Financial Market

A financial market connects people and institutions that have surplus money with those who need money.

Households save money. Companies need funds for business expansion. Government needs money for development and public expenditure. Banks, insurance companies, mutual funds, stock exchanges and other institutions help move this money from savers to borrowers.

Chapter 6 explains the structure of the financial market, including money market, capital market, bonds, shares, mutual funds, stock market, SEBI, derivatives, external commercial borrowing, FDI and FII.

What Is Financial Market?

A financial market is a market where short-term and long-term financial instruments are used for lending, borrowing, investment and trading.

In simple words, it is a system that allows money to move from those who have surplus funds to those who need funds.

Examples of financial instruments include:

• Treasury bills
• Commercial paper
• Certificate of deposit
• Bonds
• Debentures
• Shares
• Mutual funds
• Derivatives

Main Types Of Financial Market

The financial market is broadly divided into:

• Money Market
• Capital Market

The chapter also divides markets into organised and unorganised forms.

Type	Meaning	Regulator Or Nature
Money Market	Market for short-term funds up to 1 year	Mostly regulated by RBI in organised form
Capital Market	Market for long-term funds above 1 year	Mostly regulated by SEBI
Unorganised Market	Informal lending and borrowing	Not properly regulated
Organised Market	Formal financial institutions and instruments	Regulated by RBI or SEBI

What Is Money Market?

The money market is a market where short-term financial instruments are used for lending and borrowing.

The time period is usually up to 1 year.

Money market helps banks, companies, financial institutions and government manage short-term liquidity.

Organised And Unorganised Money Market

HUnorganised Money Market

The unorganised money market is not controlled or regulated by RBI.

It is also called a shadow or grey market in the chapter.

Examples:

• Mahajan
• Sahukar
• Informal moneylenders
• Hawala-type informal channels

Such markets may charge high interest and do not follow formal banking rules.

Organised Money Market

The organised money market is regulated by RBI.

It includes formal institutions and instruments such as:

• Commercial banks
• RBI
• Financial institutions
• Treasury bills
• Commercial paper
• Certificate of deposit

Instruments Of Money Market

The chapter discusses several important money market instruments.

Call Money Market

The call money market deals with very short-term borrowing and lending, usually overnight.

If the borrowing period extends from 2 to 14 days, it is called the notice money market.

Important features:

• Very short-term market.
• Used mostly by banks.
• Collateral is generally not required.
• Interest rate depends on demand and supply of funds.
• If there is shortage of funds, interest rate may rise.

The interest rate decided between banks in such transactions is called the interbank call rate.

Commercial Bills

A commercial bill is a promissory note used in business transactions.

It is a document through which one party promises to pay a certain amount of money at a certain time.

Commercial bills can be discounted by banks.

Commercial Bill Example

Suppose Firm A buys goods from Firm B and promises to pay after 3 months.

Firm B needs money immediately, so it takes the bill to a bank.

The bank pays Firm B a discounted amount and later collects the full amount from Firm A.

This process is called discounting of commercial bills.

Treasury Bills

Treasury Bills, or T-Bills, are short-term securities issued by the central government to raise funds.

They are used by the government to borrow money for short periods.

The chapter mentions 3 types:

• 91-day Treasury Bill
• 182-day Treasury Bill
• 364-day Treasury Bill

Treasury bills may be purchased by:

• Commercial banks
• RBI
• LIC
• GIC
• UTI
• Other financial institutions

The chapter mentions that they are issued in denominations of Rs 25 lakh.

Commercial Paper

Commercial Paper, or CP, is a short-term instrument issued by companies to raise funds.

It is generally used by companies with good credit ratings.

The chapter mentions that commercial paper was introduced in 1992 and may be issued by companies when they need short-term funds.

Participants in the commercial paper market include:

• Individuals
• Corporate entities
• Financial institutions
• NRIs

The chapter mentions denomination of Rs 5 lakh.

Certificate Of Deposit

A Certificate of Deposit, or CD, is issued by scheduled commercial banks and other financial institutions.

It is issued at a discounted rate and is a negotiable money market instrument.

Important features mentioned in the chapter:

• Issued by scheduled commercial banks and financial institutions.
• Issued at discount.
• Denomination may be Rs 5 lakh.
• Minimum time period may be 7 days.
• Maximum time period may be 1 year.
• Participants include commercial banks and financial institutions.

Money Market Instruments At A Glance

Instrument	Issuer	Time Period	Main Use
Call Money	Banks and financial institutions	Overnight	Very short-term liquidity
Notice Money	Banks and financial institutions	2 to 14 days	Short-term liquidity
Commercial Bill	Business firms	Short-term	Trade and business credit
Treasury Bill	Central government	91, 182, 364 days	Government short-term borrowing
Commercial Paper	Companies	Short-term	Corporate short-term funds
Certificate of Deposit	Banks and financial institutions	7 days to 1 year	Short-term deposit instrument

What Is Capital Market?

