Introduction to Financial Markets - Study Notes
Lesson summary
Business firms need large funds for their projects and governments need funds to provide goods and services. The financial market helps both raise money by issuing and selling instruments, and helps investors put surplus funds to work and earn a return. It provides both short term and long term finance.
Indian financial system
| Organised sector | Unorganised sector |
|---|---|
| Regulators | Money lenders |
| Financial institutions | Indigenous bankers |
| Financial markets | |
| Financial services |
4.01 Meaning and definition
- A market wherein financial instruments such as financial claims, assets and securities are traded is a financial market.
- It is a channel through which loanable funds flow from a supplier with excess assets to a demander with a deficit of funds.
- Brigham, Eugene F: the place where people and organisations wanting to borrow money are brought together with those having surplus funds.
- It creates and exchanges financial assets from household savers to business firms or financial institutions.
4.02 Scope
The market gives financial assistance to individuals, agricultural, industrial and service sectors, banks, insurance sectors, provident funds and the Government, in time and for both short and long terms. This leads to overall economic development.
4.03 Types of financial markets
| Basis | Markets |
|---|---|
| Type of financial claim | Debt market (government bonds, corporate debentures); equity market (equity shares) |
| Maturity of claim | Money market (one year or less: Treasury Bills, Commercial Paper, Certificates of Deposit); capital market (more than a year: shares, debentures) |
| Time of issue | Primary market (first sale, money goes directly to issuers); secondary market (already issued securities; stock exchange) |
| Timing of delivery | Cash or spot market (immediate settlement); forward or futures market (pre-determined future time) |
| Organisational structure | Exchange traded market (centralised, standardised); over-the-counter market (decentralised, customised) |
The classification is not rigid; one market may fall under more than one category.
4.04 Role
- Savings mobilisation: obtaining funds from surplus units.
- Investment: placing the funds with units that need them.
- National growth: unfettered flow of surplus funds to deficit units.
- Entrepreneurship growth: making financial resources available to entrepreneurs.
- Industrial development: faster industrial and economic growth and a higher standard of living.
4.05 Functions
Intermediary functions: transfer of resources, enhancing income, productive usage, capital formation, price determination (price discovery), sale mechanism (marketability and liquidity) and information (lower transaction cost).
Financial functions: funds for borrowers, earning assets for lenders and liquidity in the market.
4.06 New issue market vs secondary market
| Basis | New issue market | Secondary market |
|---|---|---|
| Buying | Direct | Indirect |
| Financing | Funds new and existing companies | No funding to companies |
| Times sold | Only once | Multiple times |
| Between | Company and investors | Investors |
| Gainer | Company | Investors |
| Intermediary | Underwriters | Brokers |
| Price | Fixed | Fluctuates with demand and supply |
| Organisation | No specific spot | Physical existence |
Financial assets
- Marketable: easily transferred, e.g. listed shares, government securities, PSU bonds.
- Non-marketable: not easily transferred, e.g. bank deposits, provident and pension funds, National Savings Certificates, insurance policies.
- The purpose decides the asset: a building for residence is a physical asset; bought for hiring it is a financial asset.