ICSI Notes: Indian Financial Markets | Economics for CSEET PDF Download

 Page 1


486
CSEET Reference Reading Material - I
Economic and  
Business Environment
INDIAN FINANCIAL MARKETS
LESSON 4
Page 2


486
CSEET Reference Reading Material - I
Economic and  
Business Environment
INDIAN FINANCIAL MARKETS
LESSON 4
487
Economic and  
Business Environment
INTRODUCTION
The financial markets play a vital role in the modern economy by facilitating capital formation, 
enterprise growth, risk management, and free exchange of capital. Financial markets in particular 
help direct resources to their most valuable use, fueling innovation and employment. A well-regulated, 
transparent system allows both small investors and large corporations to raise money in public securities 
markets. This lowers the cost of capital for businesses while offering optionality and wealth growth 
opportunities. By incorporating myriad views into pricing, the exchanges also guide capital allocation 
decisions through information discovery.
Financial markets refer to the markets where buyers and sellers participate in the trade of assets like 
equities, bonds, currencies and derivatives. Financial markets provide a platform for investors to invest 
money in securities and for companies to raise money by issuing securities. The securities are traded on 
exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) in India. Stock 
market allows companies to raise capital by issuing shares to the public and investors to purchase 
shares of companies.
Financial markets are the organisations, systems, and venues that permit the buying and selling of 
financial assets like derivatives, stocks, bonds, currencies, and commodities. Financial markets’ primary 
goal is to make it easier for money to move from savers to borrowers, giving people, businesses, and 
governments a way to invest and finance their endeavours. Financial markets are vital to the smooth 
operation of capitalist economies.
In other words, financial markets refer broadly to any marketplace where securities trading occurs, 
including the stock market, bond market, forex market, and derivatives market. Financial markets are 
vital to the smooth operation of capitalist economies.  
Thus, the key points pertaining to the financial markets are-
	 l	 Financial markets refer broadly to any marketplace where the trading of securities occurs.
	 l	 There are many kinds of financial markets, including (but not limited to) forex, money, stock, 
and bond markets.
	 l	 These markets may include assets or securities that are either listed on regulated exchanges or 
trade over-the-counter (OTC).
	 l	 Financial markets trade in all types of securities and are critical to the smooth operation of a 
capitalist society.
	 l	 When financial markets fail, economic disruption, including recession and rising unemployment, 
can result.
The term “Indian financial market” refers to the country’s system of institutions, instruments, and rules 
that play a key role in streamlining the exchange of money between market participants.
FUNCTIONS OF FINANCIAL MARKET 
The following are the major functions of Financial Market:
 1. Facilitating capital formation: Financial markets allow companies to raise fresh capital from 
investors to finance their operations or expansion plans. This helps businesses grow and create 
jobs, leading to economic growth.
Lesson 4 - Indian Financial Markets
Page 3


486
CSEET Reference Reading Material - I
Economic and  
Business Environment
INDIAN FINANCIAL MARKETS
LESSON 4
487
Economic and  
Business Environment
INTRODUCTION
The financial markets play a vital role in the modern economy by facilitating capital formation, 
enterprise growth, risk management, and free exchange of capital. Financial markets in particular 
help direct resources to their most valuable use, fueling innovation and employment. A well-regulated, 
transparent system allows both small investors and large corporations to raise money in public securities 
markets. This lowers the cost of capital for businesses while offering optionality and wealth growth 
opportunities. By incorporating myriad views into pricing, the exchanges also guide capital allocation 
decisions through information discovery.
Financial markets refer to the markets where buyers and sellers participate in the trade of assets like 
equities, bonds, currencies and derivatives. Financial markets provide a platform for investors to invest 
money in securities and for companies to raise money by issuing securities. The securities are traded on 
exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) in India. Stock 
market allows companies to raise capital by issuing shares to the public and investors to purchase 
shares of companies.
