Unit III

Financial Markets
Financial Market
A market that serves as a link between the savers and borrowers, by transferring the capital or
money from those who have a surplus amount of money to those who are in need of money or
investment, is known as Financial Market. Simply put, Financial Market is a market that creates
and exchanges financial assets. In general, the investors are known as the surplus units and
business enterprises are known as the deficit units. Hence, a financial market acts as a link
between surplus units and deficit units and brings the borrowers and lenders together.

The financial market refers to the market where the sale and purchase of financial products
occurs. Such products include stocks, bonds, currencies, derivatives, commodities,
cryptocurrencies, etc. It acts as a platform for sellers and buyers to connect and deal in their
desired financial assets at a price determined by market forces.

Functions of Financial Markets

1. Price Determination: The financial market performs the function of price discovery of
the different financial instruments traded between the buyers and the sellers on the
financial market. The prices at which the financial instruments trade in the financial
market are determined by the market forces, i.e., demand and supply.So the financial
market provides the vehicle by which the prices are set for both financial assets which
are issued newly and for the existing stock of the financial assets.

2. Funds Mobilization: Along with determining the prices at which the financial
instruments trade in the financial market, the required return out of the funds invested
by the investor is also determined by participants in the financial market. The
motivation for persons seeking the funds is dependent on the required rate of return,
which the investors demand. Because of this function of the financial market only, it is
signaled that funds available from the lenders or the investors of the funds will get
allocated among the persons who need the funds or raise funds through the means of
issuing financial instruments in the financial market. So, the financial market helps in
the mobilization of the investors’ savings.

3. Liquidity: The liquidity function of the financial market provides an opportunity for the
investors to sell their financial instruments at their fair value prevailing in the market
at any time during the working hours of the market. In case there is no liquidity function
of the financial market. The investor forcefully have to hold the financial securities or
the financial instrument until the conditions arise in the market to sell those assets or
the issuer of the security is obligated contractually to pay for the same, i.e., at the time
of maturity in debt instrument or at the time of the liquidation of the company in case
of the equity instrument is until the company is either voluntarily or involuntarily
 liquidated. Thus, investors can sell their securities readily and convert them into cash
in the financial market, thereby providing liquidity.

4. Risk sharing: The financial market performs the function of risk-sharing as the person
who is undertaking the investments is different from the persons who are investing their
fund in those investments. With the help of the financial market, the risk is transferred
from the person who undertakes the investments to those who provide the funds for
making those investments.

5. Easy Access: The industries require the investors to raise funds, and the investors
require the industries to invest their money and earn the returns from them. So the
financial market platform provides the potential buyer and seller easily, which helps
them save their time and money in finding the potential buyer and seller.

6. Reduction in Transaction Costs and Provision of the Information: The trader requires
various types of information while doing the transaction of buying and selling the
securities. For obtaining the same time and money is required. But the financial market
helps provide every type of information to the traders without the requirement of
spending any money by them. In this way, the financial market reduces the cost of the
transactions.

7. Capital Formation: Financial markets provide the channel through which the new
investors’ savings flow in the country, which aids in the country’s capital formation.
Example: Let’s consider an example of the company XYZ ltd, which requires the funds
to start a new project, but at present, it doesn’t have such funds. On the other hand, some
investors have spare money and want to invest in areas where they can get the required rate of
expected returns.
So, in that case, the financial market will function where the company can raise funds
from the investors, and the investors can invest their money through the help of the financial
market.

Classification of financial market

1. By Nature of Claim
o Debt Market: The market where fixed claims or debt instruments, such as
debentures or bonds are bought and sold between investors.
o Equity Market: Equity market is a market wherein the investors deal in
equity instruments. It is the market for residual claims.
2. By Maturity of Claim
o Money Market: The market where monetary assets such as commercial
paper, certificate of deposits, treasury bills, etc. which mature within a
year, are traded is called money market. It is the market for short-term
 funds. No such market exist physically; the transactions are performed over
a virtual network, i.e. fax, internet or phone.
o Capital Market: The market where medium and long term financial assets
are traded in the capital market. It is divided into two types:
➢ Primary Market: A financial market, wherein the company listed on an
exchange, for the first time, issues new security or already listed company
brings the fresh issue.
➢ Secondary Market: Alternately known as the Stock market, a secondary
market is an organised marketplace, wherein already issued securities are
traded between investors, such as individuals, merchant bankers,
stockbrokers and mutual funds.
3. By Timing of Delivery
o Cash Market: The market where the transaction between buyers and sellers
are settled in real-time.
o Futures Market: Futures market is one where the delivery or settlement of
commodities takes place at a future specified date.
4. By Organizational Structure
o Exchange-Traded Market: A financial market, which has a centralised
organisation with the standardised procedure.
o Over-the-Counter Market: An OTC is characterised by a decentralised
organisation, having customised procedures.

MONEY MARKET

A market or a segment of the financial market in which lending and borrowing of

short-term funds take place is known as a Money Market. A money market
primarily deals with highly liquid and low-risk instruments having maturity,
usually with a range from overnight to one year. In a money market, the short-
term surplus investible funds with the banks and other financial institutions are
bid by borrowers. It plays a crucial role in facilitating efficient fund allocation. It
also helps meet short-term fund requirements of different participants of an
economy. The basic objectives of the Money Market include short-term
financing, liquidity management, low-risk investments, benchmark interest rates,
market stability and transparency, and monetary policy implementation.

A Money Market is not the same as a Capital Market. The former is a market that
deals with borrowing and lending of short-term funds; however, the latter is a
market that deals with long-term funds. Even though these markets are different
from each other, they are closely related as there is some overlapping between
the short-term and long-term loan transactions. A money market is a part or
segment of the financial market. A financial market includes a money market,
capital market, government securities market, and foreign exchange market.

HISTORY OF MONEY MARKET

Money Market in India Evolution
The beginning of the money market in India can be traced back to the late 19th
century during the colonial era. The establishment of the Bombay Stock
Exchange (BSE) in 1875 played a crucial role in the development of the money
market. Initially, the market operated as a platform for trading stocks and shares,
but it gradually expanded to include short-term borrowing and lending activities.

The evolution of the money market in India can be divided into different phases:

Pre-Independence Era (Late 19th century to 1947)

During this period, the money market was largely unregulated and informal.
Indigenous bankers, known as Shroffs and Mahajan, facilitated short-term
borrowing and lending transactions. The bill market, comprising of treasury bills,
commercial bills, and promissory notes, started gaining prominence.

Post-Independence Era (1947 to 1991)

After India gained independence, the Reserve Bank of India (RBI) was
established as the central bank in 1935 and took on a more prominent role in
regulating the money market. The RBI introduced various measures to develop
and regulate the money market, including the issue of Treasury Bills, the
establishment of the Discount and Finance House of India (DFHI) in 1988, and
the introduction of Certificates of Deposit (CDs) and Commercial Papers (CPs)
in 1990.

Liberalization and Reforms (1991 Onwards)

In the early 1990s, India initiated economic reforms and liberalization. These
reforms aimed to modernize the financial sector and promote market-oriented
policies. The money market underwent significant changes during this period.
The RBI introduced new money market instruments, such as inter-bank call
money, term money, and the introduction of the Negotiated Dealing System
(NDS) for trading government securities. The reforms also led to the
establishment of the Securities and Exchange Board of India (SEBI) as the
regulatory authority for the securities market.

Technological Advancements and Integration (Late 1990s to present)

With the advancement of technology and the implementation of electronic trading
platforms, the money market in India witnessed further evolution. The
introduction of the Negotiated Dealing System-Order Matching (NDS-OM) in
2002 facilitated the electronic trading of government securities. Additionally, the
introduction of the Clearing Corporation of India Limited (CCIL) in 2001 brought
efficiency and transparency to the settlement of money market transactions.

Furthermore, the money market in India has expanded to include various

participants, including banks, financial institutions, corporates, mutual funds, and
non-banking financial companies (NBFCs). The RBI continues to play a crucial
role in regulating and developing the money market by implementing policies
and measures to ensure stability and liquidity.

