FINANCIAL MARKETS

UNIT – 1

Meaning of Financial Market

Financial Market refers to a marketplace, where creation and trading of financial

assets, such as shares, debentures, bonds, derivatives, currencies, etc. take place. It
plays a crucial role in allocating limited resources, in the country’s economy. It acts as
an intermediary between the savers and investors by mobilising funds between them.

The financial market provides a platform to the buyers and sellers, to meet, for trading
assets at a price determined by the demand and supply forces.

Participants of Financial Market

1) Banks:
Banks participate in the capital market and money market. Within the capital market,
banks take active part in bond markets. Banks may invest in equity and mutual funds as a
part of their fund management. Banks take active trading interest in the bond market and
have certain exposures to the equity market also. Banks also participate in the market as
clearing houses.

2) Primary Dealers (PDs):

PDs deal in government securities both in primary and secondary markets. Their basic
responsibility is to provide two-way quotes and act as market makers for government
securities and strengthen the government securities market.

3) Financial Institutions (FIs):

FIs provide/lend long term funds for industry and agriculture. FIs raise their resources
through long-term bonds from financial system and borrowings from international
financial institutions like International Finance Corporation (IFC), Asian Development
Bank (ADB) International Development Association (IDA), International Bank for
Reconstruction and Development (IBRD), etc.

4) Stock Exchanges:
A Stock exchange is duly approved by the Regulators to provide sale and purchase of
securities by “open cry” or “on-line” on behalf of investors through brokers. The stock
exchanges provide clearing house facilities for netting of payments and securities
delivery. Such clearing houses guarantee all payments and deliveries. Securities traded in
stock exchanges include equities, debt, and derivatives.

5) Brokers:
Only brokers approved by Capital Market Regulator can operate on stock exchange.
Brokers perform the job of intermediating between buyers and seller of securities. They
help build up order book, price discovery, and are responsible for a contract being
honoured. For their services brokers earn a fee known as brokerage.

6) Custodians:
Custodians are organizations which are allowed to hold securities on behalf of customers
and carry out operations on their behalf. They handle both funds and securities of
Qualified Institutional Borrowers (QIBs) including FIIs.

Custodians are supervised by the Capital Market Regulator. In view of their position and
as they handle the payment and settlements, banks are able to play the role of custodians
effectively. Thus most banks perform the role of custodians.

7) Depositories:
Depositories hold securities in demat (electronic) form, maintain accounts of depository
participants who, in turn, maintain accounts of their customers. On instructions of stock
exchange clearing house, supported by documentation, a depository transfers securities
from buyers to sellers’ accounts in electronic form.

Functions of Financial Market

(1) Price Determination

The financial market performs the function of price discovery of the different
financial instruments which are 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 in the market.
(2) Funds Mobilization

Along with the determination of the prices at which the financial instruments trade in
the financial market, 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 is demanded by the
investors. So, the financial market helps in the mobilization of the savings of the
investors.

(3) Liquidity

Liquidity function of the financial market provides an opportunity for the investors to
sell their financial instrument at its 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, then the investor forcefully have to hold the financial securities.
Thus, in the financial market investors can sell their securities readily and convert
them into the cash thereby providing the liquidity.

(4) Risk sharing

Financial market performs the function of the risk-sharing as the person who is
undertaking the investments are 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 persons who provides the
funds for making those investments.

(5) Easy Access

The industries require the investors for raising the funds and the investors require the
industries for investing its money and earning the returns from them. So financial
market platform provides the potential buyer and seller easily, which help them in
saving 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 in providing every type of information to the traders without
the requirement of spending any money by them. By this way, the financial market
reduces the cost of the transactions.

(7) Capital Formation

Financial markets provide the channel through which the new savings of the investors
flow in the country which aid in the capital formation of the country.

(8) Saves time and money

Financial markets serve as a platform where buyers and sellers can easily find each
other without making too much efforts or wasting time. Also, since these markets
handle so many transactions it helps them to achieve economies of scale. This results
in lower transaction cost and fees for the investors.

Security Market and Economic Development

1) Mobilizes inactive savings

The security market mobilizes saving for economic development. The instruments
which are used in security market have liquidity and they are easily available. Hence,
people secure their saved property by purchasing financial investments. The interest
rate is also attractive in those instruments. So people like to mobilize more savings.

2) Economic growth
For the economic growth or development of a country, saving and investment are
prerequisites. Higher the saving and investment, higher the rate of return or rate of
economic growth. Hence, financial market helps the efficient utilization of
resources and economic growth.

3) Promotion of trade

The security market helps in promotion of trade. It increases internal as well as

external trade by providing the means of exchange.
4) Channel savings to investments

Through security market a large amount of capital can be collected by selling the
instruments like stock, bond etc. and the income earned from them can be used to pay
debt. The investment on these securities provides interest and dividend. In the absence
of security market, even those having adequate capital cannot use capital in
productive sectors.

