Financial Market Chapter Notes | Business Studies (BST) Class 12 - Commerce PDF Download

Understanding Financial Markets

A financial market is a platform where financial assets are created and exchanged. It plays a crucial role in the economy by facilitating the transfer of funds from savers to borrowers, thereby supporting economic growth and development.

Functions of Financial Market

• Mobilization of Savings: The financial market helps in gathering savings from individuals and institutions and channels these savings into productive investments. This process is essential for economic growth as it ensures that funds are directed towards projects and businesses that can generate returns and create jobs.
• Facilitating Price Discovery: The financial market aids in determining the prices of financial assets through the forces of supply and demand. This process ensures that prices reflect the true value of assets based on market conditions.
• Providing Liquidity: The financial market offers liquidity to financial assets, allowing investors to easily buy and sell these assets. This liquidity is vital as it provides investors with the flexibility to convert their assets into cash when needed.
• Reducing Transaction Costs: The financial market minimizes the costs associated with transactions by providing necessary information related to financial securities. This reduction in transaction costs makes it easier and cheaper for investors to trade securities.

Types of Financial Markets

Financial markets can be classified into two main categories: the money market and the capital market.

Money Market

The money market deals with short-term funds and monetary assets with a maturity period of up to one year. Major participants in the money market include the Reserve Bank of India (RBI), commercial banks, non-banking finance companies (NBFCs), state governments, large corporate houses, and mutual funds.

Money Market Instruments:

• Treasury Bill: A short-term instrument issued by the Reserve Bank of India on behalf of the central government to meet its short-term funding requirements. Treasury bills have a maturity period of no more than one year and are also known as zero-coupon bonds.
• Commercial Paper: Commercial papers are short-term unsecured promissory notes issued by large and creditworthy companies to raise short-term funds at lower interest rates than market rates. They are sold at a discount and redeemed at par, with a maturity period typically ranging from 15 days to one year.
• Call Money: Call money refers to short-term finance that is repayable on demand, with maturity periods ranging from one to 15 days.
• Certificate of Deposit: Certificates of deposit are unsecured, negotiable, short-term instruments in bearer form issued by commercial banks and development financial institutions.
• Commercial Bill: A commercial bill is a short-term negotiable, self-liquidating bill of exchange used to finance the working capital requirements of business firms.

Capital Market

The capital market is where long-term funds, both debt and equity, are raised and invested. Shares and debentures are the main securities traded in this market. An ideal capital market offers finance at a reasonable cost.

The capital market can be divided into two parts:

• Primary market: The primary market is where securities are sold for the first time to raise long-term capital. It is also known as the New Issues Market. Companies can raise capital through equity shares, preference shares, debentures, loans, and deposits in this market.
• Secondary market: The secondary market is where existing securities are bought and sold without the intervention of the issuing company. Its primary purpose is to create liquidity in securities.

Distinction between Capital Market and Money Market

Stock Exchange

Definition of stock exchange according to securities contracts (Regulation) Act 1956: 

• Stock exchange means anybody of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying and selling or dealing in securities.

Functions of a Stock Exchange:

• Providing Liquidity and Marketability to Existing Securities.
• Share prices are determined by the forces of demand and supply.
• The investing public gets a safe and fair deal because its dealings are well defined according to the existing legal framework.
• A stock exchange provides liquidity to securities. This gives the investor a double benefit –first, the benefit of the change in the market price of securities can be taken advantage of, and secondly, in case of need for money they can be sold at the existing market price at any time.
• The stock exchange ensuring a wider ownership by regulating new issues, better trading practices and taking effective steps in educating the public about investment.
• When securities are purchased with a view to getting profit as a result of change in their market price, it is called speculation.

Trading

Advantage of electronic trading systems:

• It ensures transparency, increases the efficiency of information, and enhances the efficiency of operations.

Steps in the Trading and Settlement Procedure:

• If an investor wishes to buy or sell any security, he must first register as a broker or sub-broker and enter into an agreement. This requires mandatory information such as PAN number, date of birth and address, educational qualification and occupation, residential status, bank account details, depository account details, name of any other broker with whom registered, and client code number in the client registration form.
• The investor must open a ‘demat’ account or ‘beneficial owner’ account.
• The investor places an order with the broker.
• The broker goes online to match the shares and best prices available.
• When the final deal is done, the broker issues a trade confirmation slip and contract note to the investor.
• After receiving a contract note, the investor must deliver the shares sold or pay cash for the shares bought.

Dematerialisation and Depositories:

• Dematerialisation: Dematerialisation is the process of converting a share certificate from physical form to electronic form.
• Depository: The investor must open a Demat Account with an organization called a depository.
• Rematerialisation: Physical shares can be converted into electronic form, or electronic holdings can be reconverted into physical certificates, a process called rematerialisation.

NSE (National Stock Exchange of India)

• Establishment: NSE was incorporated in 1992, recognized as a stock exchange in April 1993, and started operations in 1994. It was set up by leading financial institutions, banks, insurance companies, and other financial intermediaries.
• Objective: The objectives of NSE include establishing a nationwide trading facility for all types of securities, ensuring equal access to investors across the country through an appropriate communication network, providing a fair, efficient, and transparent securities market using an electronic trading system, enabling shorter settlement cycles and book entry settlements, and meeting international benchmarks and standards.
• Market Segments: NSE provides trading in two segments: the Wholesale Debt Market Segment and the Capital Market Segment.

Wholesale Debt Market Segment:

• This segment offers a trading platform for a wide range of fixed-income securities, including central government securities, treasury bills, state development loans, bonds issued by public sector undertakings, floating rate bonds, zero coupon bonds, index bonds, commercial paper, certificate of deposit, corporate debentures, and mutual funds.

Capital Market Segment:

• This segment provides an efficient and transparent platform for trading in equity, preference shares, debentures, exchange-traded funds, and retail government securities.

BSE (Bombay Stock Exchange Ltd)

• Establishment: BSE Ltd was established in 1875 and is Asia’s first stock exchange. It was granted permanent recognition under the Securities Contract Act, 1956.
• Objective: BSE aims to provide a fair and transparent market for trading in equity, debt instruments, derivatives, and mutual funds. It also offers a trading platform for equities of small and medium enterprises and conforms to international standards. In addition to trading, BSE provides risk management, clearing, settlement, market data, and education.

SEBI (Securities and Exchange Board of India)

• Establishment: SEBI was established in 1988 and given statutory status through an Act in 1992. It was set up to protect the interests of investors and regulate the securities market.
• Purpose and Role: SEBI aims to create an environment for efficient mobilization and allocation of resources through the securities markets. It also seeks to stimulate competition and encourage innovation. SEBI’s role includes providing a market place for issuers to raise finances easily and fairly, protecting the rights and interests of investors, and offering a competitive and professionalized market for intermediaries.
• Objective: SEBI's objective is to regulate stock exchanges and the securities industry to promote orderly functioning, protect the rights and interests of investors, prevent insider trading and malpractices, and develop a code of conduct for intermediaries.
• Functions: SEBI’s functions are divided into regulatory, development, and protective functions. Regulatory functions include registering brokers, sub-brokers, and other market players, regulating stock brokers and other market participants, and overseeing takeover bids by companies. Development functions involve training intermediaries and conducting research to benefit all market participants. Protective functions focus on investor protection, controlling insider trading, and promoting fair practices in the securities market.
• Organizational Structure: SEBI is divided into five operational departments, each headed by an executive director. Its office is in Mumbai, with regional offices in Kolkata, Delhi, and Chennai. SEBI also has advisory committees to advise on regulation and development of the primary and secondary markets.