Financial Market enables the process of resource mobilisation in a country.
This market enables the transfer of funds from the zone of surplus to the zone of deficit.
- Zone of Surplus - Lenders
- Zone of Deficit - Borrowers.
- Borrowers - Mobilise the resource
- Lender - Invest the surplus.
Definition of financial market - The market which acts as an intermediary between these borrowers and lenders is termed as the financial market.
How does the transaction takes place between the borrowers and lenders?
These financial instruments are known as securities.
- Financial contract signed between a buyer and a seller.
- Evidence of transaction done between a borrower and lender.
Examples for securities
- Mutual Funds
- Regulated by SEBI
- SEBI - Securities & Exchange Board of India
- Governed by SCRA (1956)
- SCRA - Securities Contract Regulation Act
- Established in 1988
- Under SEBI act 1992 - Statutory Powers
- Headquarters - Mumbai
- To promote the development and regulation of the securities market
- To protect the interests of investors through education
Major differences in lending & borrowing between a bank and financial market
- In the financial market, there is a direct contact between the borrower and lender which is not present in the banking sector.
- The terms and conditions of the transaction are determined by the borrower in the financial market whereas it is determined by the lender in the banking sector.
Basic rules before investment.
- Safety / Risk
Safety / Risk
- Safety - The assurance of getting back the principal after the maturity period is known as safety.
- Risk - The probability of losing the capital during the investment process is known as risk
- The space unoccupied by the safety will be automatically occupied by the risk.
- Eg 90% safety means - 90% safe and 10% risk.
- The ability of an asset to get converted into cash completely and quickly.
- Liquidity - (Cash > Savings Deposit > Gold > FD)
- Near money - The assets maintained in liquid form.
- The amount we get back from an investment apart from the principal is known as returns.
- Risk is directly proportional to the Returns
- Returns are of 2 types
- Real returns = Nominal returns - Rate of inflation.
- Nominal returns
Safe instruments of investment
- Bank deposits - savings deposit, fixed deposits.
Classification of Securities (two types) in financial market
- Debt Securities
- Equity Securities
- The debt security is the one that represents a promise to pay back the principal and interest after the maturity period.
- It establishes a Creditor & Debtor relationship.
DEBT SECURITIES are of Two Types
- Short Term Securities
- Eg Treasury bills, Commercial Papers
- Long Term Securities
- Eg. Bonds, Debentures
- Equity Securities represent an ownership rights.
- No particular maturity period for the equity securities,
- Part ownership of the company.
- Share on profits and losses.
- The returns fluctuate based on the performance of an entity
- Equities are more risky and rewarding
- Eg. Shares
Financial Market Classification
- Money Market
- Capital Market
The market in which the transactions take place for a shorter period usually a year or less than a year. This market enables the generation of working capital. Money market doesn't involve the issuance of equity security.
Money Market are of Two Types (Regulator - RBI)
- Unorganised Money Market - Moneylenders, pawnbrokers, chits.
- Organised Money Market - GOI, banks, NBFCs, Industrial companies of India.
Organised Money Market
- Come Under RBI Control
- Eg. Treasury Bills, Certificate of Deposits, Commercial Papers, Call Money.
Short term debt security issued by central government. State governments are not permitted to issue treasury bills.
The maturity period of T-bills varies from 91, 182, and 364 days. They are financially superior than the other money market securities.
Certificate of Deposits.
- Short-term debt securities issued by the banks and financial institutions.
- The maturity period of a CD ranges from 7 days to 1 year.
- The CDs issued by NBFCs and FIs can be up to 3 years.
- The returns offered by the CDs are higher than treasury bills.
- These are short term debts issued by the Industrial companies.
- Credit rating is mandatory for commercial papers.
- Commercial papers offer more returns than Certificate of Deposit.
Call money is a segment under the money market in which financial transactions take place between a bank and an NBFC for a period of 0 to 14 days.
The call money market is divided into two segments.
- Over night market (0-1 day)
- At Short notice market (1-14 days)
Marginal standing facility (MSF) is the mechanism created by RBI to help the banks during the crisis in the overnight market. In this market, the banks can operate as lenders and borrowers. Whereas the non-banking financial companies can operate only as lenders.
