Overview of Financial Markets
Financial Markets are an important component of a country’s financial system. It is the infrastructure that connects lender and borrowers. In simple terms, individuals who have surplus money invest in securities and entities which requires capital issues securities. The investors earn a return on the security while the entity gets capital for growing or expanding its business. Let us understand this with the help of an example. Person A has excess amount and wants to invest it. He can deposit the amount in bank and earn a fixed interest. However, if he invests in stocks, he can earn higher returns. The financial market creates an alternative for the individual who has a higher risk appetite and wants to earn higher returns. Banks also use the money we deposit for giving loan to companies. In Financial Market, we directly lend money to companies and get interest or returns. Financial markets are a mechanism for the exchange trading of financial products within a policy framework. They are characterized by a large volume of transactions and the speed with which financial resources move from one owner to the other. They perform the important functions of an efficient payment mechanism, providing information about companies, enhancing liquidity of financial claims, transmutation of financial claims to suit the preferences of both savers and borrowers, diversification and reduction of risk, and an efficient source for capital generation and investment. Financial Markets consist of two distinct types of markets – Money Market and Capital Market.
The money market is a market for short-term debt instruments with maturity below one year. It is a highly liquid market where securities are bought and sold in large quantities to reduce transaction cost. Such securities are often risk free. Call money market, certificates of deposits, commercial paper, repo and treasury bills are the major instruments of the money market. Money market constitutes a very important segment of the financial system as it facilitates the conduct of monetary policy.
The main investors in money market are financially strong entities such as banks and mutual funds. Participation of retail investors is less due to low returns in comparison to other markets. The money market is regulated by the Reserve Bank of India.
Capital market is an institutional arrangement for the trading of medium and long-term securities or equity and debt. The major purpose of capital markets is to mobilize long-term savings and finance long-term investments. It also provides liquidity with a mechanism enabling the investor to sell financial assets, encourages broader ownership of productive assets, lowers the cost of transactions and information and improves the effectiveness of capital allocation by way of a competitive pricing mechanism. So, it comprises of all long-term borrowings from banks as well as financial institutions, borrowings from foreign markets and raising of capital by issuing several securities such as shares, debentures, bonds, etc.
The market participants in capital markets is widespread and includes everyone from Retail Investors to Strong Financial Entities such as Banks and Mutual Funds. SEBI is the main regulator when it comes to capital markets.Capital markets can be further classified into primary and secondary markets.
·Primary Markets – The primary market is also known as the new issue market. It consists of mechanisms for procurement of long-term funds by fresh issues of shares and debentures.
·Secondary Market – The secondary market is also called the stock market. It provides a ready market for long term securities. The secondary market has two components: over-the-counter (OTC) market and the exchange traded market.
Types of Capital Markets
Debt market is the financial market where investors buy and sell debt securities, typically in the form of bonds. These markets are vital sources of funds, particularly in a developing economy like India. A fairly well-segmented debt market has emerged in India comprising the following:
·Private corporate debt market
·Public sector undertaking bond market
·Government securities market
The government securities market accounts for nearly 90 per cent of the business in the debt market. It constitutes the major segment of the debt market.
Equity market, often known as the stock market or share market, is a place where shares of companies or entities are traded. The market enables sellers and buyers to deal in equity or shares in the same platform. Equities are mostly traded on the stock exchanges in India. In the Indian stock market, equities are available for trading at the National Stock Exchange (NSE) , the Bombay Stock Exchange (BSE) and the latest entrant, Metropolitan Stock Exchange of India (MSE).
The Foreign Exchange Market, also known as the Forex Market, is a market where people can trade in currencies. It is one of the most liquid markets. Indian law allows forex trading only in currency derivatives. RBI and SEBI strictly regulates trading in foreign currencies in India. Hence, Forex Trading in India is not as prevalent as the stock market or money market.
A derivative instrument is a contract whose value is derived from the value of another asset, known as the underlying, which could be a share, a stock market index, an interest rate, a commodity, or a currency. The derivative market in India was introduced in the year 2000. Derivatives market can be classified into – forwards, futures, options and swaps.
We shall be covering these markets and relevant financial instruments in much more details in our future articles.