Financial markets are the organisations, systems, and venues that permit the buying and selling of 
financial assets like derivatives, stocks, bonds, currencies, and commodities. Financial markets’ primary 
goal is to make it easier for money to move from savers to borrowers, giving people, businesses, and 
governments a way to invest and finance their endeavours. Financial markets are vital to the smooth 
operation of capitalist economies.
In other words, financial markets refer broadly to any marketplace where securities trading occurs, 
including the stock market, bond market, forex market, and derivatives market. Financial markets are 
vital to the smooth operation of capitalist economies.  
Thus, the key points pertaining to the financial markets are-
	 l	 Financial markets refer broadly to any marketplace where the trading of securities occurs.
	 l	 There are many kinds of financial markets, including (but not limited to) forex, money, stock, 
and bond markets.
	 l	 These markets may include assets or securities that are either listed on regulated exchanges or 
trade over-the-counter (OTC).
	 l	 Financial markets trade in all types of securities and are critical to the smooth operation of a 
capitalist society.
	 l	 When financial markets fail, economic disruption, including recession and rising unemployment, 
can result.
The term “Indian financial market” refers to the country’s system of institutions, instruments, and rules 
that play a key role in streamlining the exchange of money between market participants.
FUNCTIONS OF FINANCIAL MARKET 
The following are the major functions of Financial Market:
 1. Facilitating capital formation: Financial markets allow companies to raise fresh capital from 
investors to finance their operations or expansion plans. This helps businesses grow and create 
jobs, leading to economic growth.
Lesson 4 - Indian Financial Markets
488
CSEET Reference Reading Material - I
Economic and  
Business Environment
 2. Price discovery: Prices of all financial instruments are determined through market forces like 
supply-demand dynamics in these markets. This helps buyers and sellers determine fair prices for 
a given security or asset class at any given time. 
 3. Allocating capital efficiently: By allowing investors to allocate their capital across different 
classes of assets according to their risk appetite, financial markets help ensure that resources 
are allocated efficiently across various sectors of the economy.
 4. Risk management tools: These markets also offer sophisticated risk management tools such 
as derivatives which can be used by institutions or individual traders seeking exposure without 
taking on too much risk or leverage levels beyond what they can manage effectively.
Financial markets are an essential part of the global economy. They provide a platform for investors to 
trade securities and commodities, helping allocate resources efficiently across different asset classes 
and countries. Financial markets have become increasingly interconnected in recent years, allowing 
capital to move more quickly worldwide and making it easier for businesses to access capital when 
needed.
Financial markets play an indispensable role in facilitating the transfer of capital, aiding in price discovery, 
and managing risks. Understanding the different types of financial markets and their functions is crucial 
for any business or individual seeking to participate in the global financial system.
Types of Financial Markets 
1. Capital Market
Capital markets are marketplace where buyers and sellers engage in the trade of securities like bonds, 
stocks, and derivatives. Capital markets channel savings and investment between suppliers of capital 
such as retail investors and institutional investors, and users of capital like businesses, government, and 
individuals. Capital markets in India consist primarily of the stock exchanges like NSE and BSE where 
investors buy and sell shares, bonds, and derivatives. The main usage of capital markets is to allow 
Indian companies across sectors to raise long-term capital from investors across India. This capital is 
used to fund growth and projects for business expansion. It provides an alternative to limited bank 
lending. For investors, it provides an avenue to allocate savings into financial securities to build wealth 
over time. 
 a) Stock Market: Stock markets allow companies to raise capital by issuing and selling shares or 
stock to investors. The two main stock exchanges in India are the National Stock Exchange 
(NSE) and the Bombay Stock Exchange (BSE). Companies list and trade their shares on these 
exchanges to access equity financing from investors across the country.  Stock markets provide 
an avenue for companies to access capital for business purposes like investing in new projects 
or acquisitions. It offers an alternative to traditional bank lending. For investors, it serves as a 
platform to allocate savings and build wealth. 
 b) Bond market: Bond markets are used by organisations like governments and companies raise 
debt financing by issuing bonds that are purchased by investors. The bond market segments 
in India include the government bond market, corporate bond market, and municipal/local 
bonds. 
