• Financial market refers to a market where the creation and exchange of financial assets (such as shares and debentures) takes place.
Allocative Function of Financial Market
An important function of the financial market is known as the ‘allocative function’. A financial market acts as a link between the savers and the investors. It provides a platform for the mobilisation of savings from the households to the investors. Thus, it allocates funds from households to the investors.
• Consequences of Allocative Function
A well-performed allocative function has the following consequences:
i. A higher rate of return would be offered to the households.
ii. Resources are allocated to those firms that have the highest productivity.
Some terms related to allocative function
1. Financial Intermediation- It refers to the process through which the allocation of funds is carried out.
2. Financial Transactions- It refers to the transactions in the form of creation of new financial assets or sale and purchase of the existing financial assets.
Financial markets play a vital role in allocating scarce resources of the economy by performing the following functions:
1) Transfer of savings and alternatives for investment- A financial market acts as a platform for the mobilisation of savings from the households to the investors. In this way, it provides the investors with various alternative choices for investment.
2) Establishes the price- It provides a platform for the interaction of the demand and the supply of funds, thereby helping in determining the price of the asset being traded.
3) Facilitates liquidity- It renders liquidity to the assets in the sense that through trading (sale and purchase of assets) in the financial market, the assets can easily be converted into cash or cash equivalents.
4) Reduces the cost of transaction- It provides useful information about the various securities that are traded. In this way, it helps in reducing the cost of transaction in terms of time, effort and money for both the buyers and sellers.
Classification of Financial Market Financial
market can be classified into two broad categories: Capital market and Money market.
• Money Market
It refers to the market for trading of short-term securities and funds. Securities traded in this financial market have a very short maturity period ranging from one day to one year.
INSTRUMENTS OF MONEY MARKET
i. Treasury Bill (T-Bills)
•These are highly liquid promissory notes used by the government for short-term borrowings.
• They are auctioned and issued by the RBI on behalf of the Central Government. • T-bills are available for a minimum of Rs 25,000 and in multiples thereof.
•They are issued at a discount and redeemed at par.
• T-bills are also known as zero-coupon bonds.
ii. Call Money
•Call money are used by the commercial banks to maintain their CRR (cash reserve ratio) requirements. That is, through call money, any bank that faces shortage of funds to maintain the minimum CRR borrows from other banks that have surplus funds.
•This instrument has a very short maturity period (ranging from 1 to 15 days).
•Interest paid on call money is termed as call rate.
• Call rate is highly volatile and varies on a day-to-day basis.
iii. Commercial Paper
•It is an unsecured, negotiable and transferable promissory note.
•They are mainly issued by large companies to raise short-term funds and serve as an alternative to bank borrowings and borrowings through capital market.
•Companies use commercial papers for bridge financing.
• Commercial papers have a maturity period ranging from a minimum of 15 days to a maximum of one year.
•The rate of interest payable on commercial papers is lower than the market rates.
iv. Certificate of Deposit
• They are negotiable, unsecured instruments in bearer form.
• CDs are issued to individuals, corporations and companies by commercial banks and financial institutions.
• They are used by commercial banks to meet the demand for credit during periods of tight liquidity.
•They are issued for a period of 91 days to 1 year.
• Higher interests are offered for higher deposits.
v. Commercial Bill
• Commercial bills are used by companies to finance their working capital requirements (for instance, to finance their credit sales).
• It is a short-term negotiable instrument used by companies to finance their credit sales.
• Herein, the seller draws a bill of exchange and gives it to the buyer.
• Once the buyer accepts the bill, it becomes a tradable instrument.
• The seller can then discount the commercial paper with a commercial bank and obtain cash.
Capital Market
A capital market refers to the market that deals in the trading of medium and longterm securities (having a maturity period of greater than or equal to one year). The instruments traded in capital market comprise equity and preference shares, debentures, bonds, etc.
Capital market can further be divided into two categories: Primary Market and Secondary Market
• Characteristics of Capital Market
1) It solely deals in trading of long-term securities.
2) It acts as a platform that links the savers and investors. It directs the savings of the households to their most productive use. In this way, it adds to the growth prospects of an economy.
3) It works strictly according to the guidelines and policies issued by the government.
4) Major intermediaries involved in the capital market include banks, brokers, transfer agents, etc.
Importance of Capital Market
1) Long-term resources- It facilitates the raising of long-term funds in the form of both debt and equity.
2) Facilitates growth- By channelising the savings to the most productive use, it facilitates growth and development of the economy.
3) Capital formation- It helps in capital formation by increasing and stimulating the level of savings and investments through productive channels.
4) Mobilises savings- It helps in channelising and mobilising the savings only in those places where they can be utilised efficiently and effectively.
Primary Market (New Issue Market)
Primary market refers to a market that deals with the issue of new securities. It directs funds towards those entrepreneurs who either want to start a new enterprise or wish to expand the existing one.
METHODS OF FLOATATION
i. Offer through prospectus- Under this method, a prospectus is published in newspapers, magazines, etc., in accordance with the guidelines and rules listed under the Companies Act and SEBI disclosure. The subscriptions are then invited from the public through this prospectus.
ii. Offer through sale- In this method, securities are issued through intermediaries by following the below-mentioned two steps:
• A company sells its securities to the intermediaries at the face value.
• Intermediaries in turn resell the securities to the investing public at a higher price than the face value, in order to earn profits.
iii. Private placement- In this method, the securities are sold only to some selected individuals and big institutional investors rather than to the general public. Herein, companies either allot the securities themselves or sell them to intermediaries who in turn sell these securities to selected clients.
iv. Rights issue- In this method, existing shareholders are offered subscription of new shares of the company in proportion to the number of shares possessed by them.
v. e-IPOs- It is a system of issuing securities through online system. Herein, the company gets into an agreement with the stock exchange. Then, it appoints brokers for accepting applications and placing orders for the securities.
