Unit-2

CAPITAL MARKET AND MONEY MARKET

Meaning of Financial Market
• It refers to a system consisting of Financial Institutions (Bank, NBFC), instruments (shares,
bonds), organization (stock exchange), and regulatory bodies (RBI, SEBI) which facilitate
financial transactions.
• Objective: Capital flow and savings of household are mobilized for benefit of the market.
Structure of Financial Market

Meaning of Capital Market

• Capital markets are financial markets that bring buyers and sellers together to trade stocks,
bonds, currencies, and other financial assets.
• Capital markets include the stock market and the bond market. They help people with
ideas become entrepreneurs and help small businesses grow into big companies.
Structure/Component of Capital Market
Importance of Capital market
• Facilitate capital formation: Capital markets provide a platform for companies and
governments to raise capital by issuing securities.
• Resource Allocation: Capital markets help to allocate capital to its most productive uses
by providing investors with a wide range of investment opportunities.
• Price discovery: These markets play a crucial role in price discovery, determining the fair
value of securities.
• Debt Management – Capital markets allow the issuance of debt, which is a more efficient
and less restrictive form of borrowing for corporations. These markets equalize borrowers
and investors regarding debt, acting as buffers during economic stress or market turmoil.
• Liquidity: Capital markets provide liquidity to investors by allowing them to buy and sell
securities quickly and easily, thus freeing up capital for other investments.
• Risk management: Capital markets offer a range of risk management tools, such as
derivatives, which allow investors to manage their exposure to various types of risks.
• Building Wealth – These markets help people build wealth and invest in their future.
Investors can invest in many types of securities, including stocks, ETFs, mutual funds,
corporate bonds, etc. Individuals can use invested principal and any corresponding
appreciation to invest in their pension, buy their own home, or save for higher education.
 • Innovation – A capital market fuel companies or entrepreneurs to turn an idea or industrial
innovation into a real business or expansion for an existing company. This, in turn, creates
jobs and stimulates economic growth.
Functions of Capital Markets
• Capital markets bring together those requiring capital and those having excess capital.
• Capital markets aim to achieve better efficiency in transactions.
• It helps in economic growth
• It ensures there is the continuous availability of funds
• By ensuring the movement and productive utilisation of capital, it helps in boosting the
national income.
• Minimizes transaction costs and information costs.
• Makes trading of securities easier for companies and investors.
• It offers insurance against market risk.
Players in the Capital Market
• Stock Exchange-A stock exchange is an organized marketplace or facility that brings
buyers and sellers together and facilitates the sale and purchase of stocks. It makes sure
that trading transactions are done in an efficient, orderly, fair, and transparent manner. It
enforces rules and regulations that its publicly listed companies and trading participants
must strictly abide by. In this way, the National Stock Exchange, for instance, fulfills its
function as the “guardian” of the Indian stock market.
• 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.
• 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
• 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.
• 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.
• 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.
• 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.
Instruments of Capital market
Capital markets teem with diverse financial instruments, each having its own role and significance.
When businesses and governments need to raise capital, they issue securities that investors can
purchase. There are three main instruments in the capital market:
• equities (stocks, shares),
• bonds, and
• derivatives
• Equities, often referred to as stocks or shares, represent an ownership stake in a company.
Investing in equities gives investors a claim on part of the company's earnings and assets.
For example, if you own a share of a company like Apple, you effectively own a tiny
fraction of that business.Ordinary shares,preference shares,
• Bonds, on the other hand, are debt securities. Governments and corporations issue bonds
to borrow money from investors for a specified period. You're essentially lending money
to the issuer when you purchase a bond.Corporate bonds,government bonds,foreign
bonds,Municipal bonds
• Derivatives, another type of financial instrument, derive their value from underlying assets
like stocks, bonds, commodities, currencies, interest rates, or market indexes. Options,
futures, and swaps are common types of derivatives. They serve as tools for hedging risk
or speculating on future price movements.
Recent trends in Capital market
• RegTech Revolution: Regulatory technology (RegTech) has become a game-changer in
capital markets. Through innovative technologies like artificial intelligence and machine
learning, RegTech streamlines compliance processes, reducing costs and mitigating risks.
Automation of complex regulatory tasks enables market participants to navigate the ever-
changing regulatory landscape efficiently.
• IoT Integration: The internet of things (IoT) has extended beyond consumer devices and
made its way into capital markets. IoT devices collect real-time data from diverse sources,
empowering market participants to make informed investment decisions. IoT’s integration
 into capital markets, from supply chain monitoring to asset performance tracking, enhances
transparency and efficiency.
