Navigation
COMPUTER ORIENTED ACCOUNTING SYSTEM FINANCIAL MARKET
FINANCIAL MARKET
1. Introduction and Meaning
A financial market is a marketplace where buyers and sellers trade financial assets such as shares, debentures, bonds, government securities, and other financial instruments. It is a mechanism that facilitates the transfer of funds from those who have surplus funds (savers/investors) to those who have a deficit (borrowers/businesses).
Financial markets play a critical role in the economy by channeling funds from idle savers to productive investments, thereby promoting economic growth.
Simple meaning: A financial market is like a "supermarket" for money and financial products. People who have extra money can invest it, and people who need money can raise it.
2. Features of Financial Market
| Feature | Explanation |
|---|---|
| Mobilises savings | Converts savings into productive investments. |
| Determines prices | Prices of financial assets are determined by demand and supply. |
| Provides liquidity | Investors can buy and sell assets easily. |
| Reduces transaction costs | Brings buyers and sellers together, lowering search and information costs. |
| Facilitates risk transfer | Allows investors to diversify and transfer risk. |
| Encourages capital formation | Helps businesses raise long‑term capital. |
3. Functions of Financial Market
- Mobilisation of Savings – Encourages people to save and invest by offering various instruments with different risk‑return profiles.
- Price Determination – The interaction of demand and supply determines the price (and hence the return) of each financial asset.
- Liquidity Provision – Investors can convert their investments into cash quickly without significant loss of value.
- Reduction of Transaction Costs – Provides a centralised platform, reducing the cost and time of finding counterparties.
- Risk Sharing – Investors can choose assets that match their risk appetite; derivatives markets allow hedging of risks.
- Capital Formation – Channels funds from households to businesses, which use them for expansion, modernisation, and new projects.
- Information Dissemination – Prices reflect all available information, helping investors make informed decisions.
4. Classification of Financial Markets
Financial markets are broadly classified based on the type of instrument, maturity period, and whether the transaction is for a new or existing issue.
A. Based on Maturity Period
| Market | Maturity | Instruments |
|---|---|---|
| Money Market | Short‑term (up to 1 year) | Treasury bills, commercial paper, certificates of deposit, call money, repos. |
| Capital Market | Long‑term (more than 1 year) | Shares (equity), debentures, bonds, preference shares, mutual funds. |
B. Based on Issue / Trading (Primary vs Secondary)
| Market | Description |
|---|---|
| Primary Market | Where new securities are issued for the first time. Also called New Issue Market (NIM). Company receives the funds. Example: IPO (Initial Public Offering). |
| Secondary Market | Where existing securities are bought and sold among investors. Company does not receive funds. Example: Stock exchanges (BSE, NSE). |
C. Based on Asset Type
| Market | Instruments |
|---|---|
| Debt Market | Bonds, debentures, treasury bills, commercial paper. |
| Equity Market | Shares (common and preferred stock). |
| Derivatives Market | Futures, options, swaps, forwards. |
| Foreign Exchange Market (Forex) | Currencies. |
| Commodity Market | Gold, silver, crude oil, agricultural products. |
5. Money Market
The money market is a market for short‑term funds (maturity up to one year). It deals with highly liquid, low‑risk instruments. It helps governments and corporations meet their short‑term liquidity needs.
Key Features of Money Market
- Short‑term (up to 1 year)
- High liquidity
- Low risk (but also lower returns)
- Wholesale market (large denominations)
- Over‑the‑counter (OTC) trading
Common Money Market Instruments
| Instrument | Issuer | Maturity | Features |
|---|---|---|---|
| Treasury Bills (T-Bills) | Government | 91, 182, 364 days | Risk‑free; issued at discount; redeemed at par. |
| Commercial Paper (CP) | Large corporations | 15 days to 1 year | Unsecured promissory note; higher return than T-bills. |
| Certificate of Deposit (CD) | Banks | 7 days to 1 year | Issued against deposits; negotiable. |
| Call Money | Banks | 1 to 14 days | Overnight or short‑term loans between banks. |
| Repo (Repurchase Agreement) | Financial institutions | Short‑term | Sale of security with agreement to repurchase later. |
6. Capital Market
The capital market is a market for long‑term funds (maturity more than one year). It provides finance for fixed capital investments like machinery, buildings, and technology.
Key Features of Capital Market
- Long‑term (more than 1 year)
- Higher risk than money market
- Higher potential returns
- Instruments traded on stock exchanges
- Provides both debt and equity financing
Capital Market Segments
| Segment | Description |
|---|---|
| Primary Market | New issues (IPOs, FPOs, rights issues, private placements). |
| Secondary Market | Trading of existing securities on stock exchanges (BSE, NSE, NYSE, etc.). |
7. Primary Market (New Issue Market)
The primary market is where securities are issued for the first time. The issuer (company) receives the funds directly from investors.
Methods of Raising Funds in Primary Market
- Initial Public Offering (IPO) – First sale of shares by a private company to the public.
- Follow‑on Public Offering (FPO) – Additional issue of shares by an already listed company.
- Rights Issue – Issue of shares to existing shareholders at a discounted price.
- Private Placement – Sale of securities to a select group of institutional investors.
- Preferential Allotment – Allotment of shares to specific individuals/institutions at a predetermined price.
8. Secondary Market (Stock Exchange)
The secondary market is where existing securities are traded among investors. Major exchanges in India include BSE (SENSEX) and NSE (NIFTY 50).
Trading Mechanism (Simplified)
- Investor places an order through a broker.
- Order reaches the exchange’s trading system.
- Matching of buy and sell orders.
- Trade is executed.
- Settlement happens (T+1 day in India).
9. Regulators of Financial Markets in India
- SEBI – Regulates Capital markets (shares, debentures, mutual funds).
- RBI – Regulates Money market, forex market, and banking system.
- IRDAI – Regulates Insurance sector.
- PFRDA – Regulates Pension funds.
10. Financial Market vs Financial Institution
| Basis | Financial Market | Financial Institution |
|---|---|---|
| Nature | A platform or system | An intermediary entity |
| Examples | Stock exchange, money market | Bank, insurance company, mutual fund |
| Role | Facilitates direct trading | Intermediates between savers and borrowers |
| Risk | Investors bear their own risk | Institution often bears some risk |
11. Illustrative Problems
Problem 1: Identify the Market
Classify: (a) Treasury bills, (b) Equity shares, (c) Commercial paper, (d) Debentures, (e) Call money, (f) IPO.
Solution: (a) Money, (b) Capital, (c) Money, (d) Capital, (e) Money, (f) Capital (Primary).
Problem 2: Primary vs Secondary Market
Classify: (a) RIL issues new shares, (b) Buying TCS shares on NSE, (c) Company buyback, (d) Mutual fund NFO.
Solution: (a) Primary, (b) Secondary, (c) Primary, (d) Primary.
Problem 3: Yield Calculation
A 91‑day treasury bill with face value ₹100 is issued at ₹97.50. Calculate annualised yield.
Solution: Discount = ₹2.50. Yield = 2.50 / 97.50 = 2.564%. Annualised = 2.564% × (365/91) = 10.28%.
Interactive Practice Lab
Test your mastery of Financial Markets with our MCQ-based assessment.