Financial Market notes for CBSE Class 12 Business Studies

BUSINESS STUDIES FINANCIAL MARKET

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Financial Market Topics Covered

Concept of financial market

Nature and functions of financial market

Classification of financial market

Money market and its instruments

Capital market

Functions of the stock exchange

Dematerialisation and depository

National Stock Exchange (NSE)

Securities and Exchange Board of India (SEBI)

Concept of Financial Market

Financial market refers to a market for the creation and exchange of financial assets (such as shares

and debentures).

In this market, money from those who have surplus money is transferred to those who require

investment.

Investors are surplus units and business enterprises are deficit units, where the financial market acts

as a link between surplus and deficit units.



Classification of Financial Market

Financial markets are classified on the basis of the maturity of financial instruments traded in them. If

the maturity period is less than one year for an instrument, then they are traded in the money market.

On the other hand, the instruments with longer maturity are traded in the capital market.



A. Money Market It refers to a market which deals in short-term securities and whose maturity is less than one year. The

assets in the money market can be regarded as very close substitutes for money. Accordingly, they

are also called ‘near money instruments’.

Instruments of the Money Market

Instruments of the Money Market

1) Treasury bill

It is a short-term borrowing instrument of the

Government of India.

It is a promissory note having a maturity period of less

than one year.

It is issued by the Reserve Bank of India on behalf of the

central government and is a highly liquid instrument.

It is available for a minimum of Rs 25,000 and in multiples

thereof.

This instrument is also known as Zero-Coupon Bond and

has very low risk and offers an assured return.

The maturity period of treasury bills varies from 14 days to

364 days.

2) Call money

It is a money market instrument which is used by

commercial banks for interbank transactions.

These instruments are used by commercial banks for

meeting their cash reserve requirements, i.e.

commercial banks borrow from each other to fulfil any

shortage of funds required to maintain the cash reserve

ratio through call money.

It has a maturity period of less than fifteen days.

Interest is paid on the call money, which is called the call

rate. This rate is highly variable, varying from day to day.

An inverse relationship exists between the call rate and

money market instruments such as commercial papers

and certificates of deposit.



When the call money rate rises, other instruments of the

money market become comparatively cheaper and

thereby their demand increases.

3) Commercial paper

It is a short-term unsecured money market instrument

introduced in India in 1990.

Basically, it is a promissory note which is negotiable and

transferable.

It has a maturity period ranging from a minimum of 15

days to a maximum of one year.

These are primarily used by large and creditworthy

companies for bridge financing, i.e. used as an

alternative to borrowing from banks and the capital market.

Companies pay an interest rate lower than the market

rates. Commercial papers are used for purposes such as

to meet the flotation cost on long-term borrowings

from the capital market.

4) Commercial bill

It is a source of financing credit sales by companies for

the short term.

It is used by companies to finance their working capital

requirements.

Is a negotiable instrument.

A seller (drawer) draws a commercial bill and gives it to a

buyer (drawee) who accepts it. After the buyer’s

acceptance, it becomes a tradable instrument. The seller

can discount it with a commercial bank even before

the bill matures. This is known as discounting of a bill.

5) Certificate of deposit

These are negotiable, unsecured instruments

presented in the bearer form.

These instruments are issued by commercial banks and

financial institutions to individuals, corporations and

companies.

It is used during periods of tight liquidity by commercial

banks to meet the demand for credit.

Maturity period of these instruments range from 91 days

to 1 year.

Banks are not allowed to discount these instruments.



B. Capital Market

It refers to the market or medium through which long-term funds, both debt and equity, are

raised and invested. It comprises channels through which the savings of the community are made

available for the business sector and the public in general.

The capital market consists of development banks, commercial banks and stock exchanges.

Instruments used in the capital market are shares, debentures, bonds, mutual funds and public

deposits.

Differences between Capital Market and Money Market

Basis of Difference Capital Market Money Market

Time Span of Securities Deals in long-term and

medium-term securities having

a maturity period of more than a

year.

Money market instruments have

a maturity period of a maximum

one year.

Liquidity Securities in the capital market

are liquid only to a certain

extent that they are tradable on

stock exchanges. However, they

are comparatively less liquid

than money market securities.

Securities in the money market

are highly liquid as DFHI

provides a ready market for them.

Returns Expected They offer higher possibility of

gain as the securities are for a

longer period.