The capital market is a market where long-term funds are raised using financial instruments.

The time period is generally more than 1 year.

Capital market is important for:

• Business expansion.
• Infrastructure development.
• Long-term investment.
• Government borrowing.
• Industrial growth.

Security Market

A security market is a market where different types of security papers are issued and traded.

These may range from short-term government treasury bills to long-term government securities.

Long-term government securities may have maturity ranging from 2 years to 30 years.

Securities issued by state governments are often called State Government Loans or State Development Loans.

Types Of Securities

Securities can broadly be divided into:

• Debt securities
• Equity securities

Debt Securities

Debt securities represent borrowing.

When an investor buys a debt security, they are lending money to the issuer.

Examples:

• Bonds
• Debentures
• Treasury bills
• Commercial paper

Debt securities usually provide fixed or relatively stable returns.

They may be safer than equity, especially during economic slowdown, because debt holders have a stronger claim than shareholders.

Equity Securities

Equity securities represent ownership in a company.

Example:

• Shares

When investors buy shares, they become owners or shareholders of the company.

Equity returns depend on company profits and market conditions.

During a boom, equity securities may provide higher returns because company profits rise.

Debt Securities Vs Equity Securities

Basis	Debt Securities	Equity Securities
Meaning	Borrowing instrument	Ownership instrument
Examples	Bonds, debentures, T-bills	Shares
Return	Interest or fixed income	Dividend and capital gain
Risk	Generally lower	Generally higher
Claim During Liquidation	Higher claim	Residual claim
Best During	Slowdown or stable income preference	Boom or growth phase

Face Value Of Share

Face value is the nominal or actual value assigned to a share by the company.

Example: If a company issues a share with face value Rs 10, that Rs 10 is the face value.

Market price may be higher or lower than face value.

Share At Par

A share issued at its face value is called share at par.

Example: A share with face value Rs 10 issued at Rs 10.

Share At Premium

A share issued above its face value is called share at premium.

Example: A share with face value Rs 10 issued at Rs 100.

The extra Rs 90 is the premium.

Bonds

Bonds are debt market instruments that provide fixed income to bondholders.

They may be issued by:

• Government
• Companies
• Corporate houses

When investors buy bonds, they lend money to the issuer. In return, they usually receive interest and repayment of principal at maturity.

Debentures

Debentures are also debt instruments, mostly issued by companies.

The chapter explains that debentures may be less secure than bonds if they do not have collateral backing.

In India, the words bond and debenture are sometimes used interchangeably, but technically all debentures are bonds, while all bonds are not necessarily debentures.

Bonds Vs Debentures

Basis	Bonds	Debentures
Issuer	Government and companies	Mostly companies
Security	Often more secure	May be unsecured
Collateral	May have stronger backing	May not have collateral
Return	Fixed income	Interest payment
Risk	Generally lower	May be higher

Bond Yield

Bond yield is the return earned from a bond.

The chapter explains that bond price and bond yield move in opposite directions.

• When bond price falls, bond yield rises.
• When bond price rises, bond yield falls.

Simple Example Of Bond Yield

Suppose a bond pays fixed interest of Rs 100 per year.

If the bond price is Rs 1,000, yield is 10 per cent.

If the bond price falls to Rs 800, the same Rs 100 interest becomes a higher percentage of the price, so yield rises.

Types Of Bonds

The chapter discusses several types of bonds.

Junk Bond

A junk bond offers high returns but has high default risk.

It is issued by borrowers with weak creditworthiness.

Zero-Coupon Bond

A zero-coupon bond does not pay regular interest.

It is issued at a discount and redeemed at face value.

Example: A bond may be issued at Rs 900 and redeemed at Rs 1,000.

Bearer Bond

A bearer bond belongs to the person who physically holds it.

Ownership is transferred by delivery.

Masala Bond

A Masala Bond is a rupee-denominated bond issued outside India.

It allows Indian entities to raise money abroad in Indian rupees.

Gilt-Edged Security

Gilt-edged securities are high-quality government securities.

They are considered low-risk because they are backed by the government.

Index-Linked Bond

An index-linked bond is linked to inflation or a price index.

It protects investors from inflation risk.

Catastrophe Bond

A catastrophe bond is linked with disaster risk.

It is often used in insurance and reinsurance markets.

Primary Market And Secondary Market

Primary Market

The primary market is where new securities are issued for the first time.

Example: A company issuing shares through an IPO.

