A financial market is a link between the saver’s words borrowers. This market transfers the money or capital from those who have surplus money to those who are in need of investment.
Generally, the investors are called surplus units and business enterprises are called deficit units. So financial market transfers money supply from surplus units to deficit units.
The financial market act as a link between surplus and deficit units and brings together the borrowers and lenders.
There are mainly two ways through which funds can be allocated :
(a) Via bank
(b) Financial markets.
The households who are the surplus unit may keep their savings in banks, they may buy securities from the capital market. The banks and financial market both in turn lend the funds to businesses from which is called deficient units.
Bank and financial markets are competitors of each other. A financial market is a market for the creation and exchange of financial assets.
Functions of Financial Markets
Financial markets perform the following four important functions :
1. Mobilisation of savings and channelizing them into the most productive uses: Financial markets act as a link between savers and investors. Financial markets transfer savings of savers to the most appropriate investment opportunities.
2. Facilitate price discovery: The price of anything depends upon the demand and supply factors. Demand and supply of financial assets and securities in financial markets help in deciding the prices of various financial securities.
3. Provide liquidity to financial assets: In financial markets, financial securities can be bought and sold easily so the financial market provides a platform to convert securities in cash.
4. Reduce the cost of transaction: Financial market provides complete information regarding the price, availability, and cost of various financial securities. So investors and companies do not have to spend much on getting this information as it is readily available in the financial market.
Classification of Financial Market
There are two segments of the financial market :
1. Money market
2. Capital market
The money market is a market for short-term funds meant for use for a period of up to one year. Generally, the money market is the source of finance for working capital.
Transactions of the money market include lending and borrowing of cash for a short period of time and also sale and purchase of securities having one year term or which gets redeemed within one year period.
The money market is not fixed in the geographical area but it constitutes all organizations and Institutions which deal with short-term debts.
The common institutes are the Reserve Bank of India, State Bank of India, other Commercial banks, LIC, GIC, UTI, etc. Many of these institutions deal on the telephone and fax only.
Features of Money market
- Market for short term.
- No fixed geographical location.
- Major Institutions involved in money market are RBI, commercial banks, LIC, GIC, etc.
- Common instruments of money market are Call money, CP, CD, Commercial bill,etc.
Instruments of Money Market
1. Call Money
The money borrowed or lent is on-demand for a short period which is generally one day. Sundays and other holidays are excluded for this purpose.
Mostly Banks use call money. When one bank faces a temporary shortage of cash then the bank with surplus cash lends to the bank in shortage for one or two days. Call money is called interbank call money market.
But even other organizations such as insurance companies, mutual fund companies, etc. also deal with call money. It is a market over the telephone.
The maturity periods of call money are extremely short and vary from one day to fifteen days and its liquidity is just next to cash.
2. Treasury Bills ( T.bills )
Treasury Bills are issued by the Reserve Bank of India on behalf of the Government of India. These bills enable the government to get short-term borrowings as these bills are sold to banks and the general public.
These bills are negotiable instruments and are freely Transferable. These are issued at a discount. These are considered the safest investments as they are issued by RBI.
The maturity period of treasury bills varies from 14 to 364 days. Treasury bills are also called zero-coupon bonds. They are issued at a price lower than their face value and repaired at par.
3. Commercial Bills
Trade bills or accommodation bills are bills drawn by one business firm on another. These are common instruments used in credit purchase and sale.
These have a short-term maturity period generally of 90 days and can be discounted with banks even before the maturity period.
These are negotiable instruments and can be easily transferred. The drawee of the bill honors the bill on the due date.
A trade bill is nothing but a written acknowledgment of debt where the maker or drawer instructs or directs the payee or drawee to make payment within a fixed period of time.
The drawee accepts the bill and becomes liable to make payment on the due date.
4. Commercial Paper (C.P.)
The commercial paper was introduced in India for the first time in 1990. It is an unsecured promissory note issued by public or private sector companies with a fixed maturity period that varies from 15 days to 1 year.
Since commercial papers are unsecured so these can be issued by companies having a good reputation and creditworthiness.
Commercial banks and mutual funds are the main investors of commercial papers.
A capital market is a market for medium and long-term funds. It includes all the organizations, institutions, and instruments that provide long-term and medium-term funds.
It does not include the instruments which provide finance for short period. The common instruments used in the capital markets are shares, debentures, bonds, mutual funds, public deposits, etc.
Features of Capital Market
1. Link between savers and investment opportunities: The capital market is a crucial link between the saving and the investment process. The capital market transfers money from savers to entrepreneurial borrowers.
2. Deals in long-term investment: The capital market provides funds for the long and medium term. It does not deal with the channelizing saving for less than 1 year.
3. Utilises intermediaries: The capital market makes use of different intermediaries such as brokers, underwriters, depositories, etc. These intermediaries act as working organs of the capital market and are very important elements of the capital market.
4. Determinant of capital formation: The activities of the capital market determine the rate of capital formation in an economy. The capital market offers attractive opportunities to those who have surplus funds so that they invest more and more in the capital market and are encouraged to save more for profitable opportunities.
5. Government rules and regulations: The capital market operates freely but under the guidance of government policies. These markets function within the framework of government rules and regulation, for example:- stock exchange work under the regulations of SEBI which is a government body.