LESSON – 10 FINANCIAL MARKET

Financial market
• It is a market for the creation and exchange of financial assets. A
financial market helps to link the savers and the investors by mobilizing
funds between them.
• The process by which allocation of funds is done is called financial
intermediation. Banks and financial markets are competing
intermediaries in the financial system.
Types of financial markets
 Money market
 Capital market
Money market
 It is a market for short term funds which deals in monetary assets having
maturity up to one year.
 Money market instruments are highly liquid.
 They are less risky and short term debt instruments.
 They helps to meet temporary shortages of funds and temporary
deployment of excess funds for earning returns.
 Major participants in the market are the RBI, commercial banks, Non-
Banking Finance Companies, State governments, large corporate houses
and Mutual funds.
Capital Market: It refers to facilities and institutional arrangements through
which long term funds, both debt and equity are raised and invested. It
consists of development banks, commercial banks and stock exchanges.

1. Participants Financial institutions, banks, RBI, banks, financial institutions

corporate entities, foreign and finance companies.
investors and retail investors
from the members of public.

2. Instruments Equity shares, debentures, T-bills, trade bills, commercial

bonds, preference shares etc. paper and certificates of deposit.

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3. Investment outlay Does not require huge financial Requires huge sums of money as
outlay as the value of units of the instruments are quite
securities is generally low. expensive.

4. Duration Deals with medium and long Deals with short term securities
term securities. having a maximum tenure of 1
year.

5. Liquidity They are liquid investments as They enjoy a higher degree of

they are marketable on the stock liquidity. E.g. DFHI
exchanges.

6. Safety Riskier investments with respect Safer investments with a

to returns and principal minimum risk of default.
payment.
7. Expected return Higher returns Low return

The Capital Market can be divided into two parts:

Primary market and Secondary market.

Primary Market: It deals with new securities being issued for the first time. It is
also known as new issues market. The capital can be raised in the form of equity
shares, preference shares, debentures, loans and deposits. The investors in this
market are banks, financial institutions, insurance companies, mutual funds and
individuals.
The functions of primary market:
 To facilitate the transfer of investible funds from savers to entrepreneurs.
 To establish new enterprises, to expand existing ones or for mergers and
takeovers through the issue of securities for the first time.
Methods of floatation:
The various methods of floating new issues in the primary market are:
1. Offer through prospectus –

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  It is the most popular method of raising funds by public companies in the
primary market.
 It involves inviting subscription from the public through issue of
prospectus by advertising in newspapers and magazines.
• The issues may be underwritten and also are required to be listed on at
least one stock exchange. (Underwritten means the underwriter commits
to purchasing the issues at a predetermined price or to providing
insurance coverage for them)
2. Offer for sale –
• Under this method, securities are offered for sale through intermediaries
like issuing houses or stock brokers.
• Here companies sells securities in bulk at an agreed price to brokers who
in turn sell it to the public.
• For e.g., Holy Ltd., has sold two lakhs equity shares of ₹ 10 each at ₹ 12
per share to an investment banker, who offered them to public at ₹ 20
each.
3. Private placement –
It is the allotment of securities to institutional investors and some
selected individuals. It helps to raise capital more quickly than a public
issue. This method is less expensive than public issue.
4. Rights issue –
This is a privilege given to existing shareholders to subscribe to a new
issue of shares. The shareholders are offered the ‘right’ to buy new shares
in proportion to their existing shares.
5. e-IPOs –
Under this, the company issue securities to public through the online
system of the stock exchange. Here the company has to enter into an
agreement with the stock exchange. This is called an Initial Public Offer
(IPO).

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SECONDAY MARKET:
The secondary market is also known as the stock market or stock exchange. It is
a market for purchase and sale of existing securities.
IMPORTANCE:
 It helps existing investors to disinvest and fresh investors to enter the
market.
 It provides liquidity and marketability to existing securities.
 It contributes to economic growth by channelizing funds toward most
productive investments.
LEARN DIFF BETWEEN PRIMARY MARKET AND SECONDARY MARKET IN
TEXTBOOK
Stock Exchange
It is an institution which provides a platform for buying and selling of existing
securities. According to Securities Contracts (Regulation) Act 1956, stock
exchange means any body of individuals, 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
1. Providing liquidity and marketability to existing securities –
The stock exchange creates a continuous market to investors to disinvest and
reinvest. This provides both liquidity and easy marketability to existing securities
in the market.
2. Pricing of securities –
Share prices are determined by the forces of demand and supply in a stock
market. Such a valuation provides important instant information to both buyers
and sellers in the market.
3. Safety of transactions –
Stock exchange regulates membership and transactions by well-defined legal
framework. This ensure safety of transactions for the investors.
4. Contributes to economic growth –
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Through the process of disinvestment and reinvestment, the savings are
channelized into the productive investments leading to the capital formation and
economic growth.
5. Spreading of equity cult –
Stock exchange ensures wider share ownership by providing better trading
practices, educating people about new investment and regulating new issues.
6. Providing scope for speculation –
Stock exchange provides certain degree of healthy speculation to ensure liquidity
and price increase in securities.

Trading and settlement

Trading in securities is executed through an on-line, screen-based electronic
trading system. The trading is done in the broker’s office through a computer
terminal. It has shifted from the stock market floor to the broker’s office.
Advantages of Electronic trading system:
1. It ensures transparency as it allows participants to see the prices of all
securities in the market.
2. It increases efficiency of information, thus helping in fixing prices efficiently.
3. It increases the efficiency of operations, as there is reduction in time, cost
and risk of error.
4. It enabled a large number of participants to trade with each other, thus
improving the liquidity of the market.
5. A single trading platform has been provided as business is transacted at the
same time in all the trading centres.
TRADING PROCEDURE IN STOCK EXCHANGES
1) Selection of a Broker:
 The first step is to select a broker who will buy / sell securities on behalf of
the speculator/ investor. He can be an individual, partnership firm or
corporate.
 The investor has to sign a broker –client agreement and a client registration
form before placing an order to buy or sell securities.

