UNIT- IV

FINANCIAL MARKETS
A financial market is a transmission mechanism between investors-lenders
and borrowers-users through which transfer of funds is facilitated. [t consists of
individual investors, financial institutions and credit instruments like bills of exchange,
promissory notes, treasury bills, shares, debentures, bonds, etc.
Meaning of Financial Markets:
Definition:
Financial markets are venues where financial instruments are bought and sold,
facilitating the flow of capital between different entities.

The main functions of financial markets are :

1. Providing facilities for interaction between investors and borrowers;
2. Providing pricing information resulting from the interaction between buyers
and sellers in the markets when they trade the financial assets;
3. Providing security or dealings in financial assets;
4. Ensuring liquidity by providing a mechanism for an investor to sell the
financial assets; and
5. Ensuring law cost of transactions and ready availability of necessary
information.
The Main Purpose of Financial Markets:
They provide a platform for:
 Raising capital: Companies and governments can raise funds by
issuing securities (stocks and bonds).
 Investing: Individuals and institutions can invest their savings in
various financial assets.
 Risk management: Participants can use financial instruments to
hedge against risks and manage their financial positions.
Key Participants of Financial Markets:
 Borrowers: Companies, governments, and individuals seeking funds.
 Lenders/Investors: Individuals, institutions, and funds that provide
capital.
 Brokers and Intermediaries: Facilitate trading and provide services to
market participants.

Near Money: In economics, "near money" (also called quasi-money or cash

equivalents) refers to non-cash assets that are highly liquid and can be easily
converted into cash without significant loss of value.
MONEY MARKET AND CAPITAL MARKET
Broadly speaking, the financial markets are classified as money market and
capital market.
The money market deals with short-term debt instruments (under a year), like
Treasury bills and commercial paper, while the capital market handles long-term
securities, such as stocks and bonds.

MONEY MARKET:
Money market refers to the whole network of financial institutions where short-
term debt instruments are traded, typically with maturities of less than one year.
The Reserve Bank of India describes money market as "the centre for dealings,
mainly of short-term character. in monetary assets. It meets the short-term
requirements of borrowers and provides liquidity or cash to them by the lenders

Instruments of Money Market

1. Call Money Market :
The call money market exists in almost all developed money markets.
In call money market, borrowing and lending transactions are usually carried
out for one day.
These are often called call loans which may or may not be renewed the
next day. However, the renewals are allowed upto 14 days after which the
transaction has to be reversed.
The call money market is also known as inter bank 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

2. Treasury Bills (T-bills):

In India, treasury bills are short-term liability of the Central Government
as these are mostly issued by Reserve Bank of India on behalf of the Central
Government for meeting its temporary deficits and financing the expenditure.
A Treasury Bill (T-Bill) is a short-term debt instrument issued by the
government to raise funds for a short duration, typically ranging from 91 days,
182 days, to 364 days.
T-Bills are issued at a discount and redeemed at face value upon
maturity, with the difference representing the investor's return. They are
considered risk-free investments.

3. Commercial Paper (CP):

Commercial paper is a new money market instrument introduced by
the RBI in January 1990 for raising short-term funds by companies.
 They are issued by corporations (Non Banking financial institutions)
and financial institutions with high credit, issued in a dematerialized form in
multiples of 5 lakh Rupees with a minimum size of Rs. 25 lakh with a maturity
period ranging from three months to six months.
The initial investor who could be a bank, a company, an incorporated
body or an individual, would pay the discounted value of CP. Since the CP is
an unsecured instrument, its interest rate is higher than that of the interbank
rate or bill discount rate.