Money market objectives

o Providing lenders as individual investors, government, etc. on short-term
loans at a reasonable price. Lenders will also have the opportunity to
purchase assets as securities in the financial markets are temporary.
o It also enables lenders to convert their idle money into a viable investment.
In this way, both the lender and the borrower benefit.
o The RBI controls the money market. Therefore, it helps to control the level
of money in the economy.
o As many organizations are short on their operating needs. The money
market helps such organizations to have the necessary funds to meet their
operating financial needs.
o It is an important source of revenue in the public sector for national and
international trade. And of course, it gives banks the opportunity to park
their surplus funds.

How Does The Money Market Work?

The money market operates through the interaction of various participants,
including governments, corporations, financial institutions, and individual
investors. These participants engage in short-term borrowing and lending to meet
their immediate cash needs and manage liquidity. Here’s a breakdown of how the
money market works:

o Borrowers: Entities needing short-term funds, such as governments or

corporations, approach the money market to meet their immediate financial
obligations. They issue money market instruments to raise funds quickly.
These instruments act as a form of borrowing from investors.
o Money Market Instruments: Borrowers issue various instruments with
varying maturities, interest rates, and credit ratings. These instruments
include Treasury bills, commercial paper, certificates of deposit, and
repurchase agreements. These instruments are highly liquid and considered
low risk.
o Investors: Investors with surplus funds seeking short-term investment
opportunities turn to the money market. They purchase money market
instruments issued by borrowers. In return, investors receive interest
payments or discounts on the tools, which serve as their returns on
investment.
o Trading and Secondary Market: Money market instruments can be traded
on the secondary market, allowing investors to buy and sell them before
maturity. This secondary market enhances liquidity, as investors can access
their funds before the instrument matures.
o Money Market Funds: Money market funds pool investments from
institutional and individual investors and invest in a diversified portfolio of
money market instruments. These funds allow investors to indirectly
participate in the money market while benefiting from professional
management.
o Regulatory Oversight: The money market operates within a regulated
environment. Regulatory bodies monitor and enforce rules and regulations
to ensure transparency, stability, and fair practices. This oversight helps
maintain the integrity and reliability of the money market.

Who Uses The Money Market?

Various participants utilize the money market, including governments,
corporations, financial institutions, and individual investors. Let us look at each
of these groups and their involvement in the money market:
 o Governments: Governments often play a significant role in the money
market. They issue money market instruments, such as Treasury bills, to
finance their short-term funding requirements. These instruments are
considered highly secure, backed by the government’s creditworthiness.
o Corporations: Large and tiny corporations utilize the money market to meet
short-term funding needs. They issue commercial paper, which represents
unsecured promissory notes, to raise funds for operational expenses,
inventory management, or capital investments.
o Financial Institutions: Banks and other financial institutions actively
participate in the money market. They use money market instruments to
manage their liquidity and meet regulatory requirements. Financial
institutions also invest in money market instruments as a source of income
to ensure the stability of their cash positions.
o Individual Investors: Individual investors, including retail investors, also
engage with the money market. They can invest in money market
instruments such as Treasury bills, certificates of deposit, or money market
funds offered by banks or investment firms. These investments provide
individuals with a safe and short-term avenue to park their surplus funds
or earn modest returns.
o Money Market Funds: These are investments that pool funds from
individual and institutional investors. Professional investment managers
oversee managing these funds, and they distribute the pooled funds among
various money market instruments. Money market funds provide investors
with a convenient way to access the money market and benefit from
diversification.
o Central Banks: They play a crucial role in the money market by conducting
monetary policy operations. They use tools such as open market operations
to buy or sell money market instruments to manage the money supply,
influence interest rates, and stabilize financial markets.

FUNCTIONS OF MONEY MARKET

1. Financing Trade: Money Market plays crucial role in financing both internal
as well as international trade. Commercial finance is made available to the traders
through bills of exchange, which are discounted by the bill market. The
acceptance houses and discount markets help in financing foreign trade.
2. Financing Industry: Money market contributes to the growth of industries in
two ways:
(a) Money market helps the industries in securing short-term loans to meet their
working capital requirements through the system of finance bills, commercial
papers, etc.

(b) Industries generally need long-term loans, which are provided in the capital
market. However, capital market depends upon the nature of and the conditions
in the money market. The short-term interest rates of the money market influence
the long-term interest rates of the capital market. Thus, money market indirectly
helps the industries through its link with and influence on long-term capital
market.

3. Liquidity of Investment: Stock exchanges provide liquidity of investment to

the investors. Investors can sell out any of their investments in securities at any
time during trading days and trading hours on stock exchanges. Thus Stock
exchanges provide liquidity of investment. The on-line trading and online
settlement of demat securities facilitates the investors to sell out their investment
and realize the proceeds within a day or two. Even investors can switch over their
investment from one security to another according to the changing scenario of
capital market.

4. Investment Priorities: Stock exchanges facilitate the investors to decide his

investment priorities by providing him the basket of different kinds of securities
of different industries and companies. Investor can sell stock of one company and
buy a stock of another company through stock exchange whenever he wants. He
can manage his investment portfolio to maximize his wealth.

5. Profitable Investment: Money market enables the commercial banks to use

their excess reserves in profitable investment. The main objective of the
commercial banks is to earn income from its reserves as well as maintain liquidity
to meet the uncertain cash demand of the depositors. In the money market, the
excess reserves of the commercial banks are invested in near-money assets (e.g.
short-term bills of exchange) which are highly liquid and can be easily converted
into cash. Thus, the commercial banks earn profits without losing liquidity.
6. Self-Sufficiency of Commercial Bank: Developed money market helps the
commercial banks to become self-sufficient. In the situation of emergency, when
the commercial banks have scarcity of funds, they need not approach the central
bank and borrow at a higher interest rate. On the other hand, they can meet their
requirements by recalling their old short-run loans from the money market.

7. Investment Safety: Stock exchanges through their by-laws given by Securities

and Exchange Board of India (SEBI). Transparent procedures try to provide
safety to the investment in industrial securities. Government has established the
National stock Exchange (NSE) and over the counter Exchange of India (OTCEI)
or investor’s safety. Exchange authorities try to curb speculative practices and
minimize the risk for common investor to preserve his confidence.

8. Help to Central Bank: Though the central bank can function and influence the
banking system in the absence of a money market, the existence of a developed
money market smoothens the functioning and increases the efficiency of the
central bank. Money market helps the central bank in two ways:

(a) The short-run interest rates of the money market serve as an indicator of the
monetary and banking conditions in the country and, in this way, guide the central
bank to adopt an appropriate banking policy,

(b) The sensitive and integrated money market helps the central bank to secure
quick and widespread influence on the sub-markets, and thus achieve effective
implementation of its policy.

9. Indicator of Industrial Development: Stock exchanges are the symbolic

indicators of industrial development of a nation (i.e. Productivity, efficiency,
economic- status). A prospect of each industry and every unit in an industry is
reflected through the price fluctuation of industrial on stock exchanges. Stock
exchanges Sensex and price fluctuations of securities of various companies tell
the entire story of changes in industrial sector.

10. Barometer of National development of Economy: Stock exchanges are taken

as a Barometer of national development of the economy of a country. Each
economy is economically symbolized (indicators) by its most significant stock
exchange. New York stock Exchange, London stock Exchange, Tokyo stock
Exchange and Bombay stock Exchange are considered as barometers of U.S.A,
United Kingdom, Japan and India respectively. At both national and international
level these stock exchanges represent the progress and conditions of their
economies.

11. Borrowings by the government: The money market helps the government in
borrowing short term funds at very low interest rates. The borrowing is done on
the basis of treasury bills. But in case the government resorts to deficit financing
or to print more currency or to borrow from the central bank, it will merely raise
the money supply over and above the needs of the economy and hence the price
level will boost up. Thus, it is clear that the money market is very useful for the
government since it meets its financial needs.

12. Savings and investment: Another point of importance of the money market is
that it helps in promoting liquidity and safety of financial assets. By doing so it
can help in encouraging savings and investment. The saving and investment
equilibrium or equilibrium of demand and supply of loanable funds helps in the
allocation of resources.

