Unit 4 : Financial markets and services

Meaning and definition of financial markets and instruments

Financial Markets:
Financial markets refer to platforms or systems where buyers and sellers engage in the trade of
financial assets such as stocks, bonds, commodities, currencies, and derivatives. These markets
provide a mechanism for individuals, businesses, and governments to raise capital, manage risks,
and invest funds. Financial markets facilitate the flow of capital between borrowers and lenders,
enabling the allocation of resources and the determination of prices for various financial assets.

Financial markets can be categorized into primary markets and secondary markets. In the
primary market, newly issued securities are sold directly by issuers to investors. The secondary
market involves the trading of existing securities between investors, allowing for liquidity and
price discovery.

Financial Instruments:
Financial instruments are contractual agreements or assets that represent a claim to future cash
flows or a specific financial value. These instruments are used to transfer risks, raise capital, and
facilitate investment and speculation. Financial instruments can take various forms, including:

Stocks (Equities): Represent ownership in a company and provide the holder with a share in its
profits and voting rights.

Bonds: Debt instruments issued by governments, municipalities, and corporations to raise

capital. Bonds represent a loan made by the bondholder to the issuer and typically pay periodic
interest and repay the principal at maturity.

Commodities: Raw materials or primary goods such as gold, oil, wheat, and natural gas that are
traded on commodity exchanges.

Currencies: Represent the medium of exchange used in different countries, such as the U.S.
dollar, euro, yen, or pound sterling. Currency trading occurs in the foreign exchange (forex)
market.

Derivatives: Financial contracts whose value derives from an underlying asset or reference rate.
Examples include options, futures, swaps, and forwards. Derivatives are used for hedging,
speculation, and arbitrage.
Mutual Funds: Pooled investment vehicles that allow investors to pool their funds together and
invest in a diversified portfolio of securities managed by professionals.

Exchange-Traded Funds (ETFs): Investment funds that trade on stock exchanges and aim to
replicate the performance of a specific index, sector, or asset class.

These are just a few examples of financial instruments, and there are numerous other types
available in the financial markets. The choice of instruments depends on an individual's
investment objectives, risk tolerance, and time horizon.

Role and functions of financial Market

Financial markets play a crucial role in the global economy by facilitating the exchange of
financial assets and enabling various economic activities. The primary functions of financial
markets are as follows:

Capital Formation: Financial markets provide a platform for individuals, businesses, and
governments to raise capital by issuing and trading financial securities such as stocks and bonds.
This allows entities to finance their investments, expand their operations, and fund new projects.

Price Discovery: Financial markets serve as a mechanism for determining the prices of financial
assets. Through the interaction of buyers and sellers, supply and demand forces influence asset
prices, reflecting the market's assessment of their value. Price discovery helps allocate resources
efficiently and provides information for investors and businesses to make informed decisions.

Liquidity Provision: Financial markets offer liquidity by providing a platform for buying and
selling financial assets. This liquidity allows investors and traders to easily convert their
investments into cash, facilitating investment and risk management. It also enhances market
efficiency and reduces transaction costs.

Risk Management: Financial markets provide tools for managing various types of risks. For
example, derivative markets enable participants to hedge against price fluctuations, interest rate
changes, or currency fluctuations. By transferring and diversifying risks, financial markets help
mitigate uncertainties and stabilize the overall economy.

Efficient Allocation of Capital: Financial markets direct capital to its most productive uses.
Investors allocate their funds to entities with the highest potential returns, encouraging efficient
resource allocation and promoting economic growth. Through the pricing mechanism, financial
markets reward successful businesses and penalize those with poor performance, influencing the
allocation of capital.
Information Transmission: Financial markets act as information hubs, disseminating relevant
data about financial assets and economic conditions. Market participants rely on this information
to make investment decisions. Additionally, financial markets reflect market sentiment and
expectations, which can provide insights into future economic developments.

Investment Opportunities: Financial markets create investment opportunities for individuals

and institutions. Investors can choose from a range of financial instruments, including stocks,
bonds, mutual funds, commodities, and real estate investment trusts (REITs). These
opportunities allow investors to diversify their portfolios and potentially earn returns on their
investments.

Overall, financial markets play a vital role in mobilizing capital, facilitating economic growth,
and enabling efficient allocation of resources in the global economy.

Constituents of financial markets

Financial markets in India consist of various constituents that play crucial roles in facilitating the
trading and investment activities. Here are the key constituents of the financial markets in India:

Stock Exchanges: The major stock exchanges in India are the National Stock Exchange (NSE)
and the Bombay Stock Exchange (BSE). These exchanges provide platforms for trading in
equities, derivatives, and other financial instruments.

Securities and Exchange Board of India (SEBI): SEBI is the regulatory body that oversees and
regulates the functioning of the securities market in India. It formulates rules and regulations to
protect investors' interests and maintain fair practices in the market.