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  The broker then opens a trading account in the name of the investor
2) Opening Demat account with Depository:
 The investor has to open a Demat account or ‘Beneficial Owner’ (BO)
account for holding and transferring securities in the Demat form.
 He will also have to open a bank account for cash transactions in the
securities market.
3) Placing the order:
 The next step is to place the order with the broker to buy or sell shares.
 The instructions should specify the securities to be bought or sold and the
price range within which the order is to be executed.
 An order confirmation slip is issued to the investor by the broker.
4) Executing the order:
 The broker buys or sells the specified securities as instructed by the
investor and issues a contract note. It contains the name and prices of
securities, detail of the parties, brokerage charged etc. This is an important
document as it is legally enforceable and helps to settle disputes/claims
between the investor and the broker.
 A Unique Order Code number is assigned to each transaction by the stock
exchange and is printed on the contract note.
5) Settlement of transaction:
 Pay-in Day - Cash is paid or securities are delivered by the investor on the
pay-in day, that is, immediately after receiving the contract note. A T+2
rolling settlement cycle is followed in Indian stock market.
 Pay-out Day - On the T+2 day, the exchange will deliver the share or make
payment to the other broker. This is called the pay-out day. The broker
then has to make payment to the investor within 24 hours of the payout
day.
 The broker can make delivery of shares in demat form directly to the
investor’s demat account.

Dematerialization and Depositories

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When the records regarding ownership of stocks are kept in electronic form
instead of physical form (i.e., share certificate) it is known as ‘dematerialization of
securities’. For this, the investor has to open a demat account with an
organisation called a depository.
A depository keeps securities in electronic form on behalf of the investor. In India,
there are two depositories – National Securities Depositories Limited (NSDL) and
Central Depository Services Limited (CDSL). These national level depositories
operate through intermediaries who are electronically connected to the
depository and serve as contact points with the investors and are called
Depository Participants (DP). The DP serve as an intermediary between the
investor and the Depository (NSDL or CSDL).
Depository service
It is the service through which the transfer of ownership in shares takes place by
means of book entry without the physical movement of shares. Depository
services include:
 Opening a demat account
 De-materialisation
 Re-materialisation
 Record of securities
 Settlement of transactions
 Facilitating loan against securities
 Freezing demat account.
Depository
An institution which holds the shares of an investor in electronic form. Players in
depository system:
 Depository
 Depository participant
 Beneficial owner (Investor)
 Issuer (Issuing Company)

Depository Participant (DP)

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It is the agent of the depository, mediator between issuing company and
investors through the Depository. Financial institutions, banks, stock brokers,
NBFCs act as Depository Participants.
Re-materialisation
When the electronic holdings are reconverted into physical certificates, it is
known as Re-materialisation.
Working of the Demat system:
1. Identifying a Depository Participant (DP).
2. An account opening form and documentation may be completed.
3. The physical certificate is to be given to the DP along with a
dematerialisation request form.
4. Shares are automatically credited to the demat account.
5. If the shares are sold through a broker, the DP is to be instructed to debit
the account with the number of shares.
6. The broker gives instruction to his DP for delivery of the shares to the stock
exchange.
7. The brokers receive payment and pay the person for the shares sold.
8. All these transactions are to be completed within 2 days (T+2 basis).
Securities and Exchange Board of India (SEBI)
SEBI is an apex body for overall development and regulation of the securities
market. It was established by the Government of India on 12 th April 1988 as an
interim administrative body to promote orderly and healthy growth of securities
market and for investor protection. The SEBI was given a statutory status on 30 th
January 1992.
Reasons for establishment of the SEBI
Malpractices and unfair trade practices have eroded investor confidence and
multiplied investor grievances such as:
 Price rigging.
 Unofficial private placement
 Delay in delivery of shares
 Violation of stock exchange rules and regulations
 Unofficial premium on new shares.

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These reasons led to the establishment of the SEBI.
Objectives of SEBI
1. To regulate stock exchanges and securities industry to promote their
orderly functioning.
2. To protect the rights and interests of investors and to guide and educate
them.
3. To prevent trading malpractices and achieve a balance between self-
regulation by the securities industry and its statutory regulation.
4. To regulate and develop a code of conduct and fair practices to be
followed by intermediaries.
Functions of SEBI
The functions of SEBI can be divided into three groups.
1. Regulatory functions –
 Registration of brokers and sub-brokers and other players in the
market.
 Registration of collective investment schemes and mutual funds.
 Regulation of stockbrokers, underwriters and merchant bankers and
the business in stock exchanges.
 Regulation of takeover bids by companies.
 Undertaking inspection, conducting enquiries and audits of stock
exchanges and intermediaries.
 Levying fee or other charges for carrying out the purposes of the Act.
 Exercising other powers as delegated by the Government of India.
2. Development functions –
 Training of intermediaries of the securities market.
 Conducting research and publishing information useful to all market
participants.
 Develop the capital markets by adapting flexible approach.
3. Protective functions –
 Prohibition of fraudulent and unfair trade practices like making
misleading statements, manipulations, price rigging etc.
 Controlling insider trading and imposing penalties for such practices.
 Undertaking steps for investor protection.
 Promotion of fair practices and code of conduct in securities market.
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