As the securities have a shorter

maturity period, the expected

return is lower.

Instruments Instruments traded are equity

shares, preference shares,

bonds and debentures.

Short-term debt instruments

such as commercial papers,

treasury bills and certificates of

deposit are traded.

funds



Risk Securities traded are risky with

regard to both return and

principal repayment.

Securities traded are safe as

securities are traded for short

duration and the issuers are

financially sound.

Types of Capital Market

The main components of the capital market are primary market and secondary market.

A. Primary Market: Methods of Flotation of Securities

Primary Market: Methods of Flotation of Securities

1) Offer through prospectus Most popular method of raising funds by public companies in

the primary market.

Subscriptions from the public are invited through the issue

of a prospectus.

A direct deal is made to investors in order to raise capital

through the prospectus. This is done by means of an

advertisement in a newspaper or magazine.

The issues are underwritten, and listing is required on at

least one stock exchange.

The prospectus should be made strictly according to the

provisions of the Companies Act, Investor Protection Act and

SEBI.

2) Offer for sale Securities are offered through intermediaries.

Intermediaries can be issuing houses and stock brokers.

A company sells securities to brokers at an agreed price, who

then resells them to the public willing to invest.

A company need not go through the formalities of issuing



securities directly to the public.

3) Private placement Allotment of securities by a company to institutional investors

and some selected individuals.

Helps raise capital in lesser time than public issue.

Cost-saving method as there are lesser formalities and

mandatory and non-mandatory expenses.

4) Rights issue Privilege to existing shareholders to subscribe to new shares

according to the terms and conditions of the company.

Existing shareholders are offered a right to buy new shares in

proportion to the number of shares they already possess.

5) E-IPOs Issue of capital to the general public through an online system

of the stock exchange.

A company needs to enter into an agreement with the stock

exchange. This is called an Initial Public Offering (IPO).

Brokers registered with SEBI are appointed for accepting

applications and placing orders with the company.

Appointment of the registrar by the issuer company for

building electronic connectivity with the exchange.

Issuer company may get its securities listed on any stock

exchange except for the one from where it offered its securities.

B. Secondary Market: Stock Exchange

The secondary market (also known as the stock exchange or stock market) deals in existing or

second-hand securities.

A stock exchange is a platform for buying and selling securities.

As a first step towards generating interest of investors in corporate securities, the Government of

India introduced the Companies Act in 1850.

The first stock exchange was established in 1875 as ‘The Native Share and Stock Brokers

Association’ in Bombay. It was later renamed Bombay Stock Exchange (BSE).

Subsequently, over the years, stock exchanges were also developed in Ahmedabad, Calcutta and

Madras.

Till the 1990s, the Indian secondary market comprised only regional stock exchanges.

After the economic reforms of 1991, the Indian Stock Market acquired a three-tier system

comprising Regional Stock Exchanges, the National Stock Exchange and Over The Counter

Exchange of India (OTCEI).

Functions of the Stock Exchange

Important functions of a stock exchange:

1) Provides Liquidity and Marketability

The stock exchange provides a platform where sale and purchase of existing securities can

take place.

Facilitates the conversion of securities to cash as and when required.

Provides an opportunity for investors to disinvest and reinvest.

Renders liquidity and marketability to the securities already existing in the market.



2) Determination of Prices

Acts as a mechanism for continuous valuation of price of securities through the forces of demand

and supply.

This valuation serves as important information to buyers and sellers in the market.

3) Fair and Safe Market

Provides a safe and fair market for trading of securities through its well-regulated and well-

defined legal framework.

4) Facilitates Economic Growth

By facilitating the sale and purchase of securities, the stock exchange helps in channelising

savings to the most productive investment.

This in turn promotes capital formation and economic growth.

5) Spreading of Equity Cult

The stock exchange encourages people to invest in securities by regulating new issues, providing

investor education and better trading practices.

6) Scope for Speculation

A certain degree of healthy speculation is essential to maintain the continuous process of the

demand and supply of securities, and this function is performed by the stock exchange.

Trading Procedure at the Stock Exchange

The trading procedure at the stock exchange involves the following steps

Dematerialisation

Securities held by the investor in the physical form are cancelled, and the investor is given an

electronic entry or number so that she/he can hold it as an electronic balance in an account. This

process of holding securities in an electronic form is called dematerialisation.