• ESG Considerations: Environmental, social, and governance (ESG) factors have gained
immense importance in capital markets. Investors increasingly factor in sustainability and
ethical practices when making investment decisions. With the prevalence of ESG reporting
standards, market participants are compelled to align their strategies with responsible
investing principles, long-term value creation, and risk mitigation.
• Emergence of the Crypto Economy: Cryptocurrencies and blockchain technology have
disrupted traditional financial systems. The crypto economy offers decentralized,
transparent, and secure transactions, attracting investors seeking alternative assets. Capital
markets are exploring ways to incorporate crypto assets, creating new investment
opportunities, and fostering financial inclusivity.
• Data Monetization: The abundance of data in capital markets has led to the emergence of
data monetization strategies. Capital market organizations leverage data analytics and
artificial intelligence to extract valuable insights, optimize investment strategies, and
enhance risk management. Harnessing the power of data unlocks new revenue streams and
helps to build a competitive edge.
• Composable Enterprise Approach: The composable enterprise emphasizes modular and
interconnected systems, enabling rapid adaptation to changing market conditions. Capital
market organizations embrace microservices architecture and API-driven ecosystems,
seamlessly integrating diverse applications and services. This agility empowers companies
to respond swiftly to evolving customer needs and capitalize on emerging opportunities.
Money Market
Meaning of money market
• The money market refers to trading in very short-term debt investments.
• At the wholesale level, it involves large-volume trades between institutions and traders.
• At the retail level, it includes money market mutual funds bought by individual investors
and money market accounts opened by bank customers.
Structure of Indian Money Markets
The Indian monetary market has two broad categories – the organized sector and the unorganized
sector.
• Organized Sector: This sector comprises of the governments, the RBI, the other
commercial banks, rural banks, and even foreign banks. The RBI organizes and controls
this sector. Other corporations like the LIC, UTI, etc also participate in this sector but not
directly. Other large companies and corporates also participate in this sector through banks.
 • Unorganized Sector: These are the indigenous banks and the local money lenders and
hundis etc. Their activities are not controlled by the RBI or any other body, so they are the
unorganized sector.
Functions of money market
 Financing trade
• The money market plays a crucial role in financing domestic and 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.
 Financing industry
• The money market contributes to the growth of industries in two ways:
• They help industries secure short-term loans to meet their working capital requirements
through the system of finance bills, commercial papers, etc.
• Industries generally need long-term loans, which are provided in the capital market.
However, the 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.
 Profitable investments
• The money market enables commercial banks to use their excess reserves in profitable
investments. The main objective of commercial banks is to earn income from its reserves
as well as maintain liquidity to meet the uncertain cash demand of its depositors. In the
money market, the excess reserves of commercial banks are invested in near money assets
(e.g., short-term bills of exchange), which are easily converted into cash. Thus, commercial
banks earn profits without sacrificing liquidity.
 Self-sufficiency of commercial banks
• Developed money markets help commercial banks to become self-sufficient. In an
emergency, when commercial banks have scarcity of funds, they need not approach the
central bank and borrow at a higher interest rate. They can instead meet their requirements
by recalling their old short-run loans[clarify] from the money market.
 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 smooths the functioning and
increases the efficiency of the central bank.
• Money markets help central banks in two ways:
 • Short-run interest rates 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,
• Sensitive and integrated money markets help the central bank secure quick and widespread
influence on the sub-markets, thus facilitating effective policy implementation
Instruments of Money market
 Treasury Bills: Treasury bills are short-term debt securities issued by the government.
They have a maturity of up to one year and are considered to be the safest type of money
market instrument.
 Commercial Paper: Commercial paper is a short-term debt instrument issued by
corporations to raise funds for working capital or investment purposes. The maturity of
commercial paper is typically between one and 270 days.
 Certificates of Deposit (CDs): CDs are time deposits offered by banks and thrift
institutions. They have a fixed term, typically ranging from one month to five years, and a
fixed interest rate.
 Repurchase Agreements (Repos): Repos are short-term loans secured by government
securities or other collateral. They are typically used by financial institutions to manage
their liquidity and are considered to be a low-risk investment option.
 Money Market Funds: Money market funds are mutual funds that invest in a portfolio of
money market instruments, such as Treasury bills, commercial paper, and CDs. These
funds are designed to provide stability and safety, while also offering a higher yield than
traditional savings accounts.
 Federal Funds: Federal funds are short-term loans between banks that are used to manage
their liquidity. They are typically overnight loans and are considered to be a low-risk
investment option.
Importance of Money market
 Development of Trade and Industry

