country.
- Providing a transparent securities market using electronic trading system.
- Enabling shorter settlement cycles and book entry settlements.
- Meeting international benchmarks and standards.
Over the Counter Exchange of India (OTCEI)
The OTCEI is a company incorporated under the Companies Act 1956. It was set-up to provide smalt and medium companies an access to the capital market. It is fully computerised, transparent, single window exchange which provides quicker liquidity to securities at a fixed and fair price, liquidity for less traded securities. It is commenced trading in 1992.
Objectives of OTCEI
- Provide a trading platform to smaller and less liquid companies.
- Provide online trading facilities to the investors.
- Ensure a transparent system of trading.
- Ensure liquidity to the listed securities.
- Help the investors to exchange the securities at minimum cost.
Bombay Stock Exchange (BSE)
BSE was established in 1875 and was Asia’s first Stock Exchange. In 1995 it introduces screen based trading called BOLT (BSE Online Trading).
Objectives of BSE
- To provide an efficient and transparent market for trading in securities.
- To provide a trading platform for equities of small and medium enterprises.
- To educate the investors and brokers
- To provide other services to capital market participants, like risk management, clearing, settlement, market data, etc.
- To conform to international standards.
Securities and Exchange Board of India (SEBI)
In order to protect the investors and to promote the development of stock market, the Govt, of India established the Securities and Exchange Board of India (SEBI) in 1988. In 1992 it becomes a statutory body under a special law of the Parliament. SEBI is the supervisory body for regulation and promotion of securities market in the country. Investor protection is the major responsibility of SEBI. It’s head office is at Mumbai.
Objectives of SEBI
- To regulate stock exchange and the securities market to promote their orderly functioning.
- To protect the rights and interests of investors and to guide and educate them.
- To prevent trade malpractices.
- To regulate and develop a code of conduct to intermediaries like brokers, merchant bankers etc.
Functions of SEBI
1. Regulatory Functions:
- Registration of brokers and sub brokers and other players in the market.
- Registration of Mutual Funds.
- Regulation of stock brokers, portfolio exchanges, underwriters, etc.
- Regulation of takeover bids by companies
- Calling for information by undertaking inspection, conducting enquiries and audits of stock exchanges and intermediaries.
- Levying fee or other charges for carrying out the purposes of the Act.
2) Development Functions:
- Training of intermediaries of the securities market.
- Conducting research and publishing information useful to all market participants.
- Undertaking measures to develop the capital markets by adapting a flexible approach.
3) Protective Functions:
- Prohibition of fraudulent and unfair, trade practices.
- Controlling insider trading price rigging etc. and imposing penalties for such practices.
- Undertaking steps for investor protection.
- Promotion of fair practices and code of conduct in securities market.