The market in which transactions usually take place for a longer period usually more than a year. This market is utilized to start a new business or to expand the existing business. Both debt and equity security are issued in the capital market.
Capital market Classification.
Classification Based on Securities
- DEBT MARKET
- EQUITY MARKET.
DEBT MARKET TERMINOLOGIES.
- FACE VALUE OR PRINCIPAL VALUE
- INTEREST OR COUPON RATE
- MATURITY PERIOD
- BONDS & DEBENTURES
FACE VALUE OR PRINCIPAL VALUE -
the amount which will be paid back to the lender by the borrower at the end of the maturity period excluding the interest.
INTEREST OR COUPON RATE -
the periodical returns provided on a debt security is known as interest rate or coupon rate.
MATURITY PERIOD -
the period after which the principal will be paid back on a debt security.
the cumulative Returns received on debt security until a particular point of time or till the maturity period.
BONDS & DEBENTURES
They are long-term debts issued in the capital market. Bonds are issued by the government and top-rated corporates. The Debentures are issued only by privates. During insolvency and bankruptcy, bondholders are given more preference than debenture holders. As a result, Debentures provide a higher rate of returns than bonds.
- Safety -- Bonds > Debentures
- Returns -- Debentures > Bonds
During insolvency or bankruptcy, Bank > Financial Market (Money market> Capital market (Bond > Debenture > Share))
TYPES OF BONDS
- Fixed and Floating
- Discounted & At PAR
- Convertible/ Non convertible
- Government/ Industrial
- Green Bonds
- Angel Bonds / Junk Bonds
- Masala Bonds
- Perpetual bonds
- Overseas Sovereign Bonds
Fixed and Floating - Rate of interest are fixed or it changes.
Discounted Bonds & At PAR Bonds - When the debt securities are sold at their principal value, it is called At Par Bonds. When the debt securities are sold lower than the principal value, It is called Discounted bonds.
Treasury bills are always sold at discount.
Convertible/ Non convertible - The opposites are Debt(Debtor) and Equity(Owner). The debt securities which can get converted from one form to another form during their lifetime are known as Convertible debts. Eg. Converting Debt to Equity or Fixed to floating rate of interest. Non-convertible are the ones whose conditions cant be changed during their lifetime.
Government/ Industrial - If the Debt securities are issued by Government or Private companies.
Green Bonds - The bonds which are issued for generating capital for sustainable projects. It will have certain tax exemptions.
Angel Bonds / Junk Bonds - Angel Bonds are the bonds which carry higher credit rating. Junk Bonds are the bonds which carry comparatively Lower Credit rating. Both Junk Bonds and Angel Bonds are prevalent in Developed economies. Usually, Only Angel is prevalent in the developing economy.
Masala Bonds - Indian government sells the bonds only in rupees in India. But when it sells the bonds outside India they sell the bonds in Hard currency. But, Masala bonds are Rupee denominated bonds sold in the overseas market. Samurai Bonds - Japan started this trend. Panda Bonds are of China. Masala bonds will be more attractive for the investor during depreciation just like exports, tourism, etc.
Perpetual bonds - The bonds which run without any maturity period. The principal will not be paid back. In the Equity market, there is no assurance of interest as well as principal. But in Perpetual bonds, there is an assurance of interest and no assurance of Principal. They provide a higher rate of returns than the normal bonds.
Overseas Sovereign Bonds - Government bonds sold outside India (Overseas market)- OMO to decrease the amount of money in circulation in the domestic market. This mechanism avoids the Crowding out impact on our economy. It helps the government to bridge the deficit. It Aids our own economic growth. At the same time, our government may also face high-interest rate risk or exchange rate fluctuation in the future. The Government bonds sold inside India are Sovereign bonds that are used for wealth generation.
Equity market Terminologies
- Equity / Equity Capital
- Equity Share
- Face Value
Equity / Equity Capital - The capital required for a company gets split into multiple pieces of equal value. The resultant single unit is known as equity. The capital generated through Equity mode is known as equity capital. The value of a single unit is known as face value.
