Financial Markets

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Module-1:Financial Markets
The financial market is defined as the arrangements where it is possible to sell or purchase financial
instruments, be they shares, bonds, derivatives, fund units, etc. Today, the financial markets are no longer
physical locations, but rather virtual platforms that are also referred to as trading venues. This is where
proposals to purchase or sell are entered, which are sent to the system electronically.
Financial markets refer broadly to any marketplace where the trading of securities occurs, including the stock
market, bond market, forex market, and derivatives market, among others. Financial markets are vital to the
smooth operation of economies. It plays a crucial role in allocating limited resources, in the country’s
economy. It acts as an intermediary between the savers and investors by mobilising funds between them.
In a financial market, the stock market allows investors to purchase and trade publicly companies share. The
issue of new stocks are first offered in the primary stock market, and stock securities trading happens in
the secondary market. Financial markets dispense efficiently flow of investments and savings in the economy
and facilitate the growth of funds for producing goods and services. The right blend of financial products and
instruments and financial markets and institutions fuels the demands of investors, receiver and the overall
economy of a country.
Functions ofFinancial Market
 It facilitates mobilisation of savings and puts it to the most productive uses.
 It helps in determining the price of the securities. The frequent interaction between investors helps in
fixing the price of securities, on the basis of their demand and supply in the market.
 It provides liquidity to tradable assets, by facilitating the exchange, as the investors can readily sell their
securities and convert assets into cash.
 It saves the time, money and efforts of the parties, as they don’t have to waste resources to find probable
buyers or sellers of securities. Further, it reduces cost by providing valuable information, regarding the
securities traded in the financial market.
 Financial market performs the function of the risk-sharing . With the help of the financial market, the
risk is transferred from the person who undertakes the investments to those persons who provide the
funds for making those investments. By investing in different securities risk of loss of assets can be
diversified.

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 Easy Access The industries require the investors for raising the funds and the investors require the
industries for investing its money and earning the returns from them. So the financial market platform
provides the potential buyer and seller easily, which helps them in saving their time and money in
finding the potential buyer and seller.
 Financial markets provide the channel through which the new savings of the investors flow in the
country which aid in the capital formation of the country.
 The trader requires various types of information while doing the transaction of buying and selling the
securities. For obtaining the same time and money is required. But the financial market helps in providing
every type of information to the traders without the requirement of spending any money by them. In this
way, the financial market reduces the cost of the transactions.
The financial market may or may not have a physical location, i.e. the exchange of asset between the parties
can also take place over the internet or phone also.
Types of financial markets
1. By Nature of Claim
o Debt Market: The market where fixed claims or debt instruments, such as debentures or bonds are bought
and sold between investors.
o Equity Market: Equity market is a market wherein the investors deal in equity instruments. It is the market
for residual claims.

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2. By Maturity of Claim
o Money Market: The market where monetary assets such as commercial paper, certificate of deposits,
treasury bills, etc. which mature within a year, are traded is called money market. It is the market for short-
term funds. No such market exist physically; the transactions are performed over a virtual network, i.e. fax,
internet or phone.
o Capital Market: The market where medium and long term financial assets are traded in the capital market.
It is divided into two types:
 Primary Market: A financial market, wherein the company listed on an exchange, for the first time,
issues new security or already listed company brings the fresh issue.
 Secondary Market: Alternately known as the Stock market, a secondary market is an organised
marketplace, wherein already issued securities are traded between investors, such as individuals,
merchant bankers, stockbrokers and mutual funds.
3. By Timing of Delivery
o Cash Market: The market where the transaction between buyers and sellers are settled in real-time.
o Futures Market: Futures market is one where the delivery or settlement of commodities takes place at a
future specified date.
4. By Organizational Structure
o Exchange-Traded Market: A financial market, which has a centralised organisation with the standardised
procedure.
o Over-the-Counter Market: An OTC is characterised by a decentralised organisation, having customised
procedures.
Since last few years, the role of the financial market has taken a drastic change, due to a number of factors such
as low cost of transactions, high liquidity, investor protection, transparency in pricing information, adequate
legal procedures for settling disputes, etc.
Participants in financial marketsThey're all the people and organisations that do business in a financial
market, from banks and other lenders to individual investors. There are two basic financial market participant
categories – investor v speculator, and institutional v retail.