Types of money market instrument

o Promissory Note: A promissory note is signed promise made by one party

to other party for paying a definite sum of money by demand at a specific
future date. It is a unique instrument that binds borrowers to pay money to
the lender as specified in the promissory note. This instrument comes with
interest or without interest. This instrument can be handwritten. It is to be
stamped as per regulation. There is no maxim limit in terms of the amount
can be lent or borrowed using this note.
o Treasury Bills: Treasury bill is one of the popular money market
instruments. This instrument is issued by the RBI on behalf of the central
government. Treasury bill is risk-free and safest investment option. The
return of the treasury bill is comparatively low. Treasury bill means a
promise to pay a certain amount after a pre-determined period. These bills
are issued for a period of 3 months, 6 months or 1 year.
o Commercial Papers: Commercial papers are unsecured promissory notes
issued by the financial and corporate institutions. Commercial papers are
issued to meet short term requirements. The interest rate offered by the
 commercial paper is higher compared to treasury bills. Commercial paper
is issued from 1 day to 270 days. CP is less secured compared to treasury
bills. The buyer should look at the credit rating before buying commercial
papers.
o Certificate of Deposit: Certificate of Deposit is another money market
instrument (MMI). Certificate of deposit is similar to term deposit.
However, it differs from term deposit in two aspects. Certificate of Deposit
is issued only for large amount. Certificate of Deposit is freely negotiable.
Certificate of deposit is issued by commercial banks and selected financial
Institution approved by RBI. The interest rate offered on Certificate of
deposit is higher compared to treasury bills.
o Repurchase Agreement: Repurchase agreements are called as REPOS.
REPOS are short term loans that buyer and seller aggress upon for selling
and purchasing. These transactions are allowed only between RBI
approved securities such as state and central government securities, PSU
bonds and corporate bonds.
o Banker's Acceptance: Banker's acceptance is document that promises
future payment guaranteed by a commercial bank. This Instrument
mentions specific details such as repayment amount, date of repayment and
details of the Individual to whom payment needs to be given. BA is issued
with a maturity period ranging between 30 days to 180 days.

Defects of the Indian Money Market

The Indian money market has been associated with several defects that hinder its
efficient functioning. Some of the defects of the Indian money market are as
follows:

1. Existence of Unorganised Money Market: The Indian money market consists

of both organised and unorganised sectors. The unorganised sector, which
includes indigenous bankers and moneylenders, lacks proper regulations and
operates outside the purview of RBI. This leads to issues such as lack of
transparency, high-interest rates, and exploitation of borrowers. Borrowers may
face difficulties in accessing fair and transparent lending practices, affecting the
overall efficiency of the market.

2. Absence of Cooperation amongst the Members of the Money Market: The lack
of cooperation and coordination among the various participants in the money
market, including banks, financial institutions, and the government, hampers the
smooth functioning of the market. Without effective collaboration, the market
may experience inefficiencies, liquidity problems, and a fragmented structure.
Cooperative efforts are necessary to ensure the stability and optimal functioning
of the money market.

3. Lack of Uniformity in Interest Rates in the Money Market: In the Indian money
market, interest rates are not uniform across different segments and participants.
This lack of uniformity creates disparities and uncertainties, making it difficult
for market participants to make informed decisions. It also affects the
transmission of monetary policy and the overall stability of the market.
Transparent and consistent interest rate mechanisms are essential for an efficient
money market.

4. Absence of Organised Bill Market: A well-developed bill market is crucial for

the functioning of the money market. However, in India, the bill market is not
adequately organised. This absence of an organised bill market limits the
availability of short-term credit instruments, such as treasury bills and
commercial bills, which are essential for liquidity management and financing
trade transactions. A well-regulated bill market is necessary to facilitate efficient
short-term financing.

5. Seasonal Financial Stringency: The Indian money market experiences seasonal

fluctuations in liquidity and financial stringency. This is primarily due to factors
like agricultural cycles, festive seasons, and government borrowing patterns.
These fluctuations can lead to volatility in interest rates and create uncertainties
for market participants. Strategies to manage these seasonal fluctuations are
necessary for maintaining stability.

6. Shortage of Capital in the Money Market: The Indian money market faces a
shortage of capital to meet trade and industry requirements. The limited
availability of capital hampers the development of various sectors and restricts
the growth potential of the overall economy. Adequate availability of capital is
crucial for sustaining economic growth and meeting the funding needs of
businesses and individuals.
7. Lack of Development of the Indian Money Market: The Indian money market
is not as developed as other major global money markets. It lacks depth, breadth,
and sophistication in terms of financial products and instruments. This hinders
the efficient allocation of funds and impedes the overall growth and stability of
the financial system. Developing a diverse range of financial products and
instruments can enhance the market’s efficiency.

8. Excessive Number of Indigenous Bankers in the Money Market: The presence

of a large number of indigenous bankers, such as moneylenders and unregulated
non-banking financial entities, creates issues of unfair practices, lack of
accountability, and high-interest rates. It also contributes to the unorganised
nature of the money market. Proper regulation and oversight are necessary to
mitigate these issues and ensure fair and transparent practices.

9. Absence of Specialised Institutions in the Money Market: The Indian money

market lacks specialised institutions that can cater to specific financial needs and
provide specialised financial services. This absence limits the options available
to market participants and hampers the overall efficiency of the money market.
The establishment and strengthening of specialised institutions can enhance the
market’s ability to meet diverse financial requirements.

10. Non-availability of Credit Instruments: The Indian money market suffers

from a lack of diverse and readily available credit instruments. The absence of a
wide range of credit instruments restricts the flexibility and effectiveness of
financing options for borrowers and lenders. Developing a comprehensive range
of credit instruments can provide market participants with more options for
managing their financing needs.

Reserve Bank and Indian Money Market:

The Reserve Bank of Indian has taken various measures to improve the existing
defects and to develop a sound money market in the country.

Important among them are:

(i) Through the introduction of two schemes, one in 1952 and the other in 1970,
the Reserve Bank has been making efforts to develop a sound bill market and to
encourage the use of bills in the banking system. The variety of bills eligible for
use has also been enlarged.

(ii) A number of measures have been taken to improve the functioning of the
indigenous banks. These measures include- (a) their registration; (b) keeping and
auditing of accounts; (e) providing financial accommodation through banks; etc.

(iii) The reserve bank is fully effective in the organised sector of the money
market and has evolved procedures and conventions to integrate and coordinate
the different components of money market.

Due to the efforts of the Reserve Bank, there is now much more coordination in
the organised sector than that in the unorganised sector or that between organised
and unorganised sectors.

(iv) The difference between various sections of the money market has been
considerably reduced. With the enactment of the Banking Regulation Act, 1949,
all banks in the country have been given equal treatment by the Reserve Bank as
regards licensing, opening of branches, share capital, the type of loans to be given,
etc.

(v) In order to develop a sound money market, the Reserve Bank of Indian has
taken measures to amalgamate and merge banks into a few strong banks and given
encouragement to the expansion of banking facilities in the country,

(vi) The Reserve Bank of India has been able to reduce considerably the
differences in the interest rates between different sections as well as different
centres of the money market.

Now the interest rate structure of the country is much more sensitive to changes
in the bank rate. Thus, the Reserve Bank of India has succeeded to a great extent
in improving the Indian money market and removing some of its serious defects.

Difficulties faced by the Reserve Bank in controlling the money market:

(i) The absence of bill market restricts the Reserve Bank’s ability to withdraw
surplus funds from the money market by disposing of bills.
(ii) The existence of indigenous bankers is the major hurdle in the way of
integrating the money market.

(iii) Inadequate development of call money market is another difficulty in

controlling the money market. The banks do not maintain fixed ratios between
their cash reserves and deposits and the Reserve Bank has to undertake large open
market operations to influence the policy of the banks.

Working Group on Money Market:

In, 1986, the Reserve Bank of India set up a Working Group under the
chairmanship of Mr. N. Vaghul to examine the possibilities of enlarging the scope
of money market and to recommend specific measures for evolving other suitable
money market instruments.