When a company makes profits, then the profits are evenly distributed among the shareholders known as Dividends.
The face value of a company remains constant in the book of accounts unless it is changed by the company. The price which keeps on changing daily for a share is known as market price.
The market price is based on demand and supply. The demand and supply is based on the following
- Microeconomic performance of a company
- Macroeconomics of a country / Sector
- Global economic outlook
- The political stability of the country/globe
Classification Based on Transaction Nature
- PRIMARY MARKET
- SECONDARY MARKET
- Primary market is a market in which transaction of new securities take place.
- Also the transactions take place between the real borrower & real lender.
- Primary market enables the generation of resources by the Borrowers.
- This market provides the channel for sale & Purchase of existing Securities
- Transactions take place between the Buyers & Sellers
- Eg The stock Exchanges like BSE, NSE, etc.
- This market helps to liquidate the existing securities.
Primary Market Terms
Issuance of security
The process of selling new securities in the primary market by the borrower.
Type of Issues
- Public issues
- Private issues.
When the issuance process is restricted to a close group of participants, then it is a Private issue. Eg Family, Relatives, Selected companies, Banks, and HNIs.
Financial Market -
When the issuance process is permitted to all groups of participants, then it is known as a public issue.
Public issue are of two types
- IPO - Initial Public Offer
- FPO - Follow On Public Offer
Initial Public Offer (IPO) - When the new securities are entering the primary market for the first time.
Follow On Public Offer (FPO)- When the new securities are entering the primary market for consecutive times.
Both IPO and FPO help the company to generate capital.
Secondary Market Terms
- Listing and De-Listing
- DEMAT account
Listing and De-Listing-
The Process of entry of a company for the first time in the secondary market after finishing all the procedural formalities in the primary market is known as listing. Listing is always accompanied by the Listing Norms / Guidelines prescribed by the regulators. The companies which don't comply with the listing norms will be taken out of the secondary market referred to as Delisting.
De-Materialization, DEMAT account, and Broker -
The process of providing the security certificates in electronic format is known as the dematerialization. The account through which dematerialized transactions can be carried out is known as the Demat account. (It is similar to a bank account). The companies which provide the Demat account are known as brokers. A broker is a company registered under the Companies act of India and regulated by SEBI. The commission charged by the brokers on the clients based on their transaction value is known as brokerage.
- SENSEX and NIFTY
- Bull Market
- Bear Market
SENSEX and NIFTY -
They are the market averages / Indices which represent the overall strength and weakness of an economy.
SENSEX - SENSEX means sensitive index. SENSEX indicates the secondary market movements of 30 companies in the BSE (Bombay Stock Exchange)
NIFTY - NIFTY means National Index 50. It indicates the secondary market movements of 50 companies in the NSE (National Stock Exchange).
Bull Market and Bear Market
A bullish market is a scenario of a continuous rise in prices in the secondary market. The bullish market indicates the higher levels of buying pressure and optimistic sentiments prevailing in the market. (20% higher from the previous lows).
The bearish market scenario of continuous fall in prices in the secondary market. Bearish market signals higher levels of selling pressure and pessimistic sentiments in the market. (20 % lower than the previous high).
Derivatives are the financial contracts in which the transaction will take place on a future date and time based on predetermined terms and conditions. The value of a derivative contract is based on the underlying asset based on which the contract is made.
There are 2 kinds of derivatives based on the underlying assets
- Financial derivatives - Based on financial products, shares, currency, Exchange rate, interest rate, etc.
Commodity derivatives /Physical derivative
- Commodity derivatives / Physical derivative- Gold, Crude oil, silver, rice, wheat, etc
Based on the nature of contracts derivatives fall under 4 categories.
- Futures - Standard one
- Forwards - Personalised One
Regulative Body for derivatives - SEBI (Previous - FMC forwards market commission)
Futures and Forwards -
These are the derivatives that provide the rights and obligations to buy or sell in the future based on predetermined terms and conditions. Futures are derivatives that are sold through regulatory mediums. Futures are standardized contracts. Forwards are derivatives that are exchanged between the parties of the contract. Forwards are more customized than the Futures.