The Indian bond market consists of both government and corporate bonds. Government securities, 
including treasury bills and bonds issued by the Reserve Bank of India (RBI) on behalf of the Government 
Page 4


486
CSEET Reference Reading Material - I
Economic and  
Business Environment
INDIAN FINANCIAL MARKETS
LESSON 4
487
Economic and  
Business Environment
INTRODUCTION
The financial markets play a vital role in the modern economy by facilitating capital formation, 
enterprise growth, risk management, and free exchange of capital. Financial markets in particular 
help direct resources to their most valuable use, fueling innovation and employment. A well-regulated, 
transparent system allows both small investors and large corporations to raise money in public securities 
markets. This lowers the cost of capital for businesses while offering optionality and wealth growth 
opportunities. By incorporating myriad views into pricing, the exchanges also guide capital allocation 
decisions through information discovery.
Financial markets refer to the markets where buyers and sellers participate in the trade of assets like 
equities, bonds, currencies and derivatives. Financial markets provide a platform for investors to invest 
money in securities and for companies to raise money by issuing securities. The securities are traded on 
exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) in India. Stock 
market allows companies to raise capital by issuing shares to the public and investors to purchase 
shares of companies.
Financial markets are the organisations, systems, and venues that permit the buying and selling of 
financial assets like derivatives, stocks, bonds, currencies, and commodities. Financial markets’ primary 
goal is to make it easier for money to move from savers to borrowers, giving people, businesses, and 
governments a way to invest and finance their endeavours. Financial markets are vital to the smooth 
operation of capitalist economies.
In other words, financial markets refer broadly to any marketplace where securities trading occurs, 
including the stock market, bond market, forex market, and derivatives market. Financial markets are 
vital to the smooth operation of capitalist economies.  
Thus, the key points pertaining to the financial markets are-
	 l	 Financial markets refer broadly to any marketplace where the trading of securities occurs.
	 l	 There are many kinds of financial markets, including (but not limited to) forex, money, stock, 
and bond markets.
	 l	 These markets may include assets or securities that are either listed on regulated exchanges or 
trade over-the-counter (OTC).
	 l	 Financial markets trade in all types of securities and are critical to the smooth operation of a 
capitalist society.
	 l	 When financial markets fail, economic disruption, including recession and rising unemployment, 
can result.
The term “Indian financial market” refers to the country’s system of institutions, instruments, and rules 
that play a key role in streamlining the exchange of money between market participants.
FUNCTIONS OF FINANCIAL MARKET 
The following are the major functions of Financial Market:
 1. Facilitating capital formation: Financial markets allow companies to raise fresh capital from 
investors to finance their operations or expansion plans. This helps businesses grow and create 
jobs, leading to economic growth.
Lesson 4 - Indian Financial Markets
488
CSEET Reference Reading Material - I
Economic and  
Business Environment
 2. Price discovery: Prices of all financial instruments are determined through market forces like 
supply-demand dynamics in these markets. This helps buyers and sellers determine fair prices for 
a given security or asset class at any given time. 
 3. Allocating capital efficiently: By allowing investors to allocate their capital across different 
classes of assets according to their risk appetite, financial markets help ensure that resources 
are allocated efficiently across various sectors of the economy.
 4. Risk management tools: These markets also offer sophisticated risk management tools such 
as derivatives which can be used by institutions or individual traders seeking exposure without 
taking on too much risk or leverage levels beyond what they can manage effectively.
Financial markets are an essential part of the global economy. They provide a platform for investors to 
trade securities and commodities, helping allocate resources efficiently across different asset classes 
and countries. Financial markets have become increasingly interconnected in recent years, allowing 
capital to move more quickly worldwide and making it easier for businesses to access capital when 
needed.
Financial markets play an indispensable role in facilitating the transfer of capital, aiding in price discovery, 
and managing risks. Understanding the different types of financial markets and their functions is crucial 
for any business or individual seeking to participate in the global financial system.
