Business Studies (VKS)

XII Commerce (Orange)

Chapter 10

Financial Market

Introduction

 Financial market acts as a link between surplus and deficit units and brings together the borrowers and
lenders.
 Bank and financial market are competitor of each other.
 Financial market is a market for the creation and exchange of financial assets.
 Financial market create and exchange financial assets such as shares, debentures, treasury - bills, commercial
paper, etc.

Functions of Financial markets

1. Mobilization of savings and channelising them into the most productive uses
 It offers different investment proposals to savers.
 It helps in transfer of savings from savers to investors.
 It channelises surplus funds into the most productive uses.

2. Facilitate price discovery.

 Price of anything depends upon demand and supply factors.
 In the financial market, the households who save money are suppliers of funds and
business firm represent the demand.
 The interaction between household and business firm help to establish a price for the
financial assets (e.g., shares or debentures).
3. Provide liquidity to financial assets.
 Financial market facilitates easy purchase and sale of financial assets.
 In doing so, they provide liquidity to financial assets so that they can be easily
converted into cash whenever required.
4. Reduce the cost of transaction.
 Financial market provides complete and valuable information regarding price,
availability and cost of various financial securities.
 A Financial market provides a common platform where buyers and sellers can meet.
 It helps to save, effort and money of both buyers and sellers of financial assets.

Classification/Types of Financial Market

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Money Market

 Money market is a market for short term funds meant for use for a period of upto one
year.
 Generally money market is the source of finance for working capital.
 Money market is not a fixed geographical area but it constitutes all organisations and
institutions which deal with short term debts.
 The common institutes are Reserve Bank of India, State Bank of India, other Commercial Banks,
LIC, GIC, UTI etc. Many of these institutions deal on telephone and fax only. :
 Common instruments of money market are Call money, Treasury bill, CP, CD,
Commercial bill, etc.

Instruments of Money Market

1. Call Money.
 Commercial banks have to maintain a minimum cash reserve ratio. The Reserve Bank of India changes the
cash reserve ratio from time to time.
 Call money refers to the money lent by one bank to another to be able to maintain the cash reserve
ratio.
 Banks facing a temporary shortage of cash borrow funds from other banks having surplus Cash.
 The call money funds are for very short period of 01 day to 15 days.
 The interest rate paid on "call money loans is known as the call rate”.
 It is highly floating rate that changes from day to day and sometimes even from hour to hour.
 Call money is called interbank call money market.
 But even other organisations such as insurance companies, mutual fund companies etc. also deal
with call money.
 There is an inverse relation between the rate of interest of call money and other securities as when
rate of interest of call money increases the other securities become cheap.
2. Treasury Bills (T. Bills).
 Treasury bills are also known as Zero Coupon Bond, issued by the Reserve Bank of India on
behalf of the Central Government.
 These bills are sold to banks and public to meet their short term requirement of funds.
 Treasury Bills are available for a minimum amount of Rs. 25,000 and the multiples thereof.
 The issue period ranges from 14 to 364days.
 Treasury bills are negotiable instruments i.e. they are freely transferable.
 They are issued at a price lower than their face value and repaid at par.
 The difference between the price at which these bills are issued and their redemption value is the
interest receivable on them and is called Discount.
3. Commercial Bills.
 Commercial bills or accomodation bills are the bills drawn by one business firm on another.
These are common instruments used in credit purchase and sale.
 When goods are sold on credit, the buyer becomes liable to make payment on a specified
date in future. The seller (drawer) of the goods draws the bill and the buyer (drawee) accepts
it. On being accepted, the bill becomes a marketable instrument and is called a trade bill.

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 A trade bill is a written acknowledgment of debt by the maker. It directs the payment of the
specified sum of money by a specified date.
 These bills can be discounted with a bank if the seller needs funds before the date of maturity of
the bill.
 When a trade bill is accepted by a commercial bank, it is known as commercial bill.
 Thus, a commercial bill is a bill of exchange used to finance the working capital
requirements of business firms.
 It is a short term, negotiable, self liquidating instrument, which is used to finance the credit
sales of firms.
 These have short term maturity period generally 90 days.
4. Commercial Paper (C.P.).
 The commercial paper was introduced in India for the first time in 1990.
 It is an unsecured promissory note issued by public or private sector companies with a
fixed maturity period which varies from 3 to 12 months.
 Since commercial papers are unsecured so these can be issued by companies having
good reputation and creditworthiness.
 The commercial banks and mutual funds are the main investors of commercial papers.
 Funds raised through commercial paper are used to meet the floatation cost. This is
known as bridge financing.
5. Certificate of Deposits (C.D.).
 It is a time or deposit which can be sold in the secondary market. Only a bank can
issue C.D.
 It is a bearer certificate or document of title.
 It is also a negotiable instrument and can be transferred easily.
 C.D. is issued by banks against the deposits kept by companies and institutions.
 The time period of C.D. ranges from 91 days to one year.
 Banks are not allowed to discount these documents.
Capital Market

 Capital market is a market for medium and long term funds.