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Participants may enter on the supply side, providing capital in the form of investments, or on the demand side,
borrowing capital.
 Investor v speculator: An investor is classed as an individual or company that regularly buys equity or
debt securities for financial gain. A speculator trades commodities, bonds, equities and currencies for a
higher than average profit, but more risk.
 Institutional v retail: Institutional investors are the banks, financial services firms and mutual fund
companies that make hefty investments usually over the long term. Retail investors are individuals and
small groups who invest in the equity markets.
Banks:-Banks participate in the capital market and money market. Within the capital market, banks take active
part in bond markets. Banks may invest in equity and mutual funds as a part of their fund management. Banks
take active trading interest in the bond market and have certain exposures to the equity market also. Banks also
participate in the market as clearing houses.
Financial Institutions (FIs):-FIs provide/lend long term funds for industry and agriculture. FIs raise their
resources through long-term bonds from financial system and borrowings from international financial
institutions like International Finance Corporation (IFC), Asian Development Bank (ADB) International
Development Association (IDA), International Bank for Reconstruction and Development (IBRD), etc.
Brokers:-Only brokers approved by Capital Market Regulator can operate on stock exchange. Brokers perform
the job of intermediating between buyers and seller of securities. They help build up order book, price
discovery, and are responsible for a contract being honoured. For their services brokers earn a fee known as
brokerage.
Dealers:-Like brokers, dealers facilitate trade by matching buyers with sellers of assets; they do not engage in
asset transformation. Also, unlike brokers, dealers do not receive sales commissions. Rather, dealers make
profits by buying assets at relatively low prices and reselling them at relatively high prices (buy low - sell high).
The price at which a dealer offers to sell an asset (the "asked price") minus the price at which a dealer offers to
buy an asset (the "bid price") is called the bid-ask spread and represents the dealer's profit margin on the asset
exchange. Real-world examples of dealers include car dealers, dealers in U.S. government bonds, and
NASDAQ stock dealers.
Investment Bankers (Merchant Bankers):
These are agencies/organisations regulated and licensed by SEBI, the Capital Markets Regulator. They arrange
raising of funds through equity and debt route and assist companies in completing various formalities like filing
of the prescribed document and other compliances with the Regulator and Regulators.

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They advise the issuing company on book building, pricing of issue, arranging registrars, bankers to the issue
and other support services. They can underwrite the issue and also function as issue managers. They may also
buy and sell on their account.
Custodians:
Custodians are organizations which are allowed to hold securities on behalf of customers and carry out
operations on their behalf. They handle both funds and securities of Qualified Institutional Borrowers (QIBs)
including FIIs.
Custodians are supervised by the Capital Market Regulator. In view of their position and as they handle the
payment and settlements, banks are able to play the role of custodians effectively. Thus most banks perform the
role of custodians.
Depositories:
Depositories hold securities in demat (electronic) form, maintain accounts of depository participants who, in
turn, maintain accounts of their customers. On instructions of stock exchange clearing house, supported by
documentation, a depository transfers securities from buyers to sellers’ accounts in electronic form
The individuals:
These are net savers and purchase the securities issued by corporates.Individuals provide funds by subscribing
to these security or by making other investments.
Financial Intermediaries (FIs):
Financial intermediaries (FIs) are financial institutions that intermediate between ultimate lenders and ultimate
borrowers. Funds flow from ultimate lenders to ultimate borrowers either directly or indirectly through financial
institutions.
FIs are commercial banks, cooperative credit societies and banks, mutual savings banks, mutual funds, savings
and loan associations, building societies and housing loan associations, insurance companies, merchant banks,
unit trusts, and other financial institutions.
Are financial institutions and financial intermediaries the same?
A financial institution is an establishment that conducts financial transactions such as investments, loans and
deposits. Financial intermediaries move funds from parties with excess capital to parties needing funds.
Roles of Financial Intermediaries:

