September 11, 2020

FINANCIAL MARKET AND KEY TERMS TO CRACK CASE STUDIES- CLASS 12 BUSINESS STUDIES

FINANCIAL MARKET CLASS 12

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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Author & Editor

This blog was made by Dhruv Panjrolia and Drashti Panjrolia. Major contributions in the process were made by Mousmi Shrivastava and Kalindi Chokshi

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