Types of Financial Markets 
1. Capital Market
Capital markets are marketplace where buyers and sellers engage in the trade of securities like bonds, 
stocks, and derivatives. Capital markets channel savings and investment between suppliers of capital 
such as retail investors and institutional investors, and users of capital like businesses, government, and 
individuals. Capital markets in India consist primarily of the stock exchanges like NSE and BSE where 
investors buy and sell shares, bonds, and derivatives. The main usage of capital markets is to allow 
Indian companies across sectors to raise long-term capital from investors across India. This capital is 
used to fund growth and projects for business expansion. It provides an alternative to limited bank 
lending. For investors, it provides an avenue to allocate savings into financial securities to build wealth 
over time. 
 a) Stock Market: Stock markets allow companies to raise capital by issuing and selling shares or 
stock to investors. The two main stock exchanges in India are the National Stock Exchange 
(NSE) and the Bombay Stock Exchange (BSE). Companies list and trade their shares on these 
exchanges to access equity financing from investors across the country.  Stock markets provide 
an avenue for companies to access capital for business purposes like investing in new projects 
or acquisitions. It offers an alternative to traditional bank lending. For investors, it serves as a 
platform to allocate savings and build wealth. 
 b) Bond market: Bond markets are used by organisations like governments and companies raise 
debt financing by issuing bonds that are purchased by investors. The bond market segments 
in India include the government bond market, corporate bond market, and municipal/local 
bonds. 
The Indian bond market consists of both government and corporate bonds. Government securities, 
including treasury bills and bonds issued by the Reserve Bank of India (RBI) on behalf of the Government 
489
Economic and  
Business Environment
Lesson 4 - Indian Financial Markets
of India, form a significant portion of the bond market. Corporate bonds are issued by companies to 
raise funds for various purposes, such as expansion, working capital, and debt refinancing. The bond 
market provides investors with fixed-income securities, offering regular interest payments and the return 
of principal upon maturity.
2. Commodity market
Commodity markets are markets that facilitate the trading of primary economic goods like agricultural 
products, metals, oil and natural gas. The main commodity exchanges in India are MCX and NCDEX. 
For example, NCDEX allows farmers, traders, and processors to trade in agricultural commodities like 
wheat, rice, cotton, spices, etc. through futures contracts. This provides price risk management in agri-
commodities.  Similarly, on MCX traders buy and sell futures contracts on metals like gold, silver, copper, 
natural gas, crude oil etc. Jewellers hedge their price risk on gold inventory using gold futures.
The main usage of commodity markets in India is to provide price discovery and price risk management 
for producers, consumers and traders of commodities. It helps integrate localised commodity markets 
across India into one national market. Commodity derivatives also allow better inventory planning for 
companies. 
 a) Soft commodities: Soft commodities refer to agricultural commodities that are grown, rather 
than mined. They include crops like wheat, rice, pulses, spices, coffee, tea, cotton, rubber, fruits 
and vegetables. The National Commodity and Derivatives Exchange (NCDEX) in India provides 
a platform for trading in various soft commodities. For example, it allows futures trading in 
wheat, chana, soybean, mustard seed, cotton, cardamom, mentha oil, etc. This helps farmers, 
producers and exporters hedge against price risks. 
  The main usage of soft commodity trading in India is price discovery and risk management. It 
provides valuable information on demand, supply and prices to all participants. Farmers lock in 
future selling prices for their produce. Processors like flour mills hedge against raw material price 
changes. The efficient price signals lead to higher farm productivity and food security.
 b)  Hard commodities: Hard commodities refer to natural resources that are mined or extracted, 
rather than grown agriculturally. They include precious metals like gold, silver, platinum, base 
metals like aluminium, copper, nickel, lead, zinc and energy commodities like crude oil, natural 
gas and coal. 
In India, hard commodities are traded on exchanges like the Multi Commodity Exchange (MCX) and 
National Commodity and Derivatives Exchange (NCDEX). For example, MCX offers futures trading in 
gold, silver, copper, crude oil, natural gas, aluminium, nickel, mentha oil, cotton etc. This facilitates 
price discovery and hedging for producers, consumers and traders.