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Role in the Modern Financial System:
Financial intermediaries play an important role in the modern financial system and benefit the economy as a
whole.
Reduce Hoarding:
By bringing the ultimate lenders (or savers) and ultimate borrowers together, FIs reduce hoarding of cash by the
people under the “mattress”, as is commonly said.
Help the Household Sector:
The household sector relies on FIs for making profitable use of its surplus funds and also to provide consumer
credit loans, mortgage loans, etc. Thus they promote saving and investment habits among the ordinary people.
Help the Business Sector:
FIs also help the non-financial business sector by financing it through loan’s, mortgages, purchase of bonds,
shares, etc. Thus they facilitate investment in plant, equipment and inventories.
Spread of Risks:
FIs possess greater resources than individuals to bear and spread risks among different borrowers. This is
because of their large size, diversification of their portfolios and economies of scale in portfolio management.
They can employ skilled portfolio managers and other financial experts.
Provide Liquidity:
FIs provide liquidity when they convert an asset into cash easily and quickly without loss of value in terms of
money. When FIs issue claims against themselves and supply funds they, especially banks, always try to
maintain their liquidity.
Help in Lowering Interest Rates:
Competition among FIs leads to the lowering of interest rates. FIs prefer to keep their savings with FIs rather
than in cash. The FIs, in turn, invest them in primary securities. Consequently, prices of securities are bid up
and interest rates fall.
Moreover, when people keep their cash holdings with FIs which are safe and liquid, the demand for money falls
thereby lowering interest rates
Bring Stability in the Capital Market:
FIs deal in a variety of assets and liabilities which are mostly traded in the capital market. If there were no FIs,
there would be frequent changes in the demand and supply of financial assets and their relative yields, thereby
bringing instability in the capital market.
Benefit to the Economy:
FIs are of immense help in the working of financial markets, in executing monetary and credit policies of the
central bank and hence in promoting the growth of an economy. By transferring funds from surplus to deficit
units, FIs create large financial assets and liabilities. They provide the economy with money supply and with
near money assets.
Boost Economic Growth:

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Financial intermediaries which consist of commercial banks, cooperative credit societies, mutual savings funds,
mutual funds, saving and loan associations, insurance companies, and other financial institutions, help in the
growth process of the economy. They intermediate between ultimate lenders who are savers and ultimate
borrowers who are investors. By performing this function they discourage hoarding by the people, mobilise
their savings and lend them to investors.
Financial innovation
Financial innovation is the process of creating new financial products, services, or processes or Financial
innovation is the act of creating new financial instruments as well as new financial technologies, institutions,
and markets.
Financial innovation has come via advances over time in financial instruments and payment systems used in the
lending and borrowing of funds. These changes – which include updates in technology, risk transfer, and credit
and equity generation – have increased available credit for borrowers and given banks new and less costly ways
to raise equity capital.
Financial innovation is the act of creating new financial instruments as well as new financial
technologies, institutions, and markets. Recent financial innovations include hedge funds, private
equity, weather derivatives, retail-structured products, exchange-traded funds, multi-family offices, and Islamic
bonds (Sukuk). The shadow banking system has spawned an array of financial innovations including mortgage-
backed securities products and collateralized debt obligations (CDOs)
There are 3 categories of innovation: institutional, product, and process.
Institutional innovations relate to the creation of new types of financial firms such as specialist credit card firms
like Capital One, electronic trading platforms such as Charles Schwab Corporation, and direct banks.
Product innovation relates to new products such as derivatives, securitization, and foreign currency mortgages.
Process innovations relate to new ways of doing financial business, including online banking and telephone
banking.
A number of innovations have taken place over time among them; the development of Automated Teller
Machines (ATMs); the expansion of credit card usage; Debit cards; Money market funds; Basic forms of
securitization; Venture capital funds and interest rate and currency swaps amongst many others.
Financial system/institutional innovations: Such innovations can effects the financial sector as a whole,
relate to changes in business structures, to the establishment of new types of financial intermediaries, or to
changes in the legal and supervisory framework. Important examples include the use of the group mechanism to
retail financial services, formalizing informal finance systems, reducing the access barriers for women, or
setting up a completely new service structure.
Process innovations: Such innovations cover the introduction of new business processes leading to increased
efficiency, market expansion, etc. Examples include office automation and use of computers with accounting
and client data management software.

