CBSE Class 12 Business Studies - Financial Markets
Business is a a part of economic system that consists of mainly 2 sectors i.e households which saves funds and business firms which invest these funds.
Households can buy shares and debentures offered by a business through financial markets.
FINANCIAL MARKET- A financial market is the market for the creation and exchange of securities.
Creation of financial asset takes place when company issues new shares and debentures.
Exchange of financial assets implies purchase and sale of existing shares , debentures and bonds.
-financial market helps households to invest their surplus fund and on the other hand helps business firms to fulfil their fund requirement. This is known as allocative function of financial market.
-it helps to link the savers and investors by mobilising the funds between them.
FOR EXAMPLE -Apple wants to set up its new factory for which it needs large amount of funds. Therefore, apple has 2 option through which funds can be procured
1) to take a loan from bank- banks lend loans on the basis of money deposited by households in their saving account. Further bank utilise this amount by providing loans to the business firm for their investment purpose.
2) Apple issue shares in the financial markets- households instead of depositing their surplus amount in savings account utilise it by purchasing the shares issued by apple in the financial markets , in return of that apple will be able to raise its finance. Needed for investment
So, from the above example we can see that their are 2 types of mechanism through which funds can be allocated and mobilised-
- Financial markets.
FUNCTION OF FINANCIAL MARKETS
- Mobilising savings- Financial markets gives savers different investment options. It helps the savers to invest or channelise their surplus funds into the most productive use.
- Facilitate price discovery - price of any commodity is determined by the market forces of demand and supply. In the financial market, the households are suppliers of funds and business firms represent the demand. This interaction helps to establish a price for the financial asset .
- Provide liquidity to financial assets- financial market facilities easy sale and purchase of financial asset resulting in providing liquidity to financial assets, so that they can be easily converted into cash whenever required.
- Reduce the cost of transaction- financial markets provide important information about the price, cost and availability of the securities. It helps to save time, efforts and money of both buyers and sellers thus, reducing the cost of transaction.
CLASSIFICATION OF FINANCIAL MARKET
Financial market consist of two major segments.
- Money Market
- Capital Market
Money market refers to the market for short-term funds, which deals in monetary assets whose period of maturity is upto one year.
It helps to satisfy a business short term financial needs I.e temporary cash shortage, purchase of raw material etc.
Money market has no physical location and most of the activities are conducted over telephone and internet.
MAJOR PARTICIPANTS OF MONEY MARKET
- Reserve bank of India
- Commercial banks ( HDFC)
- Non-banking finance companies
- State government
- Large corporate houses ( Reliance , TATA )
- Mutual funds ( SBI mutual funds, HDFC mutual funds )
PROPERTY OF MONEY MARKET INSTRUMENTS
Money market instruments usually has 2 properties
- HIGHLY LIQUID- money market instruments are highly liquid. I.e they can be easily converted into cash as and when required.
- LESS RISKY- the instruments of money market are less risky , due to shorter duration of investment and financial soundness of issuers.
INSTRUMENTS OF MONEY MARKET
- TREASURY BILL ( T-Bill) - A Treasury Bill Is an instrument of short-term borrowing issued by the Reserve Bank of India (RBI) on behalf of Indian government.
- They are also known as Zero Coupon Bonds issued by the Reserve Bank of India on behalf of the Central Government to meet its short-term requirement of funds.
-They are issued at a price which is lower than their face value and repaid at par.
-Treasury bills are available for a minimum amount of Rs 25,000 and in multiples thereof.
-Treasury bills are issued in the form of a promissory note
- They are issued for a period of 14-365 days .
FOR 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.
2. COMMERCIAL PAPER- Are unsecured instruments issued in the form of a promissory note , negotiable and transferable by endorsement and delivery with a fixed maturity period.
- It usually has a maturity period of 15 days to one year.
- It is issued by large and creditworthy companies to raise short-term funds at lower rates of interest .
- commercial papers can be issued in denomination of 5 lakhs and its denominations thereof.
- commercial paper can also be issued as bridge finance.
FOR EXAMPLE - Suppose a company requires long-term finance to buy some machinery. In order to raise the funds in the capital market the company will have to incur floatation costs (costs associated with floating of an issue are brokerage, commission, printing of applications and advertising etc.). Funds raised through commercial paper are used to meet the floatation costs. This is known as Bridge Financing.
3. CALL MONEY- Call Money Is short term finance whose , maturity varies from 1 day to 15 days.
- Commercial banks have to maintain a minimum cash balance known as cash reserve ratio. The Reserve Bank of India changes the cash reserve ratio from time to time which in turn affects the amount of funds 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.