Secondary Market

The secondary market is where existing securities are bought and sold.

Example: Buying and selling shares on the stock exchange.

IPO, FPO And Other Share Issue Methods

IPO

IPO stands for Initial Public Offer.

It is the first time a company offers its shares to the public.

H3: Rights Issue

A rights issue is an offer of shares to existing shareholders.

FPO

FPO stands for Follow-on Public Offer.

It is a public issue made after the IPO.

Private Placement

Private placement means selling securities to selected investors instead of the general public.

Preference Shares

Preference shares are shares that get preference in dividend payment and repayment of capital over equity shares.

They are sometimes called quasi-debt because they have features of both debt and equity.

QIP

QIP stands for Qualified Institutional Placement.

It allows listed companies to raise money from qualified institutional buyers.

Retail And Institutional Investors

The chapter divides investors into 2 types:

• Retail investors
• Institutional investors

Retail Investors

Retail investors are individuals who invest small amounts of money.

Example: A person buying 20 shares of a company through a trading account.

Institutional Investors

Institutional investors invest large amounts of money.

Examples:

• Mutual funds
• Commercial banks
• Insurance companies
• Pension funds

Institutional investors can strongly influence market movement because they invest large funds.

Hedge Funds

Hedge funds pool money from high-net-worth individuals and invest using specialised strategies.

They are usually less accessible to small retail investors and may involve higher risk.

Mutual Funds

A mutual fund pools money from investors and invests it in a portfolio of assets.

These assets may include:

• Debt instruments
• Equity shares
• Money market instruments
• Hybrid instruments

Asset management companies manage mutual funds.

Investors receive returns in proportion to their investment after deducting expenses and commission.

Exit Load

Exit load is a charge applied when an investor exits a mutual fund before a specified period.

It discourages very early withdrawals from certain schemes.

Exchange Traded Fund

An Exchange Traded Fund, or ETF, is similar to a mutual fund, but it is traded on the stock exchange like a share.

The chapter notes that ETFs collect funds through a new fund offer and then trade in the secondary market.

A key point mentioned is that ETFs generally do not have exit load like mutual funds.

Mutual Fund Vs ETF

Basis	Mutual Fund	ETF
Trading	Bought or redeemed through fund house	Traded on stock exchange
Price	Based on NAV	Market price changes during trading
Exit Load	May apply	Generally no exit load
Management	Active or passive	Usually passive, but can vary
Liquidity	Based on redemption process	Based on exchange trading

Short-Term And Long-Term Security Papers

Security papers can be classified into:

• Short-period security paper: Treasury bills.
• Long-term security paper: Government securities with maturity above 1 year, sometimes up to 30 years.

Long-term securities issued by state governments are known as State Government Loans or State Development Loans.

Stock Market

The stock market is a secondary market where shares are bought and sold.

India has major stock exchanges such as:

• Bombay Stock Exchange – BSE
• National Stock Exchange – NSE

The chapter mentions BSE as older and NSE as established in 1992.

Sensex And Nifty

Sensex

Sensex is the index of 30 major companies listed on BSE.

It is also called BSE 30.

H3: Nifty 50

Nifty 50 is the index of 50 major companies listed on NSE.

These indices show the broad trend of the stock market.

Market Capitalisation

Market capitalisation shows the total market value of a company’s issued shares.

Formula:

Market Capitalisation = Total Number of Issued Shares × Price Per Share

Example:

If a company has 10 lakh issued shares and each share is priced at Rs 100:

Market Capitalisation = 10,00,000 × 100 = Rs 10 crore

Role Of SEBI

SEBI stands for Securities and Exchange Board of India.

It is the main regulator of the securities market in India.

The chapter notes that SEBI is a statutory body formed in 1992.

Main Functions Of SEBI

The chapter lists the role of SEBI as:

• Regulation of the share market.
• Supporting the growth of capital market.
• Protecting investors.
• Monitoring market activities.
• Taking strict action against defaulters.

SEBI helps maintain trust, transparency and discipline in the securities market.

Speculation, Bullish Market And Bearish Market

Speculation

Speculation means taking positions in the market based on expected price movement.

Speculators observe the trend of growth of a company or market.

Bullish Market

A market is called bullish when investors expect prices to rise.

It reflects optimism.

Bearish Market

A market is called bearish when investors expect prices to fall.

It reflects pessimism.

Participatory Notes

Participatory Notes, or P-Notes, are offshore derivative instruments issued by foreign institutional investors.

They allow foreign investors to participate in another country’s capital market without directly registering in that market.

The chapter explains P-Notes as instruments issued by FIIs to hedge funds or foreign investors so they can participate in the capital market without getting registered.

