Introduction to Financial

Market
Prof. Preeta Sinha

Financial System

A financial system means the structure

that is available in an economy.
It mobilizes capital from various surplus
sectors of the economy and allocate /
distribute to various needy sectors
Transformation of saving into investments
and consumption / spending (financial
assets) by the active role played by the
financial system financial intermediaries
The place where these activities take place
could be taken to connote the financial
market.

Financial system comprises a mixture

of intermediaries, markets and
instrument that are related to each
other.

Capital Formation process

1.Direct transfers of money and securities occur when a business

sells its stocks or bonds directly to savers, without going through
any type of financial institution. The business delivers its securities
to savers, who in turn give the firm the money it needs.
2. Transfers may also go through an Investment banking house
such as Merrill Lynch, which underwrites the issue. An underwriter
serves as a middleman and facilitates the issuance of securities.
The company sells its stocks or bonds to the investment bank,
which in turn sells these same securities to savers. The businesses
securities and the savers money merely pass through the
investment banking house. However, the investment bank does
buy and hold the securities for a period of time, so it is taking a risk
it may not be able to resell them to savers for as much as it paid.
Because new securities are involved and the corporation receives
the proceeds of the sale, this is called a primary market
transaction.

Investment Bank

An investment bank is a financial institution that

assists individuals, corporations and governments
in raising capital by underwriting and/or acting as
the clients agent in the issuance of securities eg:
IPO/ FPO work is handled by investment banks. An
investment bank also assist companies in mergers
and acquisitions, and provide ancillary services
such as market making, trading of derivatives,
fixed income instruments, foreign exchange,
commodities, and equity securities.
Ex: ICRA ,ICICI Securities ,Barclays ,Kotak Investing
Banks,IFCI

3. Transfers can also be made through a Financial

intermediary such as a bank or mutual fund. Here the
intermediary obtains funds from savers in exchange for its
own securities. The intermediary uses this money to buy
and hold businesses securities. For example, a saver might
deposit Rs. in a bank, receiving from it a certificate of
deposit, and then the bank might lend the money to a small
business as a mortgage loan. Thus, intermediaries literally
create new forms of capitalin this case, certificates of
deposit, which are both safer and more liquid than
mortgages and thus are better for most savers to hold. The
existence of intermediaries greatly increases the efficiency
of money and capital markets.

Questions

Identify three different ways capital

is transferred between savers and
borrowers
Why do policy makers promote the
globalization of financial markets?

Components of Financial
system
According to the structural approach, the
financial system of an economy consists
of
three main components:
1) Financial markets;
2) Financial intermediaries (institutions);
3) Financial regulators.
Each of the components plays a specific
role in the economy.

According to the functional approach,

financial markets facilitate the flow of funds
in order to finance investments by
corporations, governments and individuals.
Financial institutions are the key players in
the financial markets as they perform the
function of intermediation and thus
determine the flow of funds. The financial
regulators perform the role of monitoring and
regulating the participants in the financial
system.

Structure of Financial System

Financial Market

Financial Market

Financial market may be defined as

a transmission mechanism between
investors (or lenders) and the
borrowers (or users) through which
transfer of funds is facilitated.

Financial Market

It consists of individual investors,

financial institutions and other
intermediaries who are linked by a
formal trading rules and
communication network for trading
the various financial assets and
credit instruments

Financial Market

The financial markets act as a link

between these two different groups.

It facilitates this function by acting as

an intermediary between the
borrowers and lenders of money

Function of Financial Market

Mobilization of savings
Price discovery
Liquidity
Reduction of transaction cost

Function of Financial Market

Financial market gives strength to economy by
making finance available at the right place.
(1) Mobilisation of Savings and their
Channelization into more Productive Uses:
Financial market gives impetus to the savings of the
people. This market takes the uselessly lying finance
in the form of cash to places where it is really needed.
Many financial instruments are made available for
transferring finance from one side to the other side.
The investors can invest in any of these instruments
according to their wish.

Function of Financial Market

(2) Facilitates Price Discovery:
The price of any goods or services is determined by
the forces of demand and supply. Like goods and
services, the investors also try to discover the price
of their securities. The financial market is helpful to
the investors in giving them proper price.

Function of Financial Market

(3) Provides Liquidity to Financial Assets:
This is a market where the buyers and the sellers of
all the securities are available all the times. This is
the reason that it provides liquidity to securities. It
means that the investors can invest their money,
whenever they desire, in securities through the
medium of financial market. They can also convert
their investment into money whenever they so
desire.

Function of Financial Market

(4) Reduces the Cost of Transactions:
Various types of information are needed while
buying and selling securities. Much time and money
is spent in obtaining the same. The financial market
makes available every type of information without
spending any money. In this way, the financial
market reduces the cost of transactions.

Types of Financial Market

Financial markets can be

distinguished by the maturity
structure and trading structure of its
securities

Money & capital markets

1)
The

Money versus capital markets:

flow of short-term funds is

facilitated by money markets
The flow of long-term funds is
facilitated by capital markets

Characteristics of money market

Instruments

Short term Maturity

Highly liquid
Fluctuation in price is quite small
Safe
Low returns
Institutional investors
Monetary policy
Regulated by RBI

Money Market Instruments

Call/Notice
RBI liquidity by adjustment facility (LAF)
Repos and reverse repos
Collateralized borrowing & lending obligations
(CBLO)
Treasury Bills (T bills)
Commercial paper (CP)
Certificate of deposit (CD)
PSU bonds
Corporate Debentures

Characteristics of Capital
Market

Long term Maturity

Fluctuation in price is high
Suppliers are corporates and
governments
Regulated by SEBI

Primary & Secondary market

2) Primary versus secondary markets
Primary

markets facilitate the issuance

of new securities
e.g., the sale of new corporate
stock or
new Treasury securities
Secondary markets facilitate the
trading of existing securities
e.g., the sale of existing stock

Forex Market

3) Forex market

The foreign exchange market is a

market where foreign currencies are
bought and sold with the purpose of
trading.

