Monday, 17 September 2018

Classification of Financial Markets



In Financial Market, there are two markets namely Money Market and Capital Market and in Capital Market, there is primary market and secondary market. Let me explain you in detail about the Financial Market.


1. Money Market - The money market is a market for short term funds which deals in monetary assets whose period of maturity is upto one year. It is a market where low risk, unsecured and short term debt instruments that are highly liquid are issued and actively traded everyday. It has no physical location but is an activity conducted over the telephone.

Money Market Instruments
a) Treasury Bill - A treasury bill is basically an instrument of short-term borrowing by the Government of India maturing in less than one year. They are also known as zero coupon bonds issued by the Reserve Bank of India on behalf of Central Government to meet its short term requirement of funds.
Example: Suppose an investor purchases a 91 days Treasury bill with a face value of Rs 1,00,000/- for Rs 96,000/-. By holding the bill until the maturity date, the investor receives Rs 1,00,000/-. The difference of Rs 4,000/- between the proceeds received at maturity and the amount paid to purchase the bill represents the interest received by him.

b) Commercial Paper - Commercial Paper is a short term unsecured promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is issued by large and creditworthy companies to raise short term funds at lower rates of interest than market rates. It usually has a maturity period of 15 days to one year.
Example: Suppose a company needs long term finance to buy some machinery. In order to raise the long term funds in the capital market the company will have to incur floatation costs (costs associated with floating of an issue are brokerage, commissions, printing of applications and advertising etc). Funds raised through commercial paper are used to meet the floatation costs. This is known as Bridge Financing.

c) Call Money - Call money is short term finance repayable on demand with a maturity of one day to fifteen days, used for inter-bank transactions. Commercial banks have to maintain a minimum cash balance known as cash reserve ratio. The RBI changes the cash reserve ratio from time to time which  in turn affects the amount of fund available to be given as loans by commercial banks. Call Money is a method by which banks borrow from each other to be able to maintain the cash reserve ratio.

d) Certificate of Deposit - Certificates of Deposits are unsecured, negotiable, short term instruments in bearer form, issued by commercial bank and development financial institutions. They can be issued to individuals, corporations and companies during periods of tight liquidity when the deposit growth of banks is slow but the demand for credit is high.

e) Commercial Bill - A commercial bill is a bill of exchange used to finance the working capital requirements of business firms. It is a short term, negotiable, self-liquidating instrument which is used to finance the credit sales of firms. When goods are sold on credit, the buyer becomes liable to make payment on a specific date in future. The seller could wait till the specified date or make use of a bill of exchange.

2. Capital Market - The term capital market refers to facilities and institutional arrangements through which long term funds, both debt and equity are raised and invested. It consists of a series of channels through which savings of the community are made available for industrial and commercial enterprises and for the public in general. The Capital Market consists of development banks, commercial banks and stock exchanges. An ideal capital market is one where finance is available at reasonable cost. Capital Market consist of Primary Market and Secondary Market.

a) Primary Market - The primary market is also known as the new issues market. It deals with new securities being issued for the first time. The essential function of a primary market is to facilitate the transfer of investible funds from savers to enterprises or to expand existing ones through issue of securities for the first time. A company can raise capital through primary market in the form of equity shares, preference shares, debentures, loans and deposits.

Methods of Raising Capital through Primary Market
i) Offer through Prospectus - Offer through prospectus is the most popular method of raising funds by public companies in the primary market. This involves inviting subscription from the public through issue of prospectus. A prospectus makes a direct appeal to investors to raise capital, through an advertisement in newspapers and magazines.

ii) Offer for Sale - Under this method securities are not issued directly to the public but are offered for sale through intermediaries like issuing houses or stock brokers. In this case a company sells securities at an agreed price to brokers who in turn resell them to the investing public.

iii) Private Placement - Private placement is the allotment of securities by a company to institutional investors and some selected individuals like HNIs (High Net Worth Individuals). It helps to raise capital more quickly than a public issue.

iv) Rights Issue - This is a privilege given to existing shareholders to subscribe to a new issue of shares according to the terms and conditions of the company. The shareholders are offered the 'right' to buy new shares in proportion to the number of shares they already possess.

v) e-IPOs - A company proposing to issue capital to the public through the on-line system of the stock exchange has to enter into an agreement with the stock exchange. This is called an Initial Public Offer (IPO). SEBI registered brokers have to be appointed for the purpose of accepting applications and placing orders with the company.

b) Secondary Market - The secondary market is also known as the stock market or stock exchange. It is a market for the purchase and sale of existing securities. It helps existing investors to disinvest and fresh investors to enter the market. It also provides liquidity and marketability to existing securities. It also contributes to economic growth by channelising funds towards the most productive investments through the process of disinvestment and reinvestment.
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