The key usage of hard commodity derivatives in India is managing price volatility and inventory risks. 
Mining companies hedge against fluctuations in global metal prices. Oil marketing companies lock in 
crude oil purchase costs in advance. Jewellers offset price risks in gold/silver inventory. 
3. Money market
Money markets are short-term debt markets where participants borrow and lend for durations typically 
up to one year. Money market instruments in India include treasury bills, commercial paper, certificates 
of deposit, repo and reverse repo agreements. 
For example, a manufacturing company sometimes issues commercial paper with 3 month maturity 
Page 5


486
CSEET Reference Reading Material - I
Economic and  
Business Environment
INDIAN FINANCIAL MARKETS
LESSON 4
487
Economic and  
Business Environment
INTRODUCTION
The financial markets play a vital role in the modern economy by facilitating capital formation, 
enterprise growth, risk management, and free exchange of capital. Financial markets in particular 
help direct resources to their most valuable use, fueling innovation and employment. A well-regulated, 
transparent system allows both small investors and large corporations to raise money in public securities 
markets. This lowers the cost of capital for businesses while offering optionality and wealth growth 
opportunities. By incorporating myriad views into pricing, the exchanges also guide capital allocation 
decisions through information discovery.
Financial markets refer to the markets where buyers and sellers participate in the trade of assets like 
equities, bonds, currencies and derivatives. Financial markets provide a platform for investors to invest 
money in securities and for companies to raise money by issuing securities. The securities are traded on 
exchanges like the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) in India. Stock 
market allows companies to raise capital by issuing shares to the public and investors to purchase 
shares of companies.
Financial markets are the organisations, systems, and venues that permit the buying and selling of 
financial assets like derivatives, stocks, bonds, currencies, and commodities. Financial markets’ primary 
goal is to make it easier for money to move from savers to borrowers, giving people, businesses, and 
governments a way to invest and finance their endeavours. Financial markets are vital to the smooth 
operation of capitalist economies.
In other words, financial markets refer broadly to any marketplace where securities trading occurs, 
including the stock market, bond market, forex market, and derivatives market. Financial markets are 
vital to the smooth operation of capitalist economies.  
Thus, the key points pertaining to the financial markets are-
	 l	 Financial markets refer broadly to any marketplace where the trading of securities occurs.
	 l	 There are many kinds of financial markets, including (but not limited to) forex, money, stock, 
and bond markets.
	 l	 These markets may include assets or securities that are either listed on regulated exchanges or 
trade over-the-counter (OTC).
	 l	 Financial markets trade in all types of securities and are critical to the smooth operation of a 
capitalist society.
	 l	 When financial markets fail, economic disruption, including recession and rising unemployment, 
can result.
The term “Indian financial market” refers to the country’s system of institutions, instruments, and rules 
that play a key role in streamlining the exchange of money between market participants.
FUNCTIONS OF FINANCIAL MARKET 
The following are the major functions of Financial Market:
 1. Facilitating capital formation: Financial markets allow companies to raise fresh capital from 
investors to finance their operations or expansion plans. This helps businesses grow and create 
jobs, leading to economic growth.
Lesson 4 - Indian Financial Markets
488
CSEET Reference Reading Material - I
Economic and  
Business Environment
 2. Price discovery: Prices of all financial instruments are determined through market forces like 
supply-demand dynamics in these markets. This helps buyers and sellers determine fair prices for 
a given security or asset class at any given time. 
 3. Allocating capital efficiently: By allowing investors to allocate their capital across different 
classes of assets according to their risk appetite, financial markets help ensure that resources 
are allocated efficiently across various sectors of the economy.
 4. Risk management tools: These markets also offer sophisticated risk management tools such 
as derivatives which can be used by institutions or individual traders seeking exposure without 
taking on too much risk or leverage levels beyond what they can manage effectively.