- The interest rate paid on call money loans is known as the call rate.
- There is an inverse relationship between call rates and other short-term money market instruments such as certificates of deposit and commercial paper. Whenever there is a rise in the call money rates it makes other sources of finance i.e commercial paper and certificates of deposit relatively cheaper in comparison for banks raise funds from these sources.
FOR EXAMPLE -Yes, bank has Rs1 00crore of funds. As per , the rbi guidelines it is required to maintain 20% as cash reserve ratio which is 20% of 100 crore I.e 20 crore. So, now yes bank is having 20 crore with them as cash but there is an urgent requirement of 25crore. So ,yes bank takes call money of Rs 5 crore from ICICI bank for 15 day @ call rate of 2%.
4. CERTIFICATE OF DEPOSIT- It is a bearer document issued by commercial banks and development financial institutions against the deposits kept by companies and institutions.
- the time period of certificate of deposit ranges from 91 days to 1 year.
- it Is an unsecured and negotiable instrument and helps in raising a large amount of money for a short period .
FOR EXAMPLE - HDFC bank issue certificate of deposit of Rs 50 crore to reliance at 45crore for 6 months.
Face value= Rs 50 crore
selling price= Rs 47 crore
Maturity period= 6 months
but, after 3 months reliance sells this certificate of deposit to Tata at 47crore . Now, after 3 months at maturity Tata will go to bank and take 50 cr.
5. COMMERCIAL BILL- it is short-term instrument used by business firms to finance their working capital requirements .
- it is a written acknowledgement of debt, where seller draws the bill and buyer accepts it. On being accepted, the bill becomes a. Marketable instrument and is called a Trade Bill.
- trade bills are commonly used in credit purchases and sales.
- These bills can be discounted with a bank if the seller needs funds before the bill matures. When a trade bill is accepted by a commercial bank it is known as a commercial bill.
Capital market can be divided into two parts-
The primary market is also known as the new issues market. It deals with new securities being issued for the first time.
The Primary market performs an essential function to facilitate the transfer of investible funds from savers to investors.
The investors in primary market are banks, financial institutions, insurance companies, mutual funds and individuals.
A company can raise capital through the primary market in the form of equity shares, preference shares, debentures, loans and deposits for setting up new projects, expansion, diversification, modernisation of existing projects, mergers and takeovers etc.
METHODS OF FLOATING NEW ISSUES IN THE PRIMARY MARKET
1.OFFER THROUGH PROSPECTUS- Offer through prospectus is the most popular method of raising funds by public companies in the primary market, It involves inviting subscription from the public
-A prospectus makes a direct appeal to investors to raise capital, through an advertisement in newspapers and magazines
-The contents of the prospectus have to be in accordance with the provisions of the Companies Act and SEBI disclosure and investor protection guidelines.
2. OFFER FOR SALE- It is a method under which securities are not issued directly to the public but are offered for sale through intermediaries like issuing houses or stock brokers. Under this case, a company sells the entire lot of securities at an agreed price to the intermediaries who, in turn, resell them to the investing public.
3. PRIVATE PLACEMENTS- Private placement is the allotment of securities by a company to institutional investors ( unit trust of India, life insurance corporation ) and some selected individuals. It helps to raise capital more quickly than a public issue.
4. RIGHTS ISSUE- This is a privilege given to existing shareholders to subscribe to a new issue of shares in the proportion to the number of shares they already possess.
5. e-IPO’S- 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. The issuer company should also appoint a registrar to the issue having electronic connectivity with the exchange.
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 invest in the market. It also provides liquidity and marketability to existing securities.
A stock exchange is an institution which provides a platform for buying and selling existing securities.
As a market, the stock exchange facilitates the exchange of a security (share, debenture etc.) into money and vice versa.
According to Securities Contracts (Regulation) Act 1956, stock exchange means any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying and selling or dealing in securities.
FUNCTIONS OF STOCK EXCHANGE
1. PROVIDES LIQUIDITY AND MARKETABILITY TO EXISTING SECURITIES-
The basic function of a stock exchange is the creation of a continuous market where securities are bought and sold. It gives investors the chance to disinvest and reinvest. This provides both liquidity and easy marketability to already existing securities in the market.
FOR EXAMPLE - Reliance, which is listed in national stock exchange . If reliance wants to purchase shares so , it can easily purchase it through NSE.
2. PRICING OF SECURITIES- Price of shares on a stock exchange are determined by the forces of demand and supply. Stock market indices like SENSEX, BSE, NSE. Reflect market direction and indicate day-to-day fluctuations in share prices.
Whenever, a company performs good, the demand of its shares increases resulting in increase in price of shares.