These are the derivatives that provide the right but not the obligations on the part of the buyer in the future based on predetermined terms and conditions. At the same time, the seller has got the obligation to sell when the buyer exercises his right to buy.
Swaps are a type of derivative contract in which the cash flow of one asset is exchanged for the cash flow of another asset. Sometimes, a swap contract may also involve the transfer of entire assets during the contract period. Eg. Interest rate swap, Exchange rate Swap, Commodity Swap / Currency swap, etc.
Mutual Fund is a concept of collecting money from different sources and investing on their behalf in the financial market by the SEBI registered companies. A mutual fund provides the knowledge required to handle the market and also saves time for the people. At the same time, mutual fund investments are also subject to Market risks.
Net Asset Value (NAV) of a mutual fund = (Total number of units x Market price of a single unit).
Systematic Investment Plans (SIP) = When the mutual fund investments are done at regular intervals, then it is known as systematic investment plans. The contributions can be made in a weekly, fortnightly, monthly and quarterly manner.
Exchange-Traded Funds (ETF)
ETFs are the hybrid instruments that exhibit the characteristic feature of a share and a fund. In simple words, the funds which are listed in the secondary market are known as ETFs. ETFs are riskier than the mutual fund. Eg. Bharat 22 ETF.
Financial market and Inflation
a) Financial market on Inflation
- Financial market yeild / returns / market capital increases ---> Money supply increases ---> Inflation
- Financial market yeild / returns / market capital decreases ---> Money supply decreases --> Inflation is reduced.
b) Inflation on Financial market
- Debt market = Higher Inflation on Financial market ----> Real yield decreases/ Nominal yield increases
- Equity market = Higher Inflation on Financial market ---> The price of shares in the secondary market will come down.
- High Inflation ---> Lending rate and Repo rate is increased by RBI---> Investment environment gets effected ----> Production decreases ---> Profit decreases ----> Price of the shares decreases.
- Optimum Inflation ---> Lending rate and Repo rate is decreased by RBI---> More Investment ----> Production increases ---> Profit increase ----> Price of the shares increases.
- Deflation / No /Low inflation ----> Slowdown in the Economy ---> Investment environment gets effected ----> Production decreases ---> Profit decreases ----> Price of the shares decreases.
Financial Market and Money Supply
Financial Market on Money Supply
- Financial Market is optimistic/ positive ---> Money Supply increases
- Financial Market is pessimistic ---> Money Supply decreases.
Money Supply on Financial Market
- Higher Money Supply ---> Easy sale of securities in the market ---> More Money for investment by company ---> More profit potential ---> Good performance of Equities in the secondary market.
- Higher Money Supply ----> Tight money policy by RBI ------> RBI sells security through OMO / Interest rate hike by RBI - Repo rate ---> Less Investment ----> Fewer Profits ---> Low performance of Equities
- Low Money Supply ---> Less investment --- > Low profits ----> Low performance of Equities
- Low Money Supply when intervened by RBI ---> Easy money policy ---> RBI purchases security through OMO / Interest rate is lowered by RBI - Repo rate ---> More investment ---> More profits ----> Good performance of Equities.
- High money supply when the inflation is optimal ---> Borrow money at a low-interest rate/borrowing cost
- Low Money supply when the inflation is optimal ----> compel the borrower to borrow the money at high borrowing cost.
Financial market and capital formation
Financial market on capital formation
- Optimistic Financial market on capital formation ---> More credibility and confidence on the financial market ---> Makes capital flows towards financial market ---> Fund generation becomes easier ---> This aids capital formation for a country.
- Pessimistic Financial market on capital formation ---> No confidence in the financial market ---> Lack of investors for securities ---> Less capital ---> Fund generation is tough ---> Hinders the capital formation process of the economy.
capital formation on Financial market
- High Capital formation ---> High investment ---> High profits ---> Good performance of Equities
- Low Capital formation ---> Low investment ---> Low profits ---> Bad performance of Equities
Financial Market and Interest rates
Positive Financial Market on Interest rates
- Positive Financial Market ---> More Money supply ---> When it is undisturbed by RBI, High investment ---> High profits ---> Good performance of Equities
- Positive Financial Market ---> More Money supply ---> When RBI implements Tight money policy, Repo rate is Hiked----> Banks increase the lending Rate ---> Low investment ---> Low profits ---> Bad performance of Equities.