4. Certificate of Deposit (CD) –

A negotiable money market instrument issued by banks and financial
institutions as a time deposit with a fixed maturity period, usually ranging
from 7 days to 1 year (for banks) and up to 3 years (for financial institutions).
CDs offer higher interest rates than savings accounts but cannot be
withdrawn before maturity

5. Commercial Bill:
A Commercial Bill is a short-term, negotiable financial instrument
used in trade transactions to facilitate credit sales. It is typically issued by a
seller (drawer) to a buyer (drawee) as proof of payment due for goods or
services delivered. These bills can be discounted with banks before
maturity for immediate cash.
6. Trade Bill:
A broader category of bills used in trade transactions where the seller
(drawer) issues a bill to the buyer (drawee) as proof of payment due. It serves
as a credit instrument and can be endorsed, transferred, or discounted to
improve liquidity in trade..
 Characteristics:
 High liquidity (easy to buy and sell).
 Lower risk compared to capital market instruments.
 Lower potential returns compared to capital market instruments.
CAPITAL MARKET:
Capital market refers to an organisation and the mechanism through which the
companies, other institutions and the government raise long term funds by issue of
securities such as shares, debentures, bonds, etc. It signifies the institutional
arrangement for raising long-term funds and providing facilities for marketing and
trading of securities.
A financial market where long-term debt and equity securities are traded, typically
with maturities of more than one year.

The capital market consists of primary and secondary markets.

PRIMARY Market:
The Primary Market is where new securities are issued and sold for the first
time, helping companies raise capital. A key example is the Initial Public Offering
(IPO), where a company sells shares to the public. Funds raised go directly to the
issuer, unlike the secondary market, where securities are resold among investors.

The functions of Primary Markets are:

1. Origination – Involves evaluating and processing new project proposals
before issuing securities, often with the help of commercial banks.
2. Underwriting – Ensures the success of new issues by guaranteeing a
minimum subscription, with underwriters purchasing unsold shares.
3. Distribution – Brokers and dealers distribute securities to investors as they
have direct market connections.

SECONDARY Market:
The Secondary Market is where previously issued securities (Securities
issued in the Primary Market) are traded among investors. It provides liquidity and
enables price discovery through stock exchanges like NSE and BSE.
The functions of Secondary Markets are:
1. The security value is regularly informed, and investors are offered liquidity for
their assets.
2. Provides a marketplace where securities are traded.

Capital Market Instruments:

1. Debentures
A debenture is a debt instrument issued by companies to borrow money from
investors. Debenture holders are creditors of the company and receive fixed
interest payments. Unlike shareholders, debenture holders do not have voting
rights.
Unsecured bonds that depend on the creditworthiness of the issuer rather
than physical collateral. Common in corporate financing. They are traded in the
 secondary bond market via platforms like RBI’s NDS-OM (Negotiated Dealing
System-Order Matching) and stock exchanges.

2. Shares
Shares represent ownership in a company. Shareholders are entitled to a share
in the company's profits (dividends) and have voting rights in decision-making.
After listing, they are actively traded in the secondary market on stock exchanges
(BSE, NSE). Investors buy and sell shares through brokers and online trading
platforms.

3. Bonds
A bond is a fixed-income security where the issuer (government or corporation)
borrows money from investors and pays them interest over a period. At maturity,
the principal is repaid.

4. Equity
Equity represents ownership capital in a company. Unlike bonds or debentures,
equity does not have fixed returns but offers capital appreciation and dividends.

5. Derivative Instruments
Derivative instruments derive their value from an underlying asset like stocks,
bonds, commodities, or interest rates. They are primarily used for hedging risks
or speculating on future price movements.

Money Market vs. Capital Market

Feature Money Market Capital Market
Focus Short-term debt instruments Long-term debt and
(maturity < 1 year) equity instruments
(maturity > 1 year)
Purpose Facilitate short-term borrowing Raise long-term capital
and lending for investment and growth
Instruments Treasury bills, commercial Stocks, bonds,
papers, call money, certificates debentures, equity
of deposit
Risk Generally lower risk due to short Generally higher risk due
maturities to longer maturities and
potential for fluctuations
Liquidity Highly liquid Can be less liquid,
especially for certain
instruments
Feature Money Market Capital Market
STOCK MARKET -FUNCTIONS AND WORKINGS OF MAJOR STOCK
EXCHANGES IN INDIA;

What is Stock Market?

The stock market is a financial platform where investors can buy and sell
shares of companies. It allows businesses to raise capital and investors to earn
profits through trading securities such as stocks, bonds, derivatives, and ETFs. The
market operates based on demand and supply, and share prices fluctuate
accordingly.