• Secondary Market
Secondary market refers to a market that deals in the sale and purchase of existing securities. In other words, it deals in the trading of those securities that were initially issued in the primary market. It is also known as stock exchange.
FUNCTIONS OF SECONDARY MARKET
1) One of the basic functions of secondary market is to provide liquidity and marketability to the already existing financial assets and securities. It provides a ready platform for the trading of existing securities.
2) It enables a constant valuation of the securities and helps in building the demand and supply. In this way, it helps in determining the price of the securities.
3) It ensures safety and fairness in transactions.
4) It provides a platform for channelising the savings to the most productive use. In this way, it facilitates growth and development of the economy.
5) It takes various measures to educate people about investment and encourage wider ownership of securities. In this way, it spreads equity cult.
6) A stock market acts as an economic barometer. It indicates the level of economic activity in the country.
Steps Involved in Trading of Securities
1) Getting listed- The companies that want to sell their securities in the market first need to get them listed or quoted in the stock exchange.
2) Selecting a broker- After getting listed, the company appoints a broker for looking into the trade transactions.
3) Placing the order- As a next step, the company specifies the number and type of securities that it intends to sell.
4) Execution of the transaction- The brokers execute the order as per the instructions of the client. The transactions are executed through a computerised system.
5) Final settlement- The transactions of the stock exchange are finally settled on a cash or carry-over basis (which is also known as badla in the Indian stock market).
• Dematerialisation Account- A Dematerialisation Account (also known as Demat Account) is a pre-requisite for electronic trading in securities. In other words, if a person wants to trade the listed securities in electronic form, then it is mandatory for him/her to open up a Demat account in a depository bank.
• Depository- It is basically an organisation or an institution that holds the securities which are traded in the market. The services offered by a depository are known as depository services.
STEPS TO OPEN A DEMAT ACCOUNT
Steps to Open a Demat Account are as follows :
1. The owner first approaches the depository participant.
2. Documents such as identity proof, proof of address and PAN card are needed.
3. The owner signs an agreement that states the rights of both the owner and the depository participant.
4. The depository participant gives a copy of the agreement to the owner and the latter pays the due charges.
5. The depository participant now opens an account in the computerised electronic system and gives the owner a unique number––i.e., Beneficial Owner Identification Number.
6. The owner approaches the clearing houses/corporations
SECURITIES EXCHANGE BOARD OF INDIA ( SEBI)
ROLE OF SEBI
•Towards issuers- To provide a fair and efficient market for securities such that they can confidently raise finance in an easy manner.
•Towards investors- To provide protection to the investors against any kind of malpractices.
• Towards intermediaries- To offer a competitive and professionalised market such that the intermediaries are able to render their services in an efficient manner.
OBJECTIVES OF SEBI
The following are the primary objectives of SEBI:
1) Regulation- The primary objective of SEBI is to regulate the functioning of the stock exchange. It aims at providing a place where the issuers can raise funds in an easy and confident manner.
2) Protection- Another objective is to educate the investors by providing them valuable information regarding various securities and companies.
3) Prevention- It aims at combating various malpractices in trading of securities such as insider trading, violation of rules and regulations and non-adherence to Companies Act.
4) Code of Conduct- It aims to develop a code of conduct for fair trade practices by intermediaries such as brokers, merchant bankers and underwriters.
FUNCTIONS OF SEBI
i. Regulatory Functions
• Registration- Registers brokers, sub-brokers, agents and other players in the market.Regulating the work- Regulates the working of intermediaries such as stock brokers, underwriters and merchant bankers by framing rules and regulations for their operations.
• Regulation by legislation- Performs and exercises other authorities and powers which are delegated by the Government of India under the Securities Contracts (Regulation) Act, 1956.
ii. Development Functions
• Training- Provides training and development to the intermediaries of the securities market so as to promote healthy growth of the secondary market.
• Research- Conducts research in the important areas of the securities market so as to help investors and other market players make wise investment decisions.
• Flexible Approach- Adopts a flexible approach in trading by permitting internet trading, IPOs, etc.
iii. Protective Functions
• Prohibition- Prohibits fraudulent and unfair trade practices. In addition, it prevents the spreading of misleading statements which are likely to affect the functioning of the securities market.
• Checks on insider trading: Insider trading refers to a situation wherein an individual connected with the company leaks out crucial information regarding the company which may adversely affect its share prices. SEBI keeps a strict check on such practices.
• Promotion and protection- Encouraged fair trade practices and promotes a code of conduct for the intermediaries.
Key terms to Crack Case Studies
• New issue market — Primary market •Market for existing securities — Secondary market
• Arrangement by which banks borrow from each other to be able to maintain the cash reserve ratio — Call money
•Bridge financing — Commercial papers •Market for short term funds — Money market.
•Market for medium term and long term funds — Capital market
• Zero coupan bonds issued by RBI on behalf of Govt. of India —Treasury belts •Institution holding securities in electronic form — Depository
• Holding securities in electronic from — Dematerialisation
• Watch dog of securities market — SEBI •Allotment of securities to institutional investors —Private Placement
• Selling shares to investing public through intermediaries — Offer for sale. •Offering new shares to existing shareholders — Rights Issue
•Unsecured instrument issued in bearer form by commercial banks and financial institutions during the time of tight liquidity — Certificate of deposit.
• A person who accesses and uses the price sensitive information for his personal benefit — Insider Trading.
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