Negative Financial Market on Interest rates
- Negative Financial Market ---> Low Money supply ---> Low investment ---> Low profits ---> Bad performance of Equities
- Negative Financial Market ---> Low Money supply When RBI implements Easy money policy, Repo rate is decreased ----> Banks decrease the lending Rate ---> high investment ---> high profits ---> good performance of Equities.
Higher financial market will result in Higher interest rate. Lower financial market will result in Lower interest rate.
Interest Rate on Financial Market
- High-Interest Rate on Financial Market ---> Low investment ---> Low profits ---> Negative performance in the financial market.
- Low-Interest Rate on Financial Market ---> High investment ---> High profits ---> Positive performance in the financial market.
Financial market and Public Finance
Financial market on Public Finance
- Positive Financial market ---> Easy/quick generation of resources by the government from money or capital market- T-bill sale, Sale of bonds, Disinvestments of PSUs
- Negative Financial market -- > Difficult to generate resources by the government from money or capital market Eg - Very less scope for sale of securities or disinvestment
Public Finance on Financial market
- Positive / Surplus Public Finance on Financial market ---> Good credit rating for the government ---> Low tax rates ---> Less borrowing from the market ---> Avoids crowding out effect --->Helps the government to borrow at low cost from overseas market.
- Negative / Deficit Public Finance on Financial market ---> Bad credit rating for the government ----> More tax rates---> more borrowing from the market ---> crowding out effect since less money to borrow for the private sector since people prefer Gsecs ---> Burdens the government to borrow at high cost from the overseas market Eg Sovereign bonds, etc.
Positive financial market indicate positive economic growth of a country and negative financial market indicate negative economic growth of a country. Higher Economic growth results in positive financial market and Vice versa
Financial Market and Employment
Financial Market on Employmant
Positive Financial Market indicates the strength of the company. Strength - More production possibilities. It Demands more labour force . This increases employment opportunities.
Negative Financial Market results in less employment oppurtunities.
Employment on Financial Market
- More employment potential (Skilled / Educated workforce ) --->Enables positive
- Less employment potential (Less Skilled / Educated workforce in the country ) ---> Makes the company depend on the imported workforce ---> Drain of FOREX resource of the country
Financial Market and Exchange Rate
Financial Market on Exchange Rate
- Positive Financial Market ---> Attract more capital into our country ---> Investment come in terms of foreign currency --->Selling of Foreign currency Buying of Rupee ---> Demand of Rupee increases ---> Currency will Appreciate.
- Negative Financial Market ---> Flight of capital from our country ---> The money goes out in terms of foreign currency---> Creates more selling pressure on the Rupee---> More supply of Rupee in the Economy ---> Currency will Depreciate.
Exchange Rate on Financial Market
- High Exchange Rate (Appreciation) ---> Favors importers --> Good for importing companies ---> Bad for exporting companies.
- Low Exchange Rate (Depreciation) ---> Favors Exporters--> Good for Exporting companies (Infosys, Software, Pharma ) ---> Bad for importing companies.
Financial market and foreign investments
Financial market on foreign investments
- Positive Financial market ---> More Capital flows into the country
- Negative Financial market ---> Flight of Capital from the country
Foreign investments on Financial market
- High foreign investments ---> More Capital flows (FDI and FPI) ---> Entry of new technologies ---> Improvement of production efficiencies of our companiies.
- Low foreign investments / Drain of capital ---> Reduces the money for investment ---> Brings down thre global image on our economy / market ---> Affects the financial market negatively.
Financial market and Sectors of the economy
Financial market indicates the strenght and weakness of various sectors of an economy. The Sectoral strenght aand sectoral weakness gets represented exactly in the financial market. This helps the government of a country to frame the macro economic policies by identifying the sectoral weakness or strength indicated by the financial market.