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Product innovations: Such innovations include the introduction of new credit, deposit, insurance, leasing, hire
purchase, and other financial products. Product innovations are introduced to respond better to changes in
market demand or to improve the efficiency of product markets.
Technology driven financial innovation: Advancements in Information Technology have facilitated a number
of innovations, such as new methods of underwriting securities, Assembling portfolios of stocks,
New markets for securities, New means of executing security transactions, Many new forms of derivatives have
been made possible because business people could have some confidence in the methods of pricing and hedging
the risks of these new contracts. Various forms of innovations such as new risk management systems and
measures, on-line retirement planning services and new valuation techniques were clearly facilitated by both
intellectual and information technology innovations.
Some of the innovative financial instruments used in the Indian Financial Market are explained as
follows:
Triple Option Convertible Debentures (TOCD): First Issued by Reliance Power Limited with an issue size of
Rs. 2,172 Cr. There was no outflow of interest for first five years.
Zero Coupon Bonds: It did not involve any annual interest on the bonds. But it had a higher maturity value on
the initial investment for a particular time period.
Convertible and Zero Coupon Convertible Bonds: Similar to the zero coupon bonds except that the effective
interest was lower because of the convertibility.
Inflation linked bonds: Inflation linked bonds (ILB) securities give an opportunity to market participants and
investors to hedge against inflation
Weather Derivatives: A weather derivative contract may be termed as a financial weather dependent contract
whose payoff will be determined by future weather events.
Advantages
Financial innovation, which is the creation of new securities, markets and institutions, can improve the financial
services sector and thereby accelerate economic growth.
 Financial innovation has been shown to increase the material wellbeing of economic players. Positive
innovation has helped individuals and businesses to attain their economic goals more efficiently,
enlarging their possibilities for mutually advantageous exchanges of goods and services.
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Financial innovation, by increasing the variety of products available and facilitating intermediation, has
promoted savings and channeled these resources to the most productive uses. It has also assisted to
widen the availability of credit, help refinance obligations and allow for better allocation of risk,
matching the supply of risk instruments to the demand of investors willing to bear it.
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Innovation is also at the centre stage of encouraging technological progress when the requirements for
information technology generate new technological projects, and induce their funding as in the case of
venture capital.
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Financial innovation lowers the cost of capital, promotes greater efficiency, and facilitates the
smoothing of consumption and investment decisions with considerable benefits for households and
corporations. As the new products contribute to the deepening of financial markets, innovation, in turn,
fosters economic development.

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 Financial innovation may also help to moderate business cycle fluctuations. Innovations such as credit
cards and home equity loans allow households to keep their consumption smooth, even when their
incomes are not. The increased availability of credit to businesses allows them to smooth their spending
across short periods when revenues do not cover costs.
Disadvantages of financial innovation
Financial innovations can bring substantial costs along with the benefits described above.. Many intermediaries
underestimated the risks of new financial products and were compelled to deleverage in the crisis. The resulting
uncertainty contributed to the seizing up of key markets for liquidity, such as the interbank lending market
 Rapid financial innovation can be a source of systemic risk as evidenced during the financial crisis.
When financial products without a track record expand rapidly in a buoyant economic environment,
investors tend to underestimate the risks that only occur in periods of economic stress.
 Separately, innovations that help conceal concentrations of risk can make the financial system more
vulnerable to a shock. In both cases, the problem is that investors do not obtain adequate compensation
for the risks that they take because they do not understand the risks or because the risks are invisible.
 In conclusion, it should be noted that on balance, financial innovation has had a crucial and positive role
in financial modernization, leading to the improvement of economic wellbeing. Hence, provided that we
strengthen prudential regulation to discourage excessive risk taking in the future, innovation can
continue to benefit our societies.
 It should be further noted that potential problems are likely to increase with the complexity of the
instruments, the insufficiency of information conveyed by sellers, and the lack of due diligence on the
part of investors.
Financial inclusion Financial Inclusion is described as the method of offering banking and financial
solutions and services to every individual in the society without any form of discrimination. It refers to a
process by which individuals and businesses can access appropriate, affordable, and timely financial
products and services. These include banking, loan, equity, and insurance products. Financial inclusion
efforts typically target those who are unbanked and underbanked, and directs sustainable financial services
to them. Financial inclusion is understood to go beyond merely opening a bank account. It is possible for
banked individuals to be excluded from financial services. Having more inclusive financial systems has
been linked to stronger and more sustainable economic growth and development and thus achieving
financial inclusion has become a priority for many countries across the globe.
In 2018 it was estimated that about 1.7 billion adults lacked a bank account. Among those who are unbanked a
significant number were women and poor people in rural areas and often those who are excluded from financial
institutions face discrimination and belong to vulnerable or marginalized populations.