The forex market is the largest in the

world with over trade worth $ 4 Trillion
on an average day.
In India there are three aspects of
Forex starting with the RBI which is the
overall regulator, the bank to bank or
inter bank trading and bank to
customer or merchant rate transaction
trading of foreign exchange.

The purpose of FOREX is to help

international trade and investment.
A FOREX market helps business
convert one currency to another.
In a typical foreign exchange
transaction a party purchases a
quantity of one currency by paying a
quantity of another currency.
The foreign exchange market started
forming during the 1970s

The FOREX is unique because of:-Its trading volumes-The extremely

liquidity of the market
-Its geographical dispersion
-Its long trading hours ,24hours a day
-The low margins of profit compared with
other market or fixed income but profits
can be high due to very large trading
volumes.

Exchange rates fluctuations are

usually caused by actual monetary
flows as well as by expectations of
change in monetary flows caused by
changes in GDP growth, Inflation,
interest rates,budget and trade
deficits or surpluses and other
macro-economic conditions.

Major participants
The participants in the foreign
exchange market are:Individuals
Firms
Banks
Governments
International Agencies

There are two tier system in the foreign

exchange market
One involves the transactions between
the ultimate customer and bank.
Other consists of the transaction
between the banks

Structure of the FOREX

The foreign exchange market in India
consists of three tier system :
The first consists of transactions between
RBI and the Authorized Dealers(ADs)
Second tier is the inter bank market in
which the Ads deal with each other
Third tier consists of transactions between
Ads and their corporate customer
The daily turnover in the Indian foreign
exchange market is currently estimated to
be between USD1.5 -3 billion.

The most important center is

Mumbai.

Other active centers are Delhi,

Kolkata,Chennai, Cochin and
Bangalore

Trade currency mechanics

The main actors in the forex market are
the primary market makers who trade
on their own account and make a twoway bid offer market.
They deal actively and continuously
with each other and with their clients,
central banks and sometimes with
currency brokers.

The ISO has developed three letter codes

for all currencies which abbreviate the
name of the country as well as currency.
For Example:USD
GBP
JPY
CAD
EUR

4) Commodity Market
A market where commodities are traded is
referred to as commodity market.
commodities are raw or primary products

Bullion- gold, silver , platinum ,etc

Non-ferrous metals-copper, zinc, nickel, lead,
aluminum ,tin, etc
Energy- crude oil, natural gas ,etc
Agricultural commodities-soya oil, palm
oil,coffee,pepper,cashew etc

Buyers and sellers from different location transact

business in an electronic Market place.
There are three types of regulated commodity market in
India:
i.
Spot Market-otc market
ii.
Forward market
iii.
Derivatives market (Future & options)
The regulator of Commodity market is Forward
market Commission
The national Electronic Exchanges are:
MCX (Mumbai),NCDEX (Mumbai),NMCE
(Ahmedabad),ICEX ltd (Gurgaon)

Financial Intermediaries

Financial intermediary is a special financial entity,

which performs the role of efficient allocation of
funds, when there are conditions that make it difficult
for lenders or investors of funds to deal directly with
borrowers of funds in financial markets.
Financial intermediaries include depository
institutions, insurance companies, regulated
investment companies, investment banks, pension
funds.

Financial Intermediaries

Commercial banks
Non Banking Financial Companies
(NBFCs)
Primary dealers (PDs)
Financial institutions (FIs)
Cooperative banks

Equity & debt market

Stock exchanges
Brokers
Equity & debt raisers
Investment bankers (Merchant Bankers)
Foreign institutional investors (FII)
Depositaries
Mutual Funds
Registrars

The financial intermediaries are engaged in:

obtaining

lending

funds from lenders or investors

or investing the funds that they borrow

to those who need funds.

Asset transformation provides at least one of

three economic functions:.
Risk reduction via diversification.
Cost reduction for contracting and information
processing.

REGULATORS

Financial System

Central
Banking
Authority
(RBI)

Capital
Markets
Regulatory
Authority
(SEBI)

Insurance
and
Pension
Regulators
(IRDA)

Central Banking Authority (RBI)

Monetary Control
Supervision over

Commercial banks
NBFCs
Primary Dealers
Financial institutions
Cooperative banks
Clearing and settlement systems

Management of govt. debt

Banker to government
Lender of last resort to banks
Regulating money markets through monetary
instruments (CRR, SLR, Bank Rate, REPO Rate)

Capital Markets Regulator Authority

Equity market and debt market supervision and
(SEBI)
control

Supervision over

Stock exchanges
Brokers
Equity &debt raisers
Investment bankers (merchant bankers)
Foreign institutional investors (FII)
Custodians
Depositories
Mutual Funds
Listed companies
Service providers to capital markets like registers

Insurance and Pension Regulators

Regulatory framework including rules and
(IRDA)

regulations for running insurance business.

Supervising all insurance companies both
in general and life insurance business
Regulating pricing, investments and cost
structure of insurance companies.
Regulating insurance brokers including
agencies both individuals and banks
Pensions
Framing rules for pension funds
Regulating all pension funds