Financial Markets

In a business environment, generally there is involvement of two parties: one who invests money or lends money and other one who borrows or uses money. Financial markets acts as link between these two parties.

Financial Market

Financial market can be defined as transmission medium between investors and borrowers through which funds transfer is facilitated. It consists of individual investors, intermediaries, financial institutions.

Functions of financial market

  • It facilitates interaction between the investors and the borrowers.
  • It reduces the cost of transactions and information.
  • It ensures liquidity by providing a mechanism for an investor to sell the financial assets.
  • It provides security to dealings in financial assets.
  • It provides pricing information resulting from the interaction between buyers and sellers in the market when they trade the financial assets.

Types of financial market

The financial market is primarily divided into two types:

  1. Money Market
  2. Capital Market

Money Market

Money market is the market for short-term funds which deals in financial assets whose period of maturity is up to one year. It provides market for credit instruments such as bills of exchange, promissory notes, commercial paper, treasury bills, etc.  It helps the business units, other organisations and the Government to borrow the funds to meet their short-term requirement.

Money market is network of financial institutions dealing in short-term funds, which provides an outlet to lenders and a source of supply for such funds to borrowers. The Indian money market consists of Reserve Bank of India, Commercial banks, Co-operative banks, and other specialized financial institutions. The Reserve Bank of India is the regulator of the money market in India. Some Non-Banking Financial Companies (NBFCs) and financial institutions like LIC, UTI, etc. also operate in the Indian money market.

Money Market Instruments

  1. Call Money: Call money is generally used by banks to overcome their day-to-day shortage of cash. It is repayable on demand and its maturity period varies in between one day to a fortnight. The rate of interest paid on call money loan is known as call rate.
  2. Commercial Paper: Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. It was introduced in India in 1990 to enable the corporate borrowers to raise short-term funds. It can be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue. It can be issued in denominations of Rs.5 lakh or multiples thereof.
  3. Certificate of Deposit: Certificate of Deposit (CD) is a negotiable money market instrument issued by scheduled commercial banks {excluding Regional Rural Banks and Local Area Banks} and select All-India Financial Institutions (SFIs) which are freely transferable from one party to another. The maturity period of CDs issued by banks should not be less than 7 days and not more than one year, from the date of issue. They can be issued to individuals, corporations, trusts, funds and associations. CDs are issued in denominations of Rs.1 Lac and in the multiples of Rs. 1 Lac thereafter.
  4. Treasury Bill: A treasury bill is a promissory note issued by the RBI to meet the short-term requirement of funds. These bills are normally issued at a price less than their face value; and redeemed at face value. So the difference between the issue price and the face value of the Treasury bill represents the interest on the investment. At present, RBI issues T-Bills for three different maturities: 91 days, 182 days and 364 days. These bills are secured instruments and are issued for a period of not exceeding 364 days.
  5. Bill of Exchange: A Bill of Exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument.

Capital Market

Capital market is the market dealing with medium-term and long-term funds. It constitutes all long-term borrowings from banks and financial institutions, borrowings from foreign markets and raising of capital by issue various securities such as shares debentures, bonds, etc. Securities Exchange Board of India (SEBI) is the regulator of capital market in India. Capital market is further divided into two categories:

  • Primary Market
  • Secondary Market

Primary Market

It is that market in which shares, debentures and other securities are sold for the first time for collecting long-term capital. The primary market deals with new or fresh issue of securities and is, therefore, also known as new issue market. The major players in this market are merchant bankers, mutual funds, financial institutions, and the individual investors.

Secondary Market

The secondary market is also known as stock market or stock exchange. It is that market in which the buying and selling of the previously issued securities is done. The major players in this market are merchant bankers, mutual funds, financial institutions, individual investors and stockbrokers.

Read next: Foreign Exchange Market in India ››

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