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While it is recognized that not all individuals need or want financial services, the goal of financial inclusion is
to remove all barriers, both supply side and demand side. Supply side barriers stem from financial institutions
themselves. They often indicate poor financial infrastructure, and include lack of nearby financial institutions,
high costs to opening accounts, or documentation requirements. Demand side barriers refer to aspects of the
individual seeking financial services and include poor financial literacy, lack of financial capability, or cultural
or religious beliefs that impact their financial decisions.
It aims to include everybody in society by giving them basic financial services regardless of their income or
savings. It focuses on providing financial solutions to the economically underprivileged. The term is broadly
used to describe the provision of savings and loan services to the poor in an inexpensive and easy-to-use form.
It aims to ensure that the poor and marginalised make the best use of their money and attain financial education.
With advances in financial technology and digital transactions, more and more startups are now making
financial inclusion simpler to achieve.
Financial inclusion definition
Financial inclusion is the process of ensuring access to financial products and services needed by vulnerable
groups at an affordable cost in a transparent manner by institutional players.
Objectives of financial inclusion
 A basic no-frills banking account for making and receiving payments
 Saving products (including investment and pension)
 Simple credit products and overdrafts linked with no-frills accounts
 Remittance, or money transfer facilities
 Micro insurance (life) and non-micro insurance (life and non-life)
 Micro pension
Financial inclusion in India
The concept of financial inclusion was first introduced in India in 2005 by the Reserve Bank of India.
The Government of India has been introducing several exclusive schemes for the purpose of financial inclusion.
These schemes intend to provide social security to the less fortunate sections of the society. After a lot of
planning and research by several financial experts and policymakers, the government launched schemes keeping
financial inclusion in mind. These schemes have been launched over different years. Let us take a list of the
financial inclusion schemes in the country:
 Pradhan Mantri Jan Dhan Yojana (PMJDY)
 Atal Pension Yojana (APY)
 Pradhan Mantri Vaya Vandana Yojana (PMVVY)
 Stand Up India Scheme
 Pradhan Mantri Mudra Yojana (PMMY)
 Pradhan Mantri Suraksha Bima Yojana (PMSBY)
 Sukanya Samriddhi Yojana
 Jeevan Suraksha Bandhan Yojana
 Credit Enhancement Guarantee Scheme (CEGS) for Scheduled Castes (SCs)
 Venture Capital Fund for Scheduled Castes under the Social Sector Initiatives
 Varishtha Pension Bima Yojana (VPBY)

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PMJDY: Around 192.1 million accounts have been opened under the Pradhan Mantri Jan Dhan Yojana
(PMJDY). These zero-balance bank accounts have been accompanied by 165.1 million debit cards, a life
insurance cover of Rs 30,000 and an accidental insurance cover of Rs 1 lakh.
Other than PMJDY, there are several other financial inclusion schemes in India — Jeevan Suraksha Bandhan
Yojana, Pradhan Mantri Vaya Vandana Yojana, Pradhan Mantri Mudra Yojana, Stand Up India scheme,
Venture Capital Fund for Scheduled Castes under the social-sector initiatives, Pradhan Mantri Suraksha Bima
Yojana (PMSBY), Atal Pension Yojana (APY), Varishtha Pension Bima Yojana (VPBY), Credit Enhancement
Guarantee Scheme (CEGS) for scheduled castes, and Sukanya Samriddhi Yojana.

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