The Working Group submitted its Report in January, 1987. It has made a number
of recommendations for activating and developing the Indian money market.

Some Important recommendations are as follows:

(i) Measures should be taken to improve the operation of the call money market,

(ii) Rediscounting market should be developed with a view to facilitating the

emergence of genuine bill culture in the country.

(iii) A short-term commercial paper should be introduced.

(iv) An active secondary market for Government paper, especially a ‘182 days
Treasury Bill’ Refinance facility, should be developed.

(v) A Finance House should be set up to deal in short-term money market

instruments.

(vi) Banks and private non-bank financial institutions should be encouraged to

provide factoring services.
(vii) There should be continuing development and refinement of money market
instruments, and every new instrument must be approved by the Reserve Bank.

Recent Measures Taken by RBI:

The Reserve Bank of India has taken the following measures to implement the
recommendation of the Working Group since 1987:

(i) With a view to make bill financing attractive to the borrowers, from April
1987, the effective interest rate on bill discounting for categories subject to the
maximum lending rate has been fixed at a rate one percentage point lower than
the maximum lending rate.

(ii) In order to attract additional funds into rediscount market, the ceiling on the
bill rediscounting rate has been raised from 11.5% to 12:5%

(iii) Access to bill rediscounting market has been increased by selectively

increasing the number of participants in the market.

(iv) 182 Day Treasury Bills have been introduced in 1987. In 1992-93, 364 Day
Treasury Bills were introduced and the auction of 182 Day Bill has been
discontinued. Like 182-Day Treasury bills, 364 Day Bills can be held by
commercial banks for meeting Statutory Ratio.

(v) In August 1989, the government remitted the duty on usance bills. This step
removed a major administrative constraint in the use of bill system.

(vi) Total deregulation of money market interest rates with effect from May 1,
1989 is a significant step taken by RBI towards the activation of money market.
Removing the interest ceiling on money rates would make them flexible and lend
transparency to transactions in the money market.

(vii) Certificates of Deposits (CDs) were introduced in June 1989 to give

investors greater flexibility in employment of their short-term funds.
(viii) Another money market instrument, Commercial Paper (CP), was introduced
in 1990-91 to provide flexibility to the borrowers rather than additionally of funds
over and above the eligible credit limit.

(ix) Since July 1987, the Credit Authorisation Scheme (CAS) has been liberalised
to allow for greater access to credit to meet genuine demand in production sectors
without the prior sanction of the Reserve Bank.

(x) In April, the Discount and Finance House of Indian Limited (DFHI) was
established with a view to increasing the liquidity of money market instruments.

(xi) In 1991, the scheduled commercial banks and their subsidiaries were
permitted to set up Money Market Mutual Fund (MMMF) which would provide
additional short-term avenue to investors and bring money market instruments
within the reach of individuals and small bodies.

As a result of various measures taken by the RBI, the Indian money market
has shown signs of notable development in many ways:

(i) It is becoming more and more organised and diversified.

(ii) The government trading in various instruments, like 364 Day treasury Bills,
commercial bills and commercial paper, has increased considerably.

(iii) The volume of inter-bank call money, short notice money and term money
transactions have grown significantly.

(iv) At present, scheduled commercial banks, cooperative banks, Discount and

Finance House of India (DFHI) are participating in the money market both as
lenders and borrowers of short-term funds, while Life Insurance Corporation of
India (LIC), Unit Trust of India (UTI), General Insurance Corporation of India
(GIC), Industrial Development Bank of India (IDBI) and National Bank for
Agriculture and Rural Development (NABARD) are participating as lenders.
Capital Markets
A capital market is a place that allows the trading of funding instruments such as
shares, debentures, debt instruments, bonds, ETFs, etc. It is a source for raising
funds for individuals, firms, and governments.

The securities exchanged here would typically be a long-term investment

with over a year lock-in period. On the other hand, short-term investments
are usually found in the money market
.
Functions Of Capital Market
1. Linking Buyers And Sellers: Linking buyers and sellers is a major function
of the capital market. A market can only be called one when both buyers
and sellers come together. The capital market links those with excess funds
together with those in need of funds. That way idle resources are put to
productive use in order to generate more income and increase productivity.
Investors get more income in the form of dividends and interest payments.
Through facilitating the sell and purchase of long-term financial
instruments, the capital market reduces the cost and time of trading
significantly. This is an important role of the capital market.

2. Raising Capital: Efficient markets create an easy access to capital. Raising

capital is an essential function of the capital market. If a company requires
funds through equity it can issue shares on the stock exchange. Some
popular stock exchanges include NYSE (New York Stock Exchange), LSE
(London Stock Exchange) and JSE (Johannesburg Stock Exchange). The
capital market also caters for the financial needs of the various sectors of
the economy by mobilising peoples’ savings through investment and lends
that money for development projects. In addition, capital markets ensure
the availability of funds in the economy by continuously providing long
term investment avenues for investors.

3. Informational Role: One of the function of capital market is the

informational role. The market price of a financial instrument, either new
or existing is set by the capital market, thus the market mirrors the value of
the instrument. Stock prices reflect investors’ collective evaluation of a
company’s current and future performance. If the market is optimistic
about a company, it will be shown by a rise in the stock price of that
 company. Thus, capital markets encourage the allocation of funds to firms
that appear to have the best prospects. Keep in mind that no one knows
with certainty which ventures will do well and which will not succeed. The
informational role is an important function of the capital market.

4. Enables Investing: One of the core functions of capital markets is to enable

investing in the capital market instruments. Capital markets create the
opportunity to invest in different financial instruments such as bonds,
ordinary shares and preference shares depending on the risk appetite of the
investor. Buying these instruments and selling them again in the future is
made much easier. Investing is a major role of the capital market.

5. Risk Management: The capital market helps investors reduce the risk of
making losses in other financial instruments and commodities through
diversification. Risk management is an essential function of the capital
market. Investors can purchase bonds, preference shares and debentures
along with common stock and other commodities in order to spread out
risk. In fact, Governments bonds are regarded as risk free assets. In addition
to diversification, the capital market helps with the allocation of risk by
allocating investors with a high-risk appetite to more riskier investments
and those who are risk averse to less riskier instruments. Risk tolerant
investors purchase stocks whilst risk-averse investors purchase bonds. So
one of the function of capital markets is risk management.

6. Prevents Arbitrage: The capital market also serves the function of avoiding
arbitrage. A financial instrument should trade at the same price wherever
transactions take place. The moment a financial instrument such as a stock
trades at different prices in different locations speculators will try to make
a risk-free profit. This happens when the instrument is bought at the lower
price location and sold where the price is higher, this is referred to as
arbitrage. When markets are not well developed this occurs often.
However, well developed markets act as vehicles to create efficiency.
Arbitrage opportunities do not last long. Eventually, the market will move
 back to equilibrium when high demand for the instrument in the cheaper
location pushes the price up and excess supply of the instrument in the
expensive location pushes the price down. Eliminating arbitrage is an
essential function of the capital market.