o It is an important source of financing trade and industry, as it provides for short-

term funds adequately and quickly
o The money market, through discounting operations and commercial papers, finances
the short-term working capital requirements of trade and industry and facilities the
development of industry and trade both — national and international

 Development Of Capital Market

 o The short-term rates of interest and the conditions that prevail in the money market
influence the long-term interest, as well as the resource mobilization in capital
market

 Smooth Functioning of Commercial Banks

o The money market provides the commercial banks with facilities for temporarily
employing their surplus funds in easily realizable assets. The banks can get back the
funds quickly, in times of need, by resorting to the money market
o It also enables commercial banks to meet their statutory requirements of cash
reserve ratio (CRR) and Statutory Liquidity Ratio (SLR) by utilizing the money
market mechanism

 Effective Central Bank Control

o A developed money market helps the effective functioning of a central bank.

o It facilities effective implementation of the monetary policy of a central bank

 Formulation Of Suitable Monetary Policy

o Conditions prevailing in a money market serve as a true indicator of the monetary

state of an economy.
o Hence, it serves as a guide to the Government in formulating and revising the
monetary policy, depending upon the monetary conditions prevailing in the market

 Non-Inflationary Source of Finance To Government

o A developed money market helps the Government to raise short -term funds through
the treasury bills floated in the market
o In the absence of a developed money market, the Government would be forced to
print and issue more money or borrow from the central bank; Both of which would
lead to an increase in prices and the consequent inflationary trend in the economy

Recent trends in money market

A. An increase in secured funding- Secured funding provides an alternative source of term
liquidity for the Group balance sheet. In the unsecured market, banks' cash borrowings decreased
by 44%. And secured funding is increasing rapidly.
B. Changes in the repo market -The growing gap between where dealer-banks are willing to
finance each other through the vast and shadowy "repo" market vs. what investors charge for such
collateralized lending shows the negative feedback loop of heightened regulatory pressures on
banks. In a repo, one party sells an asset (usually fixed-income securities) to another party at one
price at the start of the transaction and commits to repurchase the fungible assets from the second
party at a different price at a future date or (in the case of an open repo) on demand. If the seller
defaults during the life of the repo, the buyer (as the new owner) can sell the asset to a third party
to offset his loss. The asset therefore acts as collateral and mitigates the credit risk that the buyer
has on the seller. As banks continue to repay the liquidity facilities provided by the ECB, they have
returned to the repo market for funding. The survey reveals that the market share of euro-
denominated repos has recovered from 57% in June 2012 to 66% in December last year. As a
result, collateral remains in high demand, not only from central bank holdings (due to asset
purchases) and capital requirements, but also from banks attempting to secure funding. Investors
such as money-market mutual funds have had the option of parking their cash elsewhere at these
times when dealers are shunning them, even as rates are lower.
C. Price Formation and Transmission -This is very popular trends in money market. Price
formation is one of the key elements of market economy functioning. The price of a commodity
or a service is formed as a result of numerous economic, political and social processes and this is
true for traditional commodity relations as well as for financial markets. In business terms, price
transmission means the process in which upstream prices affect downstream prices. Upstream
prices should be thought of in terms of main inputs prices (for processing / manufacturing, etc.) or
prices quoted on higher market levels (e.g. wholesale markets).
D. Low Level of Interest Rates: Currently many banks are offering Low Level of Interest Rates
on home loan, car loan etc for attraction of people. And there are some more other trends like end
of Period Effects etc.