Depositories: The two main depositories in India are the National Securities Depository Limited
(NSDL) and the Central Depository Services Limited (CDSL). They facilitate the holding,
transfer, and settlement of securities in electronic form.

Brokers and Brokerage Firms: Brokers act as intermediaries between buyers and sellers in
financial markets. They execute trades on behalf of investors and provide various services related
to trading and investment.

Clearing Corporations: Clearing corporations ensure the smooth settlement of trades in the
derivatives segment. They act as intermediaries between the buyer and the seller, guaranteeing
the fulfillment of contractual obligations.
Mutual Funds: Mutual funds pool money from multiple investors to invest in a diversified
portfolio of securities. They offer a convenient way for individual investors to participate in the
financial markets.

Banks and Financial Institutions: Banks and financial institutions play a vital role in providing
funds, loans, and credit facilities to businesses and individuals. They also participate in capital
market activities as investors, underwriters, and lenders.

Regulators: Apart from SEBI, various other regulators oversee specific segments of the
financial market in India. For example, the Reserve Bank of India (RBI) regulates banking and
monetary policy, while the Insurance Regulatory and Development Authority of India (IRDAI)
regulates the insurance sector.

Rating Agencies: Credit rating agencies such as CRISIL, ICRA, and CARE provide credit
ratings for companies and debt instruments. Their ratings help investors assess the
creditworthiness and risk associated with investments.

Market Intermediaries: Market intermediaries include various entities like merchant bankers,
investment advisors, portfolio managers, and registrars and transfer agents. They provide
specialized services and advice to investors and companies in the financial market.

These constituents collectively contribute to the functioning, regulation, and growth of the
financial markets in India, providing opportunities for investment and capital formation.

Money Market Instruments

Money market instruments in India are short-term debt instruments that are highly liquid and
low-risk. These instruments are issued by governments, financial institutions, and corporations to
meet their short-term funding requirements. The money market in India is regulated by the
Reserve Bank of India (RBI). Here are some commonly traded money market instruments in
India:

Treasury Bills (T-Bills): These are short-term securities issued by the government of India with
maturities ranging from 91 days, 182 days, and 364 days. T-Bills are auctioned by the RBI and
are considered to be risk-free instruments.
Commercial Paper (CP): CP is an unsecured money market instrument issued by highly rated
corporations to meet their short-term funding needs. The maturity period of CP ranges from a
minimum of 7 days to a maximum of 1 year. It is usually issued at a discount to face value and
provides higher returns compared to bank deposits.
Certificates of Deposit (CD): CDs are negotiable money market instruments issued by banks
and financial institutions to raise funds from the market. They have fixed maturities ranging from
7 days to 1 year and offer higher interest rates than regular savings accounts.
Repurchase Agreement (Repo): Repo is a short-term borrowing arrangement where financial
institutions sell securities to the RBI or other banks with an agreement to repurchase them at a
later date. It provides a means for banks to manage their short-term liquidity needs.
Commercial Bills (CB): Commercial Bills are short-term negotiable instruments issued by
corporations and are primarily used in inter-corporate transactions. They are typically used to
finance trade-related activities and have maturities ranging from 30 days to 365 days.
Money Market Mutual Funds (MMMFs): MMMFs are mutual funds that invest in money
market instruments. They provide individuals and institutions with an opportunity to participate
in the money market indirectly. MMMFs offer high liquidity and low-risk investments.

These are some of the major money market instruments in India. Investors and financial
institutions utilize these instruments to park surplus funds, manage short-term liquidity, and earn
returns on their investments while maintaining capital preservation and liquidity.

Capital market instruments

Capital market instruments in India refer to various financial instruments that are traded in the
Indian capital markets, allowing investors to raise capital and trade securities. These instruments
play a crucial role in the functioning of the Indian financial system. Here are some common
capital market instruments in India:

Equity Shares: Equity shares, also known as common shares or ordinary shares, represent
ownership in a company. Investors who hold equity shares become partial owners of the
company and have voting rights in decision-making processes.

Preference Shares: Preference shares are a type of shares that offer preferential treatment to the
shareholders in terms of dividend payment and repayment of capital in case of liquidation. They
usually do not carry voting rights but provide a fixed dividend.

Bonds: Bonds are debt instruments issued by corporations, financial institutions, and the
government to raise capital. Investors who purchase bonds become creditors to the issuer and
receive periodic interest payments until maturity, at which point the principal amount is repaid.

Debentures: Debentures are similar to bonds, representing a loan agreement between the issuer
and the investor. Debentures are issued by companies and can have fixed or floating interest
rates. They are not secured by specific assets of the company and are backed by the general
creditworthiness of the issuer.
Treasury Bills: Treasury bills, also known as T-bills, are short-term debt instruments issued by
the Reserve Bank of India (RBI) on behalf of the Indian government. T-bills have maturities
ranging from 91 days to 364 days and are issued at a discount to their face value. Investors earn
the difference between the discounted purchase price and the face value as interest.