7. Shift Consumption: The capital market also serves the function of shifting
consumption. By storing one’s wealth in bonds or equity you shift your
purchasing power from one period to another. Young working-class
employees can invest their excess funds in the capital market during their
high earning periods and later spend their yields during their low earning
period, when they retire. The capital market allows investors to manage
their consumption timing and pattern by apportioning funds for
consumption in the appropriate period. Thus, the capital market enables
people to separate decisions regarding current and future consumption.
Managing of consumption is an important function of the capital market.
Other Functions of Capital Market
• It improves effectiveness in capital allocation
• The capital market leads to rapid economic growth
• Enables raising of capital
• It minimises transaction cost and information cost
• The capital market provides a variety of financial instruments to investors
• Provision of information on the value of a security
• The capital market offers liquidity to investors for their assets
• It offers insurance against the market threats through derivatives
• The capital market offers trading in securities
• It links savers and investors
• The capital market offers a valuation of financial instruments

Main participants in capital market

1. Investors: Investors, also referred to as stockholders or shareholders, are
those who own shares of stock of a publicly listed company. They are
accorded certain privileges like the right to fair and equal treatment, the
right to vote and exercise related rights, and the right to receive dividends
and other benefits due to stockholders. They are classified as either retail
or institutional, and local or foreign.
2. Stockbrokers: A stockbroker or trading participant is licensed by the
Securities and Exchange Commission (SEC) and is entitled to trade at the
Exchange. They act as an agent between a buyer and seller of stocks in the
market. For their services as stockbrokers, they receive from their clients
either a buying or a selling commission. The representatives (licensed
salesmen) of these accredited stockbrokers convene daily, at certain
specified hours, on the “trading floor” of the exchange, where they sell and
buy shares of stocks for the account of their clients. They execute orders in
the market to the greatest possible advantage of their customers, by buying
at the lowest possible price or by selling at the highest possible price.
There are two types of stockbrokers

• Traditional – those who assign a licensed salesman to handle your account

and to take your orders via a written instruction or a phone call
• Online – those whose main interface is the internet where clients execute
their orders and access market information online
3. Listed Companies: Listed companies, also called “issuers”, are those
whose shares of stock are traded on the Exchange. These companies
qualified with the stringent listing and reportorial requirements of the stock
exchange, and have gone through initial public offering (IPO) or listing by
way of introduction.

4. Clearing House: A clearing house is a wholly owned subsidiary of the

Exchange. It was established to ensure the orderly settlement of equity
trades executed at the Exchange. The clearing house is responsible for
establishing the cash and securities liabilities and entitlements of its
clearing members, synchronizing the settlement of funds and the transfer
of securities based on the delivery-versus-payment model or multilateral
net settlement; guaranteeing the settlement of trades in the event of a
trading participant’s trade default in order to ensure the finality and
irrevocability of all Exchange trades through its fails management
procedures; implementing appropriate risk management measures in order
to mitigate risks inherent in the clearing and settlement of Exchange trades
and the maintenance and administration.
5. Depository: The depository acts as securities depository or “custodian” of
listed shares of stock that are traded at the exchange. It was organized to
 establish a central depository in India and to implement scripless
trading.The depository performs book-entry transfer of securities:

• From seller’s to buyer’s accounts during settlement of Exchange trades;

• From one PDTC participant to another per client instruction, and;
• From lender’s to borrower’s account for loan transactions.
• Settlement Banks

The settlement banks accept deposits of funds for payment of securities bought,
confirm payments of due clearing obligations to SCCP, debit buyer’s cash
account and credit seller’s cash account during settlement, and receive and/or
return cash collateral put up by clearing members to cover their daily trade
negative exposures.

6. Transfer Agents: The stock transfer agent is considered the “official

keeper” of the corporate shareholder records. The stock transfer agents
provide the issuer or the listed company with a list of holders of its
securities. They effect transfer of beneficial ownership and process
corporate actions like stock or cash dividends, stock rights, stock splits,
and collation of proxy forms.

Types of Capital Market

The capital market is divided into two parts:
• Primary Market- Also know as New Issue Market, it is the first time
market trading of new securities and later available for institutions and
individuals. It supports both private and public offerings. An organisation
provides securities to the public to accumulate funds and satisfy its long
term goals. In the primary market, the securities are issued by either Initial
Public Offer (IPO) or Further Public Offer (FPO). IPO is a process through
which an organisation can make a public offer to the investors for the first
time to make an investment. This trade is between the investors and the
original issuer in the primary market.
• Secondary Market – It is called secondary because the securities they
have are old and already have been issued in the primary market for trade.
This trade is between the investors and the original issuer in the primary
market. The trade is between the buyer and seller and the stock exchange
facility.
Primary Market
A primary market is a platform where securities are created for sale to investors
for the first time. Here, the investors are the direct buyers of the assets and
securities, which means the stocks or equities are sold to them as soon as they are
introduced in the market.

A primary market is a capital market that puts securities for sale initially. These
assets enter the next market when the primary buyers trade them further. This
next marketplace becomes their secondary market. In short, the primary market
is the platform wherefrom investing begins.

Firms introduce new shares, bonds, bills, and notes in the market and sell them to
investors for the first time to raise capital. The investment banks
set the initial price, which receives a fee in return for undertaking sales. However,
the remaining proportion of the earnings goes to the issuers.

Companies file statements with the Securities and Exchange Commission (SEC)
and other agencies as required to start with the primary market transaction. As
soon as the stocks, bonds, and other securities are traded for the first time in the
primary market, they enter the secondary market for further sale to other
investors.

Features of New Issue Market/Primary Market

1. It is the market for new long term capital.
2. The securities are issued by company for the first time directly to the investors.
3. On receiving the money from new issues, the company will issue the
security certificates to the investors.
4. The amount obtained by the company after the new issues are utilized
for expansion of the present business or for setting up new ventures.
5. External finance for long term such as loan from financial institutions is
not included in new issue market. There is an option called <going public= in
which the borrowers in new issue market raise capital for converting private
capital into public capital.
6. The financial assests sold can be redeemed by the orginial holder of security.
Function of New Issue Market
The main function of a new issue market can be divided into three service
functions:
• Origination: It refers to the work of investigation, analysis and
processing of new project proposals.this function is done by merchant
bankers who may be commercial banks, all India financial institutions or
private firms.the success of the issue depends to a large extent on the
efficiency of the market.
• Underwriting: It is an agreement whereby the underwriter promises
to subscribe to a specified number of shares or debentures or a specified
amount of stock in the event of public not subscribing to the
issue.underwriting is a guarantee for marketability of shares. There
are two types of underwriters
• Distribution: It is the function of sale of securities to ultimate investors.
This is performed by secialized agencies like brokers and agents who
maintain a regular and direct contact with the ultimate investors.
Role of New Issue/ Primary Market
• Capital Formation: It provides attractive issue to the potential investors and
with this company can raise capital at lower costs.
• Liquidity: As the securities issued in primary market can be immediately
sold in secondary market. The rate of liquidity of securities is higher.
• Diversification of Risk: Many financial intermediaries invest in
primary market, as there is less risk of failure in investment as the company
does not depend on a single investor.it reduces the overall risk.
• Reduction in Cost: Prospectus containing all details about securities are
given to the investors. n India- Institutional (LIC,UTI, IDBI,ICICI) and
Non- institutional are brokers.
Types of Primary Market Issues
1. Public issue: The public issue is one of the most common methods of issuing
securities to the public. The company enters the capital market to raise money
from kinds of investors. Here, the securities are offered for sale to new investors.
The new investor becomes the shareholder of the issuing company. This is called
a public issue. The further classification of the public issue is –

2. Initial Public Offer: As the name suggests, it is a fresh issue of equity shares or
convertible securities by an unlisted company. These securities are traded
previously or offered for sale to the general public. After the process of listing,
the company’s share is traded on the stock exchange. The investor can buy and
sell securities after listing in the secondary market.

3. Further Public Offer or Follow on Offer or FPO: When a listed company on

the stock exchange announces fresh issues of shares to the general public. The
listed company does this to raise additional funds.

4. Private placement: Private placements mean that when a company offers its
securities to a small group of people. The securities may be bonds, stocks, or other
securities. The investors can be either individual or institution or both.
Comparatively, private placements are more manageable to issue than an IPO.
The regulatory norms are significantly less. Also, it reduces cost and time. The
private placement is suitable for companies that are at early stages (like startups).
The company may raise capital through an investment bank or a hedge fund or
ultra-high net worth individuals (HNIs)

5. Preferential issue: The preferential issue is one of the quickest methods for a
company to raise capital for their business. Here, both listed and unlisted
companies can issue shares. Usually, these companies issue shares to a particular
group of investors.
It is important to note that the preferential issue is neither a public issue nor a
rights issue. In the preferential allotment, the preference shareholders receive
dividends before the ordinary shareholders receive it.

6. Qualified institutional placement: Qualified institutional placement is another

type of private placement. Here, the listed company issues equity shares or
debentures (partly or wholly convertible) or any other security not including
warrants. These securities are convertible in nature. Qualified institutional buyer
(QIB) purchases these securities.