5) Promotes long term investments

The long term loan needed to the individuals, households, government and business
can be obtained from the security market. The fund raised by this market can be
invested in agriculture, industry, services etc.

6) Increases quality of investments

The security market mobilizes unproductive funds into productive sectors. The
investors always try to invest in the areas yielding high rate of return. The security
market assists in selecting appropriate opportunity to mobilize fund effectively.

7) Provides liquidity

Since there is liquidity and less risk of loss in financial instruments, the savers are
stimulated to invest in stocks, bonds etc. The investors can receive cash promptly
selling those securities into secondary market.

8) Attracts foreign capital

The capital or security market presents the clear picture of the economy. On account
of this, foreign capital and foreign assistance are attracted towards a country.

9) Enhances economic growth

The rate of saving and investment in the country increases from the activities of
security market. This increases productivity and brings a wave of progress in industry,
agriculture and trade sectors. Hence, it leads to an increase in the rate of economic
growths.
Recent Developments in Indian Financial Market

Economic Liberalization
The economic liberalization has led to more deregulation, liberalization and privatization
of some of the public sector undertakings in India. This has resulted in the shares of some
of the public sector undertakings being made available to the public. The Industrial policy
adopted by the government earlier did not allow investment in core sector by either
individuals or private sector. But, with the privatization of some of the public sector
undertakings, the shares are now available to the public for contribution

Promotion of Mutual Funds:

The promotion of mutual funds by nationalized as well as non-nationalized banks has also
improved the Indian capital market. They were helpful to the public by way of tax saving
schemes.

Regulation of NRI Investments:

The Amendment of Foreign Exchange Regulation Act (FERA) into Foreign Exchange
Management Act (FEMA) has given more encouragement to non resident investors. The
percentage of NRI investment in Indian companies has been increased from 5% to 24%.
In the year 1991, India faced an acute shortage of foreign exchange and the then finance
minister adopted certain methods to improve the foreign exchange reserves. He allowed
investment by any individual NRI in any Indian company from the then existing 5% of
paid up capital to 24%. This had resulted in more inflow of foreign funds into India.

Direct Foreign Investment:

The Foreign Investment Promotion Board, consisting of the Secretaries of industries,
finance and foreign affairs, have allowed more direct foreign investment in core sector,
especially in power sector.

FERA Companies:

Under the Foreign Exchange Regulation Act, a FERA company is one which has 40%
equity participation by foreigners. This limit has been removed and now even foreign
companies are allowed to have 51% equity participation. For example, Colgate Polmolive
has increased its foreign equity participation from 40 to 51%. As a result, we are able to
attract more foreign capital into Indian capital market.

Online Trading in Indian Capital Market:

Some of the leading stock markets in India have introduced computer system for their
trading activities. The brokers can get hooked-up and do their trading on Online basis.
The computer terminals will enable the public and the brokers to know the price
prevailing in the market at any time. This will prevent speculation activities.

Transparency through Online trading:

The online trading through computer has brought in transparency to the transactions in
the market. People are able to know prices prevailing in the market at any time and as
such the brokers cannot deprive their clients of their profits. The manipulation in the
opening and closing prices of shares by the brokers in the market is no longer possible.

Market Makers in Indian Capital Market:

The share price of companies will be decided by the market forces of supply and demand.
There are market makers who will ensure the supply and reasonable price for the stocks
of companies. By the introduction of these market makers, manipulation of share price by
the brokers is prevented.

Securities and Exchange Board of India:

The creation of Securities and Exchange Board of India (SEBI) is an important
development in Indian capital market of India. SEBI has not only replaced the Controller
of Capital issues, but has brought in uniformity in the transactions in all stock exchanges.

Renewal of Registration:
All the brokers and sub brokers have to register afresh with SEBI and any complaints
against them will be inquired and if found guilty, punishment is given.

Forward trading in Indian Capital market:

Forward trading has been introduced since 9th June 2000 in Bombay Stock Exchange on
a trial basis and if found successful, it will be extended. It will be helpful to the investors
in ascertaining the true colors of existing companies.
Educating Public:
Press and media have contributed a lot in popularizing the Indian capital market and they
are highlighting the prices of securities everyday. The mutual funds and merchant banks
have been asked to set apart a portion of their funds towards educating the public on the
developments in the Indian capital market.

Future trading in Indian Capital Market:

Future trading is a contract to buy or sell a particular financial instrument on a future date
at a specific price. The contract enables the parties to transfer according to the changes in
the price from one person to another. By this, the risk is minimized. In every future
contract, we have a buyer and a seller. And if one makes a profit in a particular contract,
the other person may try to minimize his loss through some other contract. Thus, the
future market provides scope for the traders to minimize their loss or the risks in trading
of financial instruments. We have different types of ‘financial futures’.