Depository Receipts

Depository Receipts allow foreign investors to invest in shares of companies from another country.

The chapter explains that Indian entities may use institutions such as EXIM bank, merchant banks or investment banks to issue depository receipts to foreign depositories, which then issue receipts to foreign investors.

Types Of Depository Receipts

• ADR – American Depository Receipt
• GDR – Global Depository Receipt

ADR is issued in the American market.

GDR is issued in international markets outside the home country.

Derivatives

A derivative is a financial instrument whose value is derived from an underlying asset.

Underlying assets may include:

• Shares
• Bonds
• Commodities
• Currency
• Interest rates

Derivatives are used for hedging, speculation and risk management.

Futures

A future is a standardised contract traded on an organised exchange.

It is an agreement to buy or sell an asset at a future date at a predetermined price.

Futures are used to reduce price risk.

Forwards

A forward is a contract between 2 parties to buy or sell an asset at a future date at an agreed price.

The chapter describes forwards as derivative arrangements in the unorganised sector.

Forwards are customised and usually traded over the counter.

Futures Vs Forwards

Basis	Futures	Forwards
Market	Organised exchange	Over-the-counter or unorganised market
Contract	Standardised	Customised
Regulation	More regulated	Less regulated
Risk	Lower counterparty risk	Higher counterparty risk
Use	Hedging and trading	Hedging and customised contracts

Call Option

A call option gives the holder the right to buy an asset, but not the obligation to buy.

Example: If an investor expects a share price to rise, they may buy a call option.

Put Option

A put option gives the holder the right to sell an asset, but not the obligation to sell.

Example: If an investor expects a share price to fall, they may buy a put option to protect against loss.

Call Option Vs Put Option

Basis	Call Option	Put Option
Right	Right to buy	Right to sell
Used When	Price expected to rise	Price expected to fall
Obligation	No obligation to buy	No obligation to sell
Purpose	Benefit from price rise	Protection from price fall

Credit Default Swap

A Credit Default Swap, or CDS, is a financial arrangement used to transfer credit risk.

It works like insurance against default.

If a company defaults on its debt, the protection buyer can recover money from the protection seller according to the contract.

The chapter explains it as shifting credit default risk from one party to another, such as from a company to an insurance-like institution.

External Commercial Borrowing

External Commercial Borrowing, or ECB, allows eligible Indian companies and entities to raise loans from outside India.

The chapter mentions that Government of India allows domestic corporates and investors in areas such as affordable housing to raise loans from outside Indian territory.

Important points:

• ECB is borrowing from outside India.
• It is used by companies and eligible entities.
• It may have a minimum maturity period.
• Funds should follow rules set by Indian authorities.

FDI And FII

Foreign investment is an important part of the financial market.

The chapter compares:

• FDI – Foreign Direct Investment
• FII – Foreign Institutional Investor

FDI – Foreign Direct Investment

FDI means long-term investment by a foreign investor in a company or business.

Important features from the chapter:

• Long-term relationship with the company and its board.
• 10 per cent or more stake in a listed company.
• Any level of investment in an unlisted company may be treated under direct investment rules.
• Sector caps may apply.
• Investment may go into infrastructure, development and business expansion.
• Investment routes include automatic route and government approval route.

Strategic sectors such as defence may require government approval.

FII – Foreign Institutional Investor

FII means foreign institutional investor investing mainly in financial markets.

Important features from the chapter:

• Usually short-term and anonymous compared to FDI.
• Less than 10 per cent stake in a listed company.
• Mostly invests in capital markets.
• SEBI is the prime regulator for FII.
• Government approval may be required for buying certain long-term government securities.

FDI Vs FII

Basis	FDI	FII
Full Form	Foreign Direct Investment	Foreign Institutional Investor
Nature	Long-term	Short-term or portfolio-based
Relationship	Direct relation with company and management	No direct management control
Stake	Usually 10 per cent or more in listed company	Usually less than 10 per cent
Investment Area	Infrastructure, business, development	Capital market and securities
Route	Automatic route or government approval route	Market route under SEBI regulation
Regulator	Government and sectoral rules	SEBI is the main regulator
Stability	More stable	More volatile

Why Financial Market Matters

Financial markets are important because they:

• Mobilise savings.
• Provide funds to businesses.
• Help government borrow money.
• Support investment and growth.
• Provide liquidity to investors.
• Help price discovery.
• Allow risk management through derivatives.
• Connect domestic markets with global capital.

Important Financial Market Formulas

Concept	Formula
Market Capitalisation	Total Number of Issued Shares × Price Per Share
Bond Yield	Annual Return / Current Bond Price × 100
Net Return From Investment	Total Return – Cost or Charges

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