QIBs are investors who have requisite financial knowledge and expertise to invest
in the capital market. Some of the QIBs are –
Foreign institutional investors who are registered with SEBI.
• Alternate investment funds
• Foreign venture capital investors
• Mutual funds
 • Public financial institutions
• Insurers
• Scheduled commercial banks
• Pension funds
Comparatively, qualified institutional allotment is simpler than the preferential
allotment. The reason is they do not attract any standard regulations like
submitting pre-issue filings with SEBI. Thus, the process becomes much more
comfortable and less time-consuming.

7. Rights issue: This is another type of issue in the primary market. Here, the
company issues shares to its existing shareholders by offering them to purchase
more. The issue of securities is at a predetermined price.
In a rights issue, the investors have a choice of buying shares at a discount price
within a specific period. It enhances the control of the existing shareholders of
the company. It helps the company to raise funds without any additional costs.

8. Bonus issue: When a company issues fully paid additional shares to its existing
shareholders for free. The company issues shares from its free reserves or
securities premium account. These shares are a gift for its current shareholders.
However, the issuance of bonus shares does not require fresh capital.

Players in money market

1. Merchant Bankers (Managers to the Issue):
“Merchant banker means any person/institution who is engaged in the business
of issue management either by making arrangements regarding selling, buying or
subscribing to securities as manager, consultant, advisor or rendering corporate
advisory services in relation to such issue management.” [Sec 2(cb) SEBI
(Merchant Bankers) (Third Amendment) Regulations, 2006]

Depending on the size of the issue there can be more than one manager to the
issue. If the size exceeds Rs. 400 crores there can be five or more managers as
agreed by SEBI. These Managers to the issue assist the promoters in designing
the capital structure, drafting the prospectus and application forms, listing of
shares, appointment of registrars and other operators in the new issue,
arrangement of long term loans- marketing of public issues etc. The lead manager
prepares Draft Red Herring Prospectus (RHP) and is responsible for any
irregularities in the same. The company should enter into a memorandum of
understanding with the managers to the issue in the form prescribed by SEBI.
The lead merchant bankers appointed by the Issuer Company are referred to as
the Book Running Lead Managers (BRLM) or Book Runners (If the issue is
through book building process).

2. Underwriters to the Issue:

Underwriters are financial institutions who make a firm commitment that they
will take up the shares up to a certain amount if the public does not subscribe to
it. This is an agreement with one or more institutions and a guarantee of the
marketability of shares. Under writing is mandatory for the Public Issue.
Underwriters are appointed by the company in consultation with the managers to
the issue. Financial institutions, bankers, members of stock exchanges,
investment companies, trusts etc. can act as under writers.

3. Transfer Agent
A transfer agent is a trust company, bank, or similar institution assigned by a
corporation for the purposes of maintaining an investor's financial records and
tracking each investor's account balance. The transfer agent records transactions,
cancels and issues certificates, processes investor mailings, and handles a host of
other investor problems, including reissuing lost or stolen certificates.
Transfer agents work closely with registrars to ensure investors receive their due
interest and dividend payments in a timely manner. Transfer agents likewise
oversee the mailing of monthly investment statements to mutual fund
shareholders.
4. Debenture Trustee
Debenture Trustee is a liaison between the issuer company and the debenture
holders, who hold the secured property on behalf of the issuer company, which is
mortgaged in favor of debenture trustee for protecting the interest of debenture
holders. Debenture Trustee is an entity that secures any issue of debentures of a
body corporate for the benefit of investors.

Debenture Trustee plays a very important role in the NCD issue by safeguarding
the interest of debenture holders and acting as an intermediary between the issuer
company and the debenture holders. As per the provisions of the companies act,
the appointment of a debenture trustee is mandatory in case of debentures/bonds
with maturity beyond 18 months, irrespective of whether debentures/bonds are
secured or not. However, the issue of debentures/bonds with a maturity of 18
months or less are exempt from the requirement of debenture trustee.
5. Registrar: A registrar is an institution, often a bank or trust company,
responsible for keeping records of bondholders and shareholders after an issuer
offers securities to the public. When an issuer needs to make an interest payment
on a bond or a dividend payment to shareholders, the firm refers to the list of
registered owners maintained by the registrar.

Secondary Market
A secondary market is a platform wherein the shares of companies are traded
among investors. It means that investors can freely buy and sell shares without
the intervention of the issuing company. In these transactions among investors,
the issuing company does not participate in income generation, and share
valuation is rather based on its performance in the market. Income in this market
is thus generated via the sale of the shares from one investor to another.

Types of Secondary Market

Secondary markets are primarily of two types – Stock exchanges and over-the-
counter markets.

Stock exchanges: are centralised platforms where securities trading take place,
sans any contact between the buyer and the seller. National Stock Exchange
(NSE) and Bombay Stock Exchange (BSE) are examples of such platforms.
Transactions in stock exchanges are subjected to stringent regulations in
securities trading. A stock exchange itself acts as a guarantor, and the
counterparty risk is almost non-existent. Such a safety net is obtained via a higher
transaction cost being levied on investments in the form of commission and
exchange fees.

Over-the-counter markets are decentralised, comprising participants engaging

in trading among themselves. OTC markets retain higher counterparty risks in the
absence of regulatory oversight, with the parties directly dealing with each other.
Foreign exchange market (FOREX) is an example of an over-the-counter market.
In an OTC market, there exists tremendous competition in acquiring higher
volume. Due to this factor, the securities’ price differs from one seller to another.
Apart from the stock exchange and OTC market, other types of secondary market
include auction market and dealer market.

The former is essentially a platform for buyers and sellers to arrive at an

understanding of the rate at which the securities are to be traded. The information
related to pricing is put out in the public domain, including the bidding price of
the offer.
Dealer market is another type of secondary market in which various dealers
indicate prices of specific securities for a transaction. Foreign exchange trade and
bonds are traded primarily in a dealer market.

Examples of Secondary Market Transactions

Secondary market transactions provide liquidity to all kinds of investors. Due to
high volume transactions, their costs are substantially reduced. Few secondary
market examples related to transactions of securities are as follows.

In a secondary market, investors enter into a transaction of securities with other

investors, and not the issuer. If an investor wants to buy Larsen & Toubro stocks,
it will have to be purchased from another investor who owns such shares and not
from L&T directly. The company will thus not be involved in the transaction.

Individual and corporate investors, along with investment banks, engage in the
buying and selling of bonds and mutual funds in a secondary market.

Functions of Stock Exchange/Secondary Market are listed below:

1. Economic Barometer:
A stock exchange is a reliable barometer to measure the economic condition of a
country. Secondary Market Every major change in country and economy is
reflected in the prices of shares. The rise or fall in the share prices indicates the
boom or recession cycle of the economy. Stock exchange is also known as a pulse
of economy or economic mirror which reflects the economic conditions of a
country.

2. Pricing of Securities:
The stock market helps to value the securities on the basis of demand and supply
factors. The securities of profitable and growth oriented companies are valued
higher as there is more demand for such securities. The valuation of securities is
useful for investors, government and creditors. The investors can know the value
of their investment, the creditors can value the creditworthiness and government
can impose taxes on value of securities.

3. Safety of Transactions:
In stock market only the listed securities are traded and stock exchange authorities
include the companies names in the trade list only after verifying the soundness
of company. The companies which are listed they also have to operate within the
strict rules and regulations. This ensures safety of dealing through stock
exchange.

4. Contributes to Economic Growth:

In stock exchange securities of various companies are bought and sold. This
process of disinvestment and reinvestment helps to invest in most productive
investment proposal and this leads to capital formation and economic growth.

5. Spreading of Equity Cult:

Stock exchange encourages people to invest in ownership securities by regulating
new issues, better trading practices and by educating public about investment.

6. Providing Scope for Speculation:

To ensure liquidity and demand of supply of securities the stock exchange permits
healthy speculation of securities.