Financial markets are an essential part of the global economy. They provide a platform for investors to 
trade securities and commodities, helping allocate resources efficiently across different asset classes 
and countries. Financial markets have become increasingly interconnected in recent years, allowing 
capital to move more quickly worldwide and making it easier for businesses to access capital when 
needed.
Financial markets play an indispensable role in facilitating the transfer of capital, aiding in price discovery, 
and managing risks. Understanding the different types of financial markets and their functions is crucial 
for any business or individual seeking to participate in the global financial system.
Types of Financial Markets 
1. Capital Market
Capital markets are marketplace where buyers and sellers engage in the trade of securities like bonds, 
stocks, and derivatives. Capital markets channel savings and investment between suppliers of capital 
such as retail investors and institutional investors, and users of capital like businesses, government, and 
individuals. Capital markets in India consist primarily of the stock exchanges like NSE and BSE where 
investors buy and sell shares, bonds, and derivatives. The main usage of capital markets is to allow 
Indian companies across sectors to raise long-term capital from investors across India. This capital is 
used to fund growth and projects for business expansion. It provides an alternative to limited bank 
lending. For investors, it provides an avenue to allocate savings into financial securities to build wealth 
over time. 
 a) Stock Market: Stock markets allow companies to raise capital by issuing and selling shares or 
stock to investors. The two main stock exchanges in India are the National Stock Exchange 
(NSE) and the Bombay Stock Exchange (BSE). Companies list and trade their shares on these 
exchanges to access equity financing from investors across the country.  Stock markets provide 
an avenue for companies to access capital for business purposes like investing in new projects 
or acquisitions. It offers an alternative to traditional bank lending. For investors, it serves as a 
platform to allocate savings and build wealth. 
 b) Bond market: Bond markets are used by organisations like governments and companies raise 
debt financing by issuing bonds that are purchased by investors. The bond market segments 
in India include the government bond market, corporate bond market, and municipal/local 
bonds. 
The Indian bond market consists of both government and corporate bonds. Government securities, 
including treasury bills and bonds issued by the Reserve Bank of India (RBI) on behalf of the Government 
489
Economic and  
Business Environment
Lesson 4 - Indian Financial Markets
of India, form a significant portion of the bond market. Corporate bonds are issued by companies to 
raise funds for various purposes, such as expansion, working capital, and debt refinancing. The bond 
market provides investors with fixed-income securities, offering regular interest payments and the return 
of principal upon maturity.
2. Commodity market
Commodity markets are markets that facilitate the trading of primary economic goods like agricultural 
products, metals, oil and natural gas. The main commodity exchanges in India are MCX and NCDEX. 
For example, NCDEX allows farmers, traders, and processors to trade in agricultural commodities like 
wheat, rice, cotton, spices, etc. through futures contracts. This provides price risk management in agri-
commodities.  Similarly, on MCX traders buy and sell futures contracts on metals like gold, silver, copper, 
natural gas, crude oil etc. Jewellers hedge their price risk on gold inventory using gold futures.
The main usage of commodity markets in India is to provide price discovery and price risk management 
for producers, consumers and traders of commodities. It helps integrate localised commodity markets 
across India into one national market. Commodity derivatives also allow better inventory planning for 
companies. 
 a) Soft commodities: Soft commodities refer to agricultural commodities that are grown, rather 
than mined. They include crops like wheat, rice, pulses, spices, coffee, tea, cotton, rubber, fruits 
and vegetables. The National Commodity and Derivatives Exchange (NCDEX) in India provides 
a platform for trading in various soft commodities. For example, it allows futures trading in 
wheat, chana, soybean, mustard seed, cotton, cardamom, mentha oil, etc. This helps farmers, 
producers and exporters hedge against price risks. 
  The main usage of soft commodity trading in India is price discovery and risk management. It 
provides valuable information on demand, supply and prices to all participants. Farmers lock in 
future selling prices for their produce. Processors like flour mills hedge against raw material price 
changes. The efficient price signals lead to higher farm productivity and food security.
 b)  Hard commodities: Hard commodities refer to natural resources that are mined or extracted, 
rather than grown agriculturally. They include precious metals like gold, silver, platinum, base 
metals like aluminium, copper, nickel, lead, zinc and energy commodities like crude oil, natural 
gas and coal. 
