Chapter - 10

Financial Markets

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1. Definition: Financial markets are platforms where buyers and sellers engage in the trading of financial assets such as stocks, bonds, currencies, and derivatives. These markets facilitate the mobilization of savings and their allocation to productive uses, thereby supporting economic growth and development.

2. Nature of Financial Markets:

   • Facilitates Exchange: Provides a mechanism for trading financial instruments.

   • Mobilizes Savings: Channels individual and institutional savings into investments.

   • Determines Prices: Establishes prices for financial assets through supply and demand.

   • Provides Liquidity: Ensures that investors can buy and sell securities easily.

   • Reduces Transaction Costs: Offers efficient and cost-effective means of transacting.

 

Importance of Financial Markets

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1. Mobilization of Savings: Aggregates savings from individuals and institutions, directing them towards investment opportunities.

2. Capital Formation: Supports the creation and growth of capital, fueling business expansion and economic development.

3. Economic Growth: Facilitates the allocation of capital to productive ventures, leading to job creation and economic progress.

4. Price Discovery: Helps in determining the prices of financial assets, reflecting the underlying value and market conditions.

5. Liquidity: Ensures that financial assets can be easily converted into cash, providing investors with flexibility.

6. Risk Management: Provides mechanisms such as derivatives to hedge and manage financial risks.

 

Types of Financial Markets

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1. Money Market:

   • Definition: Deals with short-term funds and financial instruments with maturities of up to one year.

   • Instruments: Treasury bills, commercial paper, certificates of deposit, and call money.

   • Participants: Commercial banks, central banks, financial institutions, and corporations.

2. Capital Market:

   • Definition: Deals with long-term funds and financial instruments with maturities greater than one year.

   • Segments: Primary market (new issues) and secondary market (trading of existing securities).

   • Instruments: Equity shares, debentures, bonds, and preference shares.

   • Participants: Individual investors, institutional investors, corporations, and governments.

 

Primary Market

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1. Definition: The primary market, also known as the new issue market, is where new securities are issued and sold to investors directly by the issuing company.

2. Functions:

   • Raising Capital: Helps companies raise new capital to finance expansion and growth.

   • Price Discovery: Determines the initial price of new securities based on market demand.

   • Direct Investment: Provides investors the opportunity to invest directly in new ventures.

3. Methods of Floatation:

   • Initial Public Offering (IPO): The first sale of shares to the public by a private company.

   • Rights Issue: Offering additional shares to existing shareholders.

   • Private Placement: Selling securities directly to a select group of investors.

   • Offer for Sale: Securities are offered to the public through intermediaries.

 

Secondary Market

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1. Definition: The secondary market is where existing securities are traded among investors. It provides liquidity and marketability to financial instruments.

2. Functions:

   • Provides Liquidity: Ensures that investors can buy and sell securities easily.

   • Continuous Pricing: Facilitates the ongoing price discovery of securities based on supply and demand.

   • Safety and Transparency: Regulated to ensure fair trading practices and protect investor interests.

3. Stock Exchanges:

   • Definition: Organized and regulated markets where securities are bought and sold.

   • Major Exchanges: Bombay Stock Exchange (BSE), National Stock Exchange (NSE).

 

Financial Regulators

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1. Securities and Exchange Board of India (SEBI):

   • Role: Regulates and oversees the functioning of financial markets to protect investor interests and ensure fair practices.

   • Functions: Regulates stock exchanges, registers and regulates market intermediaries, oversees mutual funds, and ensures investor protection.

2. Reserve Bank of India (RBI):

   • Role: Regulates the money market and the banking system in India.

   • Functions: Formulates monetary policy, regulates the issuance of currency, and manages foreign exchange.

 

Financial Instruments

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1. Equity Shares: Represent ownership in a company and entitle shareholders to voting rights and dividends.

2. Debentures: Long-term debt instruments issued by companies to raise capital, promising a fixed rate of interest.

3. Bonds: Debt securities issued by governments and corporations to raise funds, with fixed interest payments.

4. Derivatives: Financial contracts whose value is derived from underlying assets, used for hedging and speculation.

 

Conclusion

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This chapter emphasizes that financial markets play a crucial role in the economic development of a country by facilitating the efficient allocation of resources, providing liquidity, and supporting capital formation. By understanding the structure, types, and functions of financial markets, managers and investors can make informed decisions that contribute to the overall financial stability and growth of the economy.

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