7. Liquidity:
The main function of stock market is to provide ready market for sale and
purchase of securities. The presence of stock exchange market gives assurance to
investors that their investment can be converted into cash whenever they want.
The investors can invest in long term investment projects without any hesitation,
as because of stock exchange they can convert long term investment into short
term and medium term.

8. Better Allocation of Capital:

The shares of profit making companies are quoted at higher prices and are
actively traded so such companies can easily raise fresh capital from stock
market. The general public hesitates to invest in securities of loss making
companies. So stock exchange facilitates allocation of investor’s fund to
profitable channels.

9. Promotes the Habits of Savings and Investment:

The stock market offers attractive opportunities of investment in various
securities. These attractive opportunities encourage people to save more and
invest in securities of corporate sector rather than investing in unproductive assets
such as gold, silver, etc.

Features of Stock Exchange:

Salient features of stock exchange are the following:
(i) Stock exchange is a market for second hand securities
(ii) It is basically a market for second-hand listed securities of companies viz.,
shares, debentures/ bonds and government securities.
(iii) Stock exchange allows dealing only in listed securities. In fact, stock
exchange maintains an official list of securities that could be purchased and sold
at its floor. Unlisted securities i.e., securities which do not figure in the official
list of the stock exchange; could not be dealt in the stock exchange.
(iv) Stock exchange is in organised market for dealing in securities. Activities of
a stock exchange are governed by a recognised code of conduct, apart from
statutory regulations.
(v) All transactions in securities at the stock market are effected through
authorised members only.

Difference between primary market and secondary market

Basis for
Primary Market Secondary Market
difference

A marketplace where formerly

Meaning A marketplace for new shares
issued securities are traded

Another Name New Issue Market (NIM) After Market

Shares, debentures, warrants,

Products IPO and FPO
derivatives, etc.
Type of
Direct Indirect
Purchasing

Parties of buying Buying and selling takes place Buying and selling takes place
and selling between the company and investors between the investors

Intermediaries
Underwriters Brokers
involved

Fluctuates with variations in

Price Levels Remains Fixed
demand and supply

It provides financing to the existing

Financing
companies for facilitating growth No Financing is provided
provided to
and expansion.

The company issuing the shares

The purchase process happens
Purchase Process is not involved in the purchasing
directly in the primary market.
process.

Beneficiary The beneficiary is the company The beneficiary is the investor

A company issues shares and the

Government There is no involvement of the
government interferes in the
involvement government in the process.
process

Depository System
The depository is nothing but an organization where securities of the shareholders
are kept. It is kept there in the form of electronic. It is just like a bank but useful
only for securities. Thus, whenever an investor wishes to avail the service, he/she
can opt for the service by opening an account. After the process is done the
ownership of securities can be legally transferred to the beneficiary.

Objectives of the Depository System

• It removes the occurrences of forgery, duplicate share certificates, and bad
deliveries.
• This can increase the liquidity of securities by making a way for easy
transfer.
• Avoid the delay caused in the transfer of securities.
 • Furthermore, it reduces the cost of a transaction for the investors.
• It enables withdrawal and surrender from the securities with great ease.
• It also maintains a perfect record of the holdings for an investor. This is
because all the details are stored in electronic form.
• This also provides infrastructure for services in capital markets.
• By complying to global standards, it does attract foreign investors.

Key features of the Depository System in India

• Fungibility: In depository systems, identifying financial instruments does
not occur through unique numbers. Hence, all financial assets belonging to
the same class are interchangeable and identical. For instance, equity
shares belonging to the fully paid-up shares class are interchangeable.
• Participants: There are four participants in depository systems. They are
the depository, issuer, beneficial owner, and depository participant (DP).
• Elimination Of Risk: The system eliminates risks related to the physical
certificates, for example, bad deliveries, loss in transit, theft, delays, etc.
• Free Transferability Of Financial Instruments: The transfer of financial
instruments held by the institutions in electronic form occurs freely via the
electronic book-entry system. That said, this system ignores the various
procedural requirements concerning the transfer of financial assets.

Functions
The functions of depositories are as follows:
• It is a link between shareholders and public companies: These institutions
are a connecting link between public companies issuing financial
instruments and shareholders or investors. The agents associated with the
institutions are the DPs. They are responsible for transferring the financial
assets from the depositories to shareholders. Brokerages and banks are two
examples of DPs.

• Offers loans to individuals and businesses: An institution accepts currency

deposits from customers who can withdraw the amount anytime. The
organization pays interest on the deposits while it earns a higher interest
income by lending the money in the form of mortgages or loans.

• Reduces paperwork and facilitates the faster transfer of securities: When a

trade takes place, depositories transfer the ownership of the financial
 instruments from one investor’s account to another. This reduces the
paperwork involved in a trade’s finalization, thus accelerating the
securities transfer process.

• Enables traders to store financial instruments in dematerialized form:

Traders do not have to bear the risk of holding the financial instruments as
the institutions allow them to store the financial assets electronically.

Example
Suppose XYZ is a clearing house serving as a securities depository for various
organizations that trade on multiple stock exchanges in Europe. Its customer base
primarily comprises banks, brokerages, and other organizations that hold a wide
range of financial assets and engage in market-making and other activities.

XYZ settles international and domestic transactions involving financial

instruments, such as bonds, stocks, and derivatives. In addition, its system accepts
domestic financial assets from over 35 markets, which include equities,
convertible securities, and stock warrants.

Types of Depositories

There are two major types of depository institutions in India, the NSDL (National
Securities Depository Limited) and CDSL (Central Depository Services
Limited). Both of these depositories are regulated by the Securities and Exchange
Board of India (SEBI).
1. National Securities Depository Limited
The National Securities Depository Limited (NSDL) was established in August
1996 under the Depositories Act of 1996. It was furnished with state-of-the-art
technology to facilitate storage of shares in dematerialised form. The primary
market where NSDL deals is the National Stock Exchange (NSE). As of April
30, 2023, the NSDL has more than 3 Crores active Demat and trading accounts.
2. Central Depository Services Limited
Central Depository Services Limited (CDSL) is one of the world’s largest
depositories that was founded in 1999. This financial institution was also
established to provide investors and traders in India with easy and convenient
securities storage and depository services. The primary market of the CDSL is
the Bombay Stock Exchange (BSE). Moreover, as recently as February 2023, the
number of active accounts with CDSL has exceeded 8 Crores.

Difference between NSDL and CDSL

Features NSDL CDSL

Meaning NSDL is an abbreviation for National CDSL is an abbreviation for Central

Securities Depository Limited. It is an Depository Services Limited. It is an Indian

Indian central securities repository that central securities depository that offers

permits the electronic storing and trading of depository services to the Indian securities

securities. market.

Year of 1996 1999

Establishment

Market Share Greater market share in terms of the Lower market share in terms of the number

number of DEMAT accounts. of DEMAT accounts.

Depository More DPs than CDSL. Fewer DPs than NSDL.

Participants (DPs)

Operating The principal functioning market for NSDL The principal functioning market for CDSL

Markets is the National Stock Exchange (NSE). is the Bombay Stock Exchange (BSE).

DEMAT Account The NSDL code is a 14-character numeric The CDSL DEMAT account number is a

Number Format code that begins with IN. numeric code of 16 digits.

Bombay Stock Exchange (BSE)

The Bombay Stock Exchange (BSE) is the first and largest securities market in
India and was established in 1875 as the Native Share and Stock Brokers'
Association. Based in Mumbai, India, the BSE lists close to 6,000 companies and
is one of the largest exchanges in the world, along with the New York Stock
Exchange (NYSE), Nasdaq, London Stock Exchange Group, Japan Exchange
Group, and Shanghai Stock Exchange.
The BSE has helped develop India's capital markets, including the retail debt
market, and has helped grow the Indian corporate sector. The BSE is Asia's first
stock exchange and also includes an equities trading platform for small-and-
medium enterprises (SME). BSE has diversified into providing other capital
market services including clearing, settlement, and risk management.