Functions of Stock Markets:

1. Economic Barometer: The stock exchange reflects the overall state of the
economy by tracking changes in share prices. It serves as an indicator of
economic health and market trends.
2. Contribution to Economic Growth: The stock exchange facilitates
continuous investment and reinvestment, leading to capital formation and
overall economic development.
3. Encouraging Investment and Savings: The stock market provides a viable
investment alternative with higher returns compared to traditional options like
gold and silver, promoting financial growth
4. Better Capital Allocation: Profitable companies attract more investments,
ensuring that financial resources are allocated efficiently for maximum returns.
5. Facilitating Liquidity: Investors can buy and sell securities easily, converting
their investments into cash when needed, which increases confidence in the
market.
6. Awareness of Equity Investment: By providing information and encouraging
participation, stock exchanges help educate the public on investment
opportunities in securities.

What are Major Stock Exchange in India?

Most of the trading in the Indian stock market takes place on its two stock
exchanges: the Bombay Stock Exchange (BSE) and the National Stock Exchange
(NSE).
National Stock Exchange
The National Stock Exchange of India (NSE) is one of the leading stock
exchanges in India. It was established in 1992 and is located in Mumbai.
The NSE operates on an automated electronic trading system known as the
National Exchange for Automated Trading (NEAT). This system allows for faster and
more efficient order matching, ensuring transparency and liquidity in the market.
 It also provides a fair and equal opportunity for investors to participate in
trading.
It pioneered the introduction of index-based trading in India with the launch of
the Nifty 50 index, which has become a widely tracked benchmark for the Indian
equity market. The NSE has also introduced various other indices and products to
cater to the diverse needs of investors.
Bombay Stock Exchange
The Bombay Stock Exchange (BSE) is the oldest stock exchange in Asia and
one of the premier stock exchanges in India. Established in 1875, it is located in
Mumbai.
It operates on an electronic trading platform known as the BSE Online Trading
(BOLT) system. It ensures efficient order matching and facilitates seamless trading
activities.
It has almost 5000 listed businesses, making it the ninth-largest stock market
in the world. It is known for its electronic trading platforms that enable investors to
trade in investment trusts, currencies, bonds, and derivatives. Furthermore, the BSE
actively promotes investor education and awareness programs to enhance financial
literacy and empower investors to make informed decisions. It also focuses on
initiatives to attract foreign investors and promote the internationalization of the
Indian capital market.
FUNTIONS OF SEBI

What is SEBI?
SEBI stands for Securities and Exchange Board of India. It is a statutory
regulatory body that was established by the Government of India in 1992 for
protecting the interests of investors investing in securities along with regulating the
securities market. SEBI also regulates how the stock market and mutual funds
function.

What are the Objectives of SEBI?

Following are some of the objectives of the SEBI:
1. Investor Protection: It involves protecting the interests of investors by providing
guidance and ensuring that the investment done is safe.
2. Preventing the fraudulent practices and malpractices which are related to trading
and regulation of the activities of the stock exchange
3. To develop a code of conduct for the financial intermediaries such as
underwriters, brokers, etc.
4. To maintain a balance between statutory regulations and self regulation.

Write the Functions of SEBI.

SEBI has the following functions
1. Protective Function
2. Regulatory Function
3. Development Function

The following functions will be discussed in detail

Protective Function:
The protective function implies the role that SEBI plays in protecting the
investor interest and also that of other financial participants. The protective function
includes the following activities.
a. Prohibits insider trading: Insider trading is the act of buying or selling of the
securities by the insiders of a company
b. Check price rigging: Price rigging is the act of causing unnatural
fluctuations in the price of securities
c. Promoting fair practices: SEBI promotes fair trade practice and works
towards prohibiting fraudulent activities related to trading of securities.
 d. Act as Financial education provider to Investors.

Regulatory Function:
Regulatory functions involve establishment of rules and regulations for the
financial intermediaries along with corporates that helps in efficient management of
the market.

Developmental Function:
Developmental function refers to the steps taken by SEBI in order to provide
the investors with a knowledge of the trading and market function. The following
activities are included as part of developmental function.
1. Training of intermediaries who are a part of the security market.
2. Introduction of trading through electronic means or through the internet by the help
of registered stock brokers.
3. By making the underwriting an optional system in order to reduce cost of issue.