 It includes all the organisations, institutions and instruments that provide long term and
medium term funds.
 The common instruments used in capital market are shares, debentures, bonds, mutual funds,
public deposits etc.

Nature /Features of Capital Market

1. Link between savers and investment opportunities.
 Capital market is an important link between saving and investment process.
 lt transfers money from savers to entrepreneurial barriers.
2. Deals in long-term investment.
 Capital market provides funds for long and medium term.
 It does not deal with channelising saying for less than one year.
 The enterprise utilizes this market to procure finances for long-term investment such as buying plant and
machinery, building etc.
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3. Utilises intermediaries.
 Capital market makes use of different intermediaries such as brokers, underwriters, depositories
etc.
 These intermediaries act as working organs of capital market and are very important elements of
capital market.
4. Determinant of capital formation.
 The investment in capital market instruments generally yields a higher return since securities are
held for a longer duration.
 There is scope of earning capital gains in equity shares.

5. Government rules and regulations.

 The capital market operates freely but under the guidance of government policies.
 These markets function within the framework of government rules and regulations.
 For example, stock exchange works under the regulations of SEBI which is a government body.

Types of Capital Market

A. Primary Market (New Issue Market)

 The primary market is the market in which a security is sold for the first time.
 It is concerned with the issue of new securities of fresh capital.
 Therefore, primary market is also known as the new issues market.
 Companies make primary issues for the purpose of establishing new business or for modernising and
expanding the existing business.
 A company can raise capital through the primary market in the form of equity shares, preference shares,
debentures, loans and deposits.
 The investors in this market are banks, financial institutions, insurance companies, mutual funds and
individuals.
Method of floatation of securities in Primary Market
1. Public Issue through prospectus (IPO- Initial Public Offer)

 Under this method, the company wanting to raise capital, issues a propectus to inform and attract the
investing public.
 The prospectus provides the details regarding the purpose for which funds are being raised, past
financial performance of the company, background and experience of promoters.
 The contents of the prospectus have to be in accordance with the Companies Act and SEBI guidelines.
 The issue is also required to be listed on a stock exchange.

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 Offer through prospectus is the most popular method of issuing securities in the primary market.
 The services of underwriters, brokers, etc. are availed of in this method.

2. Offer for Sale

 Under this method, securities are not issued directly to the public but are offered for sale, through
intermediaries like issuing houses or stock brokers.
 In this case, a company sells the entire lot of securities at an agreed price to brokers who, in turn, resell
them to the investing public.
 Thus, the sale of securities takes place in two steps:
(i) In the first step, the company sells the entire lot of shares to the intermediary at an agreed price.
(ii) In the second step, the intermediary resells these shares to investors at a higher price.
 The advantage of this method is that the issuing company gets saved from the tedious process involved
in making a public issue.
3. Private Placement
 Under this method the securities are sold by the company to an intermediary at a fixed price
and in second step intermediaries sell these securities not to general public but to selected clients
at higher price.
 The issuing company issues prospectus to give details about its objectives, future prospects so
that reputed clients prefer to buy the security from intermediary.
 Under this method the intermediaries issue securities to selected clients such as UTI, LIC,
General Insurance, etc.
 The private placement method is a cost saving method as company is saved from the expenses
of underwriter fees, manager fees, agents' commission, listing of company's name in stock
exchange etc.
 Small and new companies prefer private placement as they cannot afford to raise from public
issue.
4. Rights Issue (For Existing Companies)

 This is the issue of new shares to existing shareholders.

 It is called right issue because it is the pre-emptive right of shareholders that company must offer
them the new issue before subscribing to outsiders.
 Each shareholder has the right to subscribe to the new shares in the proportion of shares
he already holds.
 A right issue is mandatory for companies under Companies' Act 2013.
5. e-IPO’s (Electronic Public Offer)
 It is the new method of issuing securities through online system of stock exchange.
 In this company has to appoint SEBI registered brokers for the purpose of accepting applications and
placing orders.
 The manager coordinates the activities through various intermediaries connected with the issue.
Secondary Market
 Secondary market or stock exchange refers to the market for the sale and purchase of existing
securities.