Depository

A depository is a technology-driven storage system which keeps securities in an electronic

form on behalf of the investor.

In a depository, shares can be deposited, withdrawn or sold at any time on instructions given

by the investor.

It helps to avoid all the paperwork related to share certificates, transfer forms etc.

This system has helped in increasing the speed and efficiency of trading and settlement of

securities.

Constituents of the Depository System

National Stock Exchange

The National Stock Exchange of India was established in 1992. It was recognised as a stock exchange

in 1993, and it commenced operations from 1994. It was set up by financial institutions like banks,

insurance companies and other financial intermediaries.

Objectives of NSE

1) NSE aims at establishing a country-wide facility for trading of all types of securities.

2) It ensures that all investors get equal access to the securities market through a proper

communication network.

3) It provides for an electronic trading system which is fair, efficient and transparent.

4) It enables shorter settlement cycles and book entry settlements for trading in securities.

5) It ensures that various operations and activities meet international stock exchange standards.



There are two main segments of NSE:

Wholesale Debt Market Segment

o It provides a platform for trading in fixed income securities.

o Securities like state development loans, bonds issued by public sector undertakings, corporate

debentures, commercial papers, central government securities, zero-coupon bonds, treasury bills

etc. are traded.

Capital Market Segment

o This segment of NSE deals in trading of equity shares, preference shares, debentures,

exchange traded funds as well as retail government securities.

Securities and Exchange Board of India

The Securities and Exchange Board of India (SEBI) was established in 1988 with the basic objective of promoting orderly and healthy growth of the securities market. It aims at investor protection along with promoting the development and regulation of the functions of the securities market. SEBI got a statutory status on 30 January 1992 through an ordinance which is now replaced by an Act of the Parliament known as the Securities and Exchange Board of India Act, 1992.

Major Objectives of SEBI

1) Regulation: SEBI regulates the functions of the stock exchange and securities market in order to

ensure orderly functioning.

2) Protection: SEBI protects the rights and interests of investors as well as tries to guide and educate

them.

3) Prevention: One of the major objectives of SEBI is to check malpractices such as insider trading,

violation of rules and non-adherence to the Companies Act. In addition to providing legal statutory

regulations, it promotes self-regulation by businesses.

4) Code of Conduct: SEBI provides a code of conduct for the trade practices of various intermediaries

such as brokers and merchant bankers. It keeps a check on the activities of these intermediaries and

provides them a competitive and professional environment.

To achieve the objectives as mentioned above, SEBI performs the following three main functions:

Functions of SEBI

1) Regulatory Functions

Registration: SEBI undertakes registration of various brokers,

sub-brokers, agents and other players in the market. Registration

of collective mutual schemes and mutual funds is also done by

SEBI.

Regulating work: SEBI keeps a watch on the activities and

working of stock brokers, underwriters, merchant bankers and

other market intermediaries. It provides rules and regulations for

the working of intermediaries. In addition, takeover bids by

companies are regulated by SEBI. Moreover, it conducts regular

enquires and audits the stock exchange and intermediaries.

Levying Fee: SEBI levies fees and other charges for carrying out

the purposes of the Act.

Regulation by legislation: Under the Securities Contracts

(Regulation) Act, 1956, SEBI performs various legislative

functions delegated by the Government of India.



2) Development Functions

Training: SEBI provides training and development programmes

for intermediaries of the securities market. This helps in promoting

healthy growth of the securities market.

Research: SEBI conducts research on various important areas of

the securities market, reports of which are then published. The

reports by SEBI help investors and other market players in

decision making with regard to investment.

Flexible approach: SEBI has adopted a flexible approach

towards various activities of the securities market. For instance, it

has permitted Internet trading and IPOs. This encourages the

development of the capital market.

3) Protective Functions

• Prohibition: SEBI keeps an eye on various activities and

operations in the securities market. It works towards prohibiting

fraudulent and unfair trade practices.

• Checks on insider trading: Sometimes, an individual connected

with a company spreads crucial information regarding it. Such

leak of information may adversely affect the share price of the

company. Such a practice is known as insider trading. SEBI

keeps control on such activities and imposes penalties as and

when required.

• Protection and promotion: SEBI works towards promoting fair

trade practices. It provides a code of conduct for intermediaries.

SEBI also undertakes many steps to protect the investors.

Financial Market notes for CBSE Class 12 Business Studies

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