3. SAFETY OF TRANSACTION- The membership of a stock exchange is well- regulated and its dealings are well defined according to the existing legal framework. This ensures that the investing public gets a safe and fair deal on the market.There is on-line screen-based
electronic trading system. Trading is done through SEBI, registered stock broker. A demat account has to be opened by the investor while registering with a stock broker. In the demat account securities are held electronically, and there Is electronic transfer of securities. This is new system of trading ensures safe and fair dealings in securities by eliminating the problems associated with physical certificates .
4.CONTRIBUTES TO ECONOMIC GROWTH- A stock exchange is a market in which existing securities are resold or traded. Through this process of disinvestment and reinvestment savings get channelised into their most productive investment avenues. This leads to capital formation and economic growth.
5.PROVIDING SCOPE OF SPECULATION- The stock exchange provides scope for speculation in a restricted and controlled manner. A certain degree of healthy speculation is necessary to ensure liquidity in the stock market.
DEPOSITORY SERVICE AND DEMAT ACCOUNT
Depository is an institution / organisation which holds securities I.e shares, debentures , bonds etc. in electronic form .
There , are two depositories in India-
- NSDL ( National Securities Depository Ltd.)
- CDSL ( Central Depository Services Ltd)
TRADING PROCEDURE ON STOCK EXCHANGE
- SELECTION OF BROKER- The first step is to select a broker who will buy/sell securities on behalf of the investor .this is necessary because trading of securities can only be done through SEBI registered brokers who are the members of a stock exchange .Brokers may be individual , partnership firms or corporate books. . the broker charges brokerage / commission for his services.
- OPENING DEMAT ACCOUNT- the next step is to open demat account . Demat (dematerialised) account refers to account which an Indian citizen must open with the depository participant(banks, stock brokers) to trade in listed securities in electronic form. The securities are held in the electronic form by a depository . At present, there are two depositories in India NSDL AND CDSL. depository interacts with the investors through depository participants.
- PLACING THE ORDER- the next step is to place the order with the broker. The order can be communicated to the broker either personally or through telephone , cell phone, e-mail etc. the instructor should specify the range within which the order is to be executed . Only the securities of listed companies can be traded on the stock exchange.
- EXECUTING THE ORDER- according to the instructions of the investors , the broker buys/ sells securities. The broker then issues a contract note. A copy of the contract note is sent to the client . The contract note contains the name and the price of the securities, names of the parties, brokerage charged. It assigned by the broker.
- SETTLEMENT- this is the last stage in the trading of securities done by the brokers on behalf of their clients. The mode of settlement depends upon the nature of the contract. Equity spot market follows a T+2 rolling settlement. This means that any trade taking place on Monday gets settled by Wednesday. All trading on stock exchange takes place between 9;55am to 3;330 pm. Indian standard time, Monday to Friday. Delivery of shares must be made in dematerialised form and each exchange has its own clearing house, which assumes all settlement risk.
SECURITIES AND EXCHANGE BOARD OF INDIA
The securities and exchange Board of India was established by the government of India on 12th April 1988 as a interim administrative body kya to promote orderly and healthy growth of securities market and for investor protection from trading malpractices example price rigging insider trading etc.
1. Price Rigging- making manipulations with the sole objective of inflating or depressing the market price of securities .
2. Insider Trading- the insiders to a company directors promoters using inside information example bonus issue to make personal profits
OBJECTIVES OF SEBI
1. To protect the rights and interest of investors particularly individual investors and to guide and educate them.
2. To prevent trading malpractices like price rigging insider trading making misleading statements in prospectus.
3. To regulate stock exchanges and the securities market to promote their orderly functioning.
4. To regulate and develop a code of conduct and fair practices by intermediaries like brokers merchant bankers with a view to make them competitive and professional.
5. To provide a Marketplace in which the issuers can raise finances in an easy way and efficient manner.
FUNCTIONS OF SEBI
- Prohibition of fraudulent and unfair trade practices in the securities market example price legging making misleading statements in prospectus.
- Controlling insider trading and imposing penalties for such practices.
- Undertaking steps for Investors Protection.
- Promotion of fair practices and code of conduct in securities market.
- Registration of brokers and sub brokers and other players in the market.
- Registration of collective investment schemes and mutual funds.
- Regulation of stock brokers portfolio exchanges underwriters and merchant bankers.
- Regulation of takeover bids by companies.
- Levying fee the charges for carrying out the purposes of the act.
- Training of intermediaries of the securities market.
- Conducting research and publishing information useful to market participants,
- Undertaking measures to develop the capital markets by adopting a flexible approach.
- Investor education.