In India, hard commodities are traded on exchanges like the Multi Commodity Exchange (MCX) and 
National Commodity and Derivatives Exchange (NCDEX). For example, MCX offers futures trading in 
gold, silver, copper, crude oil, natural gas, aluminium, nickel, mentha oil, cotton etc. This facilitates 
price discovery and hedging for producers, consumers and traders.
The key usage of hard commodity derivatives in India is managing price volatility and inventory risks. 
Mining companies hedge against fluctuations in global metal prices. Oil marketing companies lock in 
crude oil purchase costs in advance. Jewellers offset price risks in gold/silver inventory. 
3. Money market
Money markets are short-term debt markets where participants borrow and lend for durations typically 
up to one year. Money market instruments in India include treasury bills, commercial paper, certificates 
of deposit, repo and reverse repo agreements. 
For example, a manufacturing company sometimes issues commercial paper with 3 month maturity 
490
CSEET Reference Reading Material - I
Economic and  
Business Environment
to raise short-term working capital funds from investors instead of taking a bank loan. The investors 
purchasing this commercial paper will earn short-term returns while their money is parked for 3 
months.
The main usage of money markets in India is to allow businesses, financial institutions, government 
and investors to borrow and lend for very short periods. It serves as an alternative to bank borrowing 
and provides short-term liquidity in the economy. For businesses, it offers flexibility in managing cash 
flows. For investors, it provides very liquid and low-risk short-term investment options like treasury bills. 
An active money market is essential for the Reserve Bank of India to conduct effective monetary  
policy. 
4. Derivatives market
Derivatives markets provide instruments like futures, options, swaps etc. that derive their value from an 
underlying asset. They allow the transfer of risk from parties who want to hedge their risk exposure to 
parties more willing to bear that risk. 
For example, an Indian farmer will be able to buy a futures contract to sell his crop at a future date for 
a predetermined price. This protects him from potential decrease in crop prices at harvest time. The 
speculator taking the opposite trade is bearing the price risk in exchange for a potential profit if prices 
rise.
The main usage of derivatives markets in India is to allow hedging and speculation on asset prices. For 
producers and businesses, it provides a means to hedge against commodity price risk, interest rate 
risk and currency rate risks. For investors, it provides avenues to speculate and profit from movements 
in underlying asset prices. India has active derivatives markets in equity, commodities and currencies. 
These markets impart liquidity and price discovery to the underlying cash markets. 
 a)  Futures: Futures markets provide standardised contracts that obligate the buyer to purchase 
an asset and the seller asset and the seller to sell an asset at a predetermined future date and 
price. The contracts are standardised by the exchanges on the quantity, quality and delivery 
specifications. The main usage of futures markets in India is to allow hedging and speculation 
on future asset prices. For producers like farmers, it provides price protection against potential 
adverse price movements. For speculators, it provides an opportunity to profit from correct 
bets on future price trends. India has active futures markets in equities, commodities, currencies 
and bonds. These provide price discovery of the underlying cash markets and improve their 
liquidity. 
 b) Forward: The forward market is an over-the-counter market where two parties enter into 
customised contracts to buy or sell an asset at a specified price on a future date. The terms are 
agreed bilaterally unlike the standardised contracts traded on futures exchanges. The main 
usage of the forward market in India is to hedge against currency and commodity price risks. 
Exporters, importers and commodity producers use forward contracts to lock in future prices 
and mitigate risks. Speculators provide liquidity and absorb risks in the forward market. While 
smaller in size compared to futures markets, the forward market provides flexibility as terms are 
customised as per needs.
 c) Option: Option markets refer to derivatives exchanges where financial securities known as 
options are traded. An option is a contract that gives the buyer the right, but not the obligation, 
to buy or sell an underlying asset at a predetermined price on or before a specific date.