Purpose of SEBI
The purpose for which SEBI was setup was to provide an environment that
paves the way for mobilsation and allocation of resources.It provides practices,
framework and infrastructure to meet the growing demand.
It meets the needs of the following groups:
1. Issuer: For issuers, SEBI provides a marketplace that can utilised for raising
funds.
2. Investors: It provides protection and supply of accurate information that is
maintained on a regular basis.
3. Intermediaries: It provides a competitive market for the intermediaries by
arranging for proper infrastructure.

Structure of SEBI
SEBI board comprises nine members. The Board consists of the following members.

1. One Chairman of the board who is appointed by the Central Government of

India
2. One Board member who is appointed by the Central Bank, that is, the RBI
3. Two Board members who are hailing from the Union Ministry of Finance
4. Five Board members who are elected by the Central Government of India
The Concept Of Euro Dollar Market.

The Euro Dollar Market refers to the international market for U.S. dollar-
denominated deposits held in banks outside the United States. These deposits are
not subject to U.S. banking regulations, making them an attractive option for
investors and institutions seeking flexibility and fewer restrictions.
These deposits were originally held in Europe, hence the name “Eurodollar”
(i.e., U.S. dollars held in Europe). Eventually, several non-European countries were
included as destinations for the U.S. dollar deposits, including the Bahamas and
Cayman Islands.
As these funds are held outside of the United States, they fall outside of the
controls and regulations of the United States.
A Eurodollar is not to be confused with the Euro currency, nor with the
exchange rate between Euros and the U.S. dollar, also called confusingly euro/dollar.

Example of EuroDollar market:

A Japanese company needs a U.S. dollar loan. Instead of borrowing from a
U.S. bank, it gets a lower-rate loan from a London bank holding U.S. dollar deposits,
saving costs while the bank earns interest.

Features of the Euro Dollar Market

 Less Regulation: Since Eurodollar deposits are held outside their home
country, they don’t have to follow local banking rules, making transactions
easier.
 Higher Interest Rates: Depositors earn more interest because these
accounts don’t have protections like FDIC insurance, while borrowers can get
cheaper loans.
 Futures Market: Banks and investors can trade Eurodollar futures to protect
themselves from changes in interest rates on major exchanges like CME and
NYMEX.

Uses of Euro Dollar Market

 The eurocurrency market is commonly used as an advantageous

source of capital and a beneficial way to receive international
funding because of its liquidity.
 Banks that take Eurodollars and other currencies deploy those funds
to lend back out as loans in the offshore markets or hedge in the
eurocurrency futures market.

 Individuals and businesses may also use the Eurodollar market or

other eurocurrencies as a way to protect themselves against risks in
foreign exchange and other capital controls, both in foreign and
domestic markets.
  The Eurodollar market is also a blessing for many countries with
a balance of payments deficit, as borrowers are able to borrow
funds offshore and reduce the potential foreign exchange reserve
drain.

What is EuroBank and its features?

Eurobanks
Eurobanks handle foreign currency deposits and loans worldwide. They
operate with fewer regulations, offer higher interest rates, and deal in large
transactions (often $1 million+), mainly serving businesses managing financial risks.

 Less Regulation: Eurobanks operate with fewer restrictions, lowering costs

but often lacking deposit insurance.
 Higher Interest Rates: They offer higher interest rates to both depositors and
borrowers due to the absence of interest rate ceilings.
 Large Transactions: Typically deal in large sums, often starting at $1 million,
catering to businesses and corporations managing financial risks.

Disadvantages of the Eurodollar

 Weakened Financial Control: Since the Eurodollar market is unregulated by
the U.S., it can bypass financial rules, making it harder for the Federal
Reserve to control monetary policy.
 Risk of Excess Credit: Depositors lack FDIC insurance, and loans issued
offshore may carry higher risks due to weaker security measures.
 Exchange Rate Instability: Large amounts of U.S. dollars held offshore can
put pressure on foreign exchange rates, increasing currency volatility.