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 In secondary market companies get no additional capital as securities are bought and sold
between investors only so directly there is no capital formation.
 The investors can convert their securities into cash whenever they want.
 Secondary Market also gives chance to investors to make profit as securities are bought and
sold at market price which is generally more than the original price of the securities.
 The liquidity offered by secondary market encourages even those investors to invest in
securities who want to invest for small period of time as there is option of selling securities at
their convenience.
Stock Exchange
 The first stock exchange in India was setup in 1875 - The Bombay Stock Exchange (BSE).
 This was followed by the development of exchanges in Ahmedabad, Calcutta and Madras.
 Every stock exchange has a specific location. In India there are 24 recognised stock exchanges.
 These are in following locations:

Ahmedabad Cochin Guwahati Kanpur Bombay Pune

Bangalore Coimbatore Hyderabad Calcutta NSEI Rajkot

Bhubaneshwar Cuttack Indore Ludhiana OTCEI Sikkim

Madras Delhi Jaipur Manealore Patna Vadodara

 Out of these stock exchanges NSEI(National stock exchange of India) and OTCEI(Over the counter
exchange of india) are all India level stock exchanges.
 From business point of view Bombay Stock Exchange is at No. 1 followed by Calcutta and Delhi.
 The Bombay Stock Exchange is popularly known as Dalai Street and Calcutta is popular as Lyons
Range.
Defination
 A stock exchange is an institution which provides a platform for buying and selling of existing securities.
 As a market, the stock exchange facilitates the exchange of a security (Share, debenture, etc.) into
money and vice-versa.
 According to the Securities Contracts (Regulations) Act, 1956,
 “stock exchange means any body of individuals, whether incorporated or not, constituted for the
purpose of assisting, regulating or controlling the business of buying and selling or dealing in
securities."
Listing
 Securities that are bought and sold on a stock exchange are called listed securities.
 Listing of Securities means the security has been included for trading in the official list of stock
exchange.

Functions of stock Exchange/ Secondary Market

1. Economic barometer.
 A stock exchange is a reliable barometer to measure the economic condition of a country.
 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

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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.
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 of speculation
 To ensure liquidity and demand of supply of securities the stock exchange permits
healthy speculation of securities.
7. Liquidity
 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 insecurities 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.

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Trading procedure on a stock exchange

Depository

 Depository is an institution or an organisation which holds securities (e.g. shares,

debentures, bonds, mutual (funds, etc.).

Depository participant

 DP is the vital intermediary in depository system and all buying and selling of shares under
depository system take place through DP only.
 As per SEBI guidelines, any financial institution, the share brokers, banks etc. can become DP after
registration with SEBI.

 The Trading procedure involves the following steps:

1. Selection of broker.
 The buying and selling of securities can only be done through SEBI registered brokers who
are members of the stock exchange.
 The broker can be an individual, partnership firms or corporate bodies.
2. Opening demat account with depository.
 Second step in trading procedure is to open a Demat account.
 The securities are held in the electronic form by a depository.
 At present in India there are two depositories: NSDL (National Securities Depository Ltd.)
and CDSL (Central Depository Services Ltd.)
 There is no direct contact between depository and investor. Depository interacts with
investors through depository participants only.
3. Placing the order.
 The order can be placed to the broker either (DP) personally or through phone, email,
etc.
 Investor must place the order very clearly specifying the range of price at which securities
can be bought or sold. e.g. "Buy 100 equity shares of Reliance for not more than 3500 per share"
4. Executing the order.
 As per the instructions of the investor, the broker executes the order i.e. he buys or sells the
securities.
 Broker prepares a contract note for the order executed.
 The contract note contains the name and the price of securities, name of parties and
brokerage (commission) charged by him. Contract note is signed by the broker.
5. Settlement.
 This is the last stage in the trading of securities done by the broker on behalf of their clients.

 There can be two types of settlement.

(a) On the spot settlement:

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 It means settlement is done immediately and on spot settlement follows. T+2 rolling
settlement. This means any trade taking place on Monday gets settled by Wednesday.
(b) Forward settlement:
 It means settlement will take place on some future date. It can be T + 5 or T + 7, etc.

 All trading in stock exchanges takes place between 9.55 am and 3.30 pm. Monday to
Friday.
Stock Exchange Indices

(i) Sensex.

 This is Bombay Stock Exchange Index.

 It is calculated by taking prices of 30 stocks across key sector of BSE.

(ii) Nifty.

 This is a National Stock Exchange Index.

 It is calculated by taking prices of 50% key stocks listed in NSEI.

Benefits of on-line stock exchange

1. Demutualisation.
 Demutualisation refers to separation of ownership and control of stock exchange from
the trading rights of members.
 Earlier on the intermediaries, i.e., brokers used to own, control and manage the stock
exchanges. This ownership and management of stock exchange by brokers often led to
conflict of interests between brokers and their clients.
 Through demutualisation there is reduction of chances of brokers using stock
exchange for personal gains.
2. Dematerialisation.
 An electronic book entry form of holding and transferring securities has been
introduced to eliminate the chances of theft, forgery, delay and other problems of
paper work, This is referred as dematerialisation of securities (more commonly known
as Demat account).