Commercial Paper: Commercial paper is an unsecured money market instrument issued by

highly rated corporations to meet short-term financing needs. It has a fixed maturity typically
ranging from 7 days to 1 year and is usually issued at a discount to its face value.

Mutual Funds: Mutual funds are investment vehicles that pool money from multiple investors
and invest in a diversified portfolio of securities, such as stocks, bonds, or money market
instruments. Investors in mutual funds own units proportionate to their investment, and the fund's
performance is based on the underlying assets' performance.

Derivatives: Derivatives are financial contracts whose value derives from an underlying asset,
such as stocks, bonds, commodities, or indices. In India, derivatives trading primarily takes place
on stock exchanges, and the most common derivatives instruments are futures and options.

Exchange-Traded Funds (ETFs): ETFs are investment funds traded on stock exchanges,
representing a basket of securities that track a specific index, sector, commodity, or asset class.
ETFs offer investors the opportunity to gain exposure to a diversified portfolio of assets in a
single transaction.

These are some of the key capital market instruments in India. The regulatory framework and
trading mechanisms for these instruments are overseen by regulatory bodies like the Securities
and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI).

SEBI

SEBI stands for the Securities and Exchange Board of India. It is the regulatory authority in
India that oversees and regulates the securities market. SEBI was established in 1988 and was
given statutory powers on April 12, 1992, through the SEBI Act. Primary objectives of SEBI are
to protect the interests of investors in securities, promote the development and regulation of the
securities market, and regulate intermediaries and participants in the market. Some of the key
functions of SEBI include:
Regulation of Stock Exchanges: SEBI regulates and supervises stock exchanges in India to
ensure fair and transparent trading practices, prevent fraudulent and manipulative activities, and
maintain investor confidence in the market.
Registration and Regulation of Intermediaries: SEBI registers and regulates various
intermediaries in the securities market, such as brokers, sub-brokers, portfolio managers,
investment advisers, and mutual funds, to ensure compliance with rules and regulations.
Investor Protection: SEBI takes measures to protect the interests of investors by promoting fair
practices, ensuring adequate disclosure of information, and taking action against fraudulent
activities in the securities market.
Regulation of Securities: SEBI regulates the issuance and trading of securities, including
shares, debentures, and bonds, to ensure proper disclosure of information, prevention of insider
trading, and fair pricing of securities.
Promoting Market Development: SEBI works towards the development and growth of the
securities market by introducing new regulations, products, and trading mechanisms. It
encourages the adoption of technology and innovation in the market.

SEBI plays a crucial role in maintaining the integrity and stability of the Indian securities market
and ensuring investor protection. Its regulations and guidelines are aimed at creating a fair and
transparent market environment for investors and promoting the growth of the Indian capital
market.

SEBI guidelines for listing of shares and issue of commercial paper

Listing of Shares:
Initial Public Offering (IPO): SEBI regulates the process of listing shares through an IPO.
Companies seeking to go public must comply with SEBI's guidelines, which include disclosure
and filing requirements, pricing guidelines, and various other conditions to protect the interests
of investors.
Listing Agreement: Companies listed on stock exchanges in India must enter into a listing
agreement with the respective stock exchange. The agreement outlines the rights and obligations
of the company and the stock exchange.
Minimum Public Shareholding: SEBI mandates a minimum public shareholding requirement,
which stipulates that companies must have a minimum percentage of their shares held by the
public. The requirement helps promote transparency and liquidity in the market.
Continuous Listing Obligations: Listed companies must comply with SEBI's continuous listing
obligations, which include timely disclosure of information, financial reporting requirements,
corporate governance norms, and other regulatory obligations to ensure transparency and
investor protection.
Issue of Commercial Paper:
Commercial paper refers to short-term debt instruments issued by companies to raise funds for
their working capital requirements. SEBI has prescribed guidelines for the issuance of
commercial paper, which include the following:

Eligibility: Only companies that meet certain criteria, such as a tangible net worth, a track record
of financial soundness, and compliance with regulatory requirements, are eligible to issue
commercial paper.

Limit on Issue: SEBI imposes limits on the amount of commercial paper that a company can
issue based on its financials and credit rating.

Maturity Period: The maturity period of commercial paper cannot exceed one year from the
date of issue.

Disclosure Requirements: Companies issuing commercial paper must comply with disclosure
requirements regarding their financial position, credit rating, and other relevant information.

It is advisable to refer to the latest SEBI guidelines and consult with professionals or visit the
SEBI website for the most accurate and up-to-date information on the listing of shares and
issuance of commercial paper.