National Stock Exchange of India Limited (NSE)

The National Stock Exchange of India Limited (NSE) is India's largest financial
market. Incorporated in 1992, the NSE has developed into a sophisticated,
electronic market, which ranked fourth in the world by equity trading volume.
Trading commenced in 1994 with the launch of the wholesale debt market and a
cash market segment shortly thereafter.
the National Stock Exchange of India Limited (NSE) conducts transactions in the
wholesale debt, equity, and derivative markets. One of the more popular offerings
is the NIFTY 50 Index, which tracks the largest assets in the Indian equity market.
US investors can access the index with exchange-traded funds (ETF), such as the
iShares India 50 ETF (INDY).
The National Stock Exchange of India Limited was the first exchange in India to
provide modern, fully automated electronic trading. It was set up by a group of
Indian financial institutions with the goal of bringing greater transparency to the
Indian capital market.

Difference Between NSE And BSE

NSE BSE

Full Form NSE Full Form – National Stock Exchange BSE Full Form – Bombay
Stock Exchange

Incorporation NSE was established in 1992 BSE was established in

1875

Benchmark Index NIFTY 50 SENSEX

 Headquarters NSE is located in Mumbai. BSE is also located in
Mumbai.

Companies listed 1696 companies are listed on NSE. 5749 companies are listed
on BSE.

Products 1. Equity 2. Equity, Currency, and Commodity Derivatives3. 1. Equity 2. Equity,

Exchange-Traded Funds4. Mutual Funds5. Security Lending Currency, and Commodity
& Borrowing Scheme 6. Corporate Bonds 7. Initial Public Derivatives3. Exchange-
Offering (IPO)8. Institutional Placement Program (IPP)9. Traded Funds4. Mutual
Offer for Sale Funds5. Corporate Bonds 6.
Initial Public Offering
(IPO)7. Offer for Sale

SME Platform NSE Emerge BSE SME

Market 2.27 Trillion 2.1 Trillion

Capitalization

Liquidity High Liquidity Low Liquidity

Index Value (as of 12,848 43,834

23rd November
2020)

Global Rank 11th 10th

Website www.nseindia.com www.bseindia.com

Index
To determine the market trend, the market experts cannot calculate the
performance of each listed stock. That would be time-consuming and impossible
as thousands of stocks are listed, and by the end of the calculation, the market
trends would have changed.
So, how can anyone make a spontaneous decision? With an Index value.
An index picks a sample of listed companies from their respective industries that
act as a representative. It is similar to choosing a few apples from the basket and
not the entire store, as they would be enough to know if the Apples are overall
good. This sample of listed companies is called the Index, and the companies
under the sample are called index constituents.
In the Index, stocks are not picked only from a specific industry; instead, they are
chosen from all the major sectors. This way, when the performance is evaluated
and presented, we are looking at the overall picture and not a specific industry in
the stock market.

Nifty
Nifty is the Index used by the National Stock Exchange and is made by the
combination of National and Fifty (Nifty). Unlike Sensex, Nifty collects the
sample of 50 performing and luring stocks to determine the market trends.
Similar to Sensex, Nifty picks stocks from different sectors. Some of these
include the stocks from the sectors such as IT, Consumer Goods, financial
services, automobiles, telecommunication, and more. Besides, stocks picked
under Nifty are those that outperform others.
Criteria to qualify for Nifty are -
Liquidity
Float Adjustment
Domicile

Sensex
Sensex, aka Sensitive Index, is the Index for the Bombay Stock Exchange. As
discussed earlier, an index is a sample of listed companies that act as the
representative. Over 6000 companies are listed under the Bombay Stock
Exchange, and practically it would be impossible to analyze the performance
individually.
To solve this issue, BSE uses Sensex. Sensex picks up 30 companies that are
luring, performing, and best for the market. If these companies are performing
poorly, then the market trends are down. However, if only these 30 companies
are outperforming, then the market trends are bullish.
Now, the question is, how does a company qualify to fall under Sensex?
There is a certain criterion that the Bombay Stock Exchange use to pick
companies under Sensex. A few of these criteria are -
Market Capitalization.
Trading Frequency.
High Liquidity.
Industry Representation.
Average daily turnover.

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.

Objectives of SEBI
Following are some of the objectives of the SEBI:
1. Investor Protection: This is one of the most important objectives of setting up
SEBI. 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.

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, which includes the directors, employees
and promoters. To prevent such trading SEBI has barred the companies to
purchase their own shares from the secondary market.

b. Check price rigging: Price rigging is the act of causing unnatural fluctuations
in the price of securities by either increasing or decreasing the market price of the
stocks that leads to unexpected losses for the investors. SEBI maintains strict
watch in order to prevent such malpractices.

c. Promoting fair practices: SEBI promotes fair trade practice and works towards
prohibiting fraudulent activities related to trading of securities.

d. Financial education provider: SEBI educates the investors by conducting

online and offline sessions that provide information related to market insights and
also on money management.

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.

The following are some of the regulatory functions.

a. SEBI has defined the rules and regulations and formed guidelines and code of
conduct that should be followed by the corporates as well as the financial
intermediaries.

b. Regulating the process of taking over of a company.

c. Conducting inquiries and audit of stock exchanges.

d. Regulates the working of stock brokers, merchant brokers.

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.
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.

Investor Protection
The investor insurance money is a symbol of assurance. In simpler words
investor protection implies that up to a specific breaking point, you get your cash
back if the dealer goes into Bankruptcy or submits extortion. It is a significant
Factor to consider when you open a Trading Account or a record with an online
dealer. At the point when you open an exchanging account at a brokerage, you
normally get financial backer security.

The Role of SEBI in Investor Protection

SEBI has given out various methods and measures to ensure the investor
protection from time to time. It has published various directives, driven many
investor awareness programmes, set up investor protection Fund (IPF) to
compensate the investors. We will look into the investor protection measures by
SEBI in detail: To begin with, SEBI constructs the limit of financial backers
through instruction and attention to empower a financial backer to take educated
choices. SEBI tries to guarantee that the financial backer gets the hang of
contributing. In simpler words, SEBI ensures that the investor gets and utilizes
data needed for contributing and assesses different speculation alternatives to suit
his particular objectives. It helps the investor find out his privileges and
commitments in a specific venture, bargains through enlisted mediators, plays it
safe, looks for help if there should be an occurrence of any complaint, and so on.
SEBI has been putting together financial backer schooling and mindfulness
workshops through financial backer affiliations and market members, and has
been urging market members to sort out comparable projects. It keeps a refreshed,
far-reaching site for training of financial backers. It distributes different sorts of
alerts through media. It reacts to the questions of financial backers through phone,
messages, letters, and face to face for the individuals who visit SEBI office.
Secondly, SEBI makes everything of interest accessible in public domain. SEBI
has received revelation based administrative system. Under this structure, backers
and go-betweens unveil applicable insights concerning themselves, the items, the
market and the guidelines so the financial backer can take educated venture
choices dependent on such divulgences. SEBI has endorsed and screens different
introductory and persistent exposures.
Thirdly, SEBI guarantees that the market has frameworks and practices which
make exchanges safe. SEBI has taken different estimates, for example, screen
based exchanging framework, dematerialization of protections and outlined
different guidelines to direct delegates. It has also issued an exchange of
protections, corporate rebuilding, etc. to ensure the interests of financial backers
in protections. It additionally guarantees that only legitimate people are permitted
to work on the lookout, each member has motivation to agree with the
recommended principles, and the defaulters are granted praiseworthy discipline.
Lastly, SEBI encourages a redressal of financial backer complaints. SEBI has a
far-reaching system to encourage redressal of financial backer complaints against
middle people and recorded organizations. It circles back to the organizations and
middle people who don't change financial backers' complaints, by sending
suggestions to them and having gatherings with them. It makes proper
implementation moves as given under the law (counting dispatch of settling,
indictment procedures, bearings) where progress in redressal of financial backer
complaints isn't good. It has set up a complete mediation instrument in stock
trades and vaults for goal debates of the financial backers. The stock trades have
financial backer security assets to remunerate financial backers when a dealer is
pronounced a defaulter. Store repays financial backers for misfortune because of
carelessness of storehouse or safe member.