The Securities and Exchange Board of India (SEBI)

 The government of India constituted 'The Securities and Exchange Board of India’
(SEBI) in 1988. Initially, SEBI was setup as an administrative body.
 In 1992, SEBI was made a statutory body under the Securities and Exchange Board of
India Act 1992.

Reasons for establishment of SEBI

 Due to following malpractices the customers started losing confidence and faith in the
stock exchange.
a) Price rigging,

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b) Unofficial premium on new issue,

c) Delay in delivery of shares,
d) Violation of rules and regulations of stock exchange &
e) Listing requirements.
 So, government of India decided to set up an agency or regulatory body known as
Securities Exchange Board of India (SEBI).

Role of SEBI
 SEBI was set up to meet the needs of three groups (Especially Investor).
1. Issuers.
 Provides a market place in which they can raise finance fairly, easily and in an efficient
manner.
2. Investors.
 provides protection of their rights and interest through supply of adequate, accurate
and correct information.
3. Intermediaries.
 Provides a competitive professional market.

Objectives of SEBI
1. To regulate the activities of stock exchange.
2. To protect the rights of investors and ensuring safety to their investment.
3. To prevent fraudulent and malpractices by having balance between self regulation of
business and its statutory regulations.
4. To regulate and develop a code of conduct for intermediaries such as brokers,
underwriters, etc.

Organisation of SEBI
1. SEBI is working as a corporate sector.
2. The head office of SEBI is in Mumbai and it has branch office in Kolkata, Chennai and
Delhi.
3. SEBI has formed two advisory committees to deal with primary and secondary
markets.
(a) Primary market advisory committee

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(b) Secondary market advisory committee

4. These committees consist of market players, investors associations and eminent persons.

Functions of SEBI
 The SEBI performs the following three important functions to meet its objectives.
a) Protective functions
b) Developmental functions
c) Regulatory functions.
 Protective Functions.
 These functions are performed by SEBI to prefect the interest of investor and provide
safety of investment
 Under this category the following functions are performed by SEBI:
(i) Check on Price Rigging.
 Making manipulations with sole objective of inflating or depressing the market price of
securities is called 'price rigging'.
 Such practices are prohibited by law because they can defraud or cheat investors.
(ii) Check on Unfair Trade Practices.
 SEBI does not allow the companies to make misleading statements in prospectus
which are likely to Induce the sale or purchase of securities by any other person.
(iii) Check on Insider Trading.
 SEBI prohibits 'insider trading' and imposes penalties for such practices.
 An insider (Directors, promoters, etc.) is any person connected with the company who
is having price sensitive information (in respect of securities of the company), which is
not available to the general public & they use inside information to make individual
profits, it is referred to as 'insider trading‘.
(iv) Investors Protection.
 SEBI undertakes various steps to educate investors so that
they can evaluate the securities of various companies and select the most profitable
securities.
(v) Check on Preferential allotment.
SEBI promotes fair practices and code of conduct in security market by
a. Restricting companies to change terms in midterm (Debenture-holders case).
b. Investigating cases of insider trading and providing fine.
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c. Stopping the practice of making preferential allotment of shares.

2. Development Functions.
 These functions are performed by SEBI to promote and
develop activities in stock exchange and increase the business in stock exchange.
 Under development category following functions are performed by SEBI:
(i) SEBI promotes training of intermediaries of the securities market.
(ii) SEBI tries to promote activities of stock exchange by adopting flexible and adoptable
approach in following way:
a. SEBI has permitted internet trading through registered stock brokers.
b. SEBI has made underwriting optional to reduce the cost of issue.
c. Even initial public offer of primary market is permitted through stock exchange.
3. Regulatory Functions.
 These functions are performed by SEBI to regulate the business in stock exchange.
 To regulate the activities of stock exchange following functions are performed:
(i) SEBI has framed rules and regulations and a code of conduct to regulate the
intermediaries such as merchant bankers, brokers, underwriters, etc.
(ii) Intermediaries have been brought under the regulatory purview and private placement
has been made more restrictive.
(iii) SEBI registers and regulates the working of stock brokers, sub-brokers, share transfer
agents, trustees, merchant bankers and all those who are associated with stock exchange in
any manner.
(iv) SEBI registers and regulates the working of mutual funds etc.
(v) SEBI regulates takeover of the companies.
(vi) SEBI conducts inquiries and audit of stock exchanges.

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