This article throws light upon the six important financial markets that operate in India. The financial markets are: 1. Capital Market 2. Stock or Equity Market 3. Commodity Market 4. Derivatives Market 5. Foreign Exchange Market 6. Debt Market.
1. Capital Market:
The Capital Market is an integral part of financial system of any country. In case of money market it provides short term lending and borrowing whereas in case of Capital Market plays a vital role of raising long term funds for governments, banks, and corporations by providing a strong system for trading of securities.
Basically a Capital Market is a Stock Market and refers to trading shares and bonds of companies on recognized stock exchange in a regulated manner where member organisations of the capital market may issue stocks and bonds in order to raise funds.
Investors can than invest in the capital market by purchasing those stocks and bonds. Contrary to the money market where individual players cannot invest because the value of investment is large, in capital market anybody can make investment through brokers.
Being most important segment of Indian financial system the capital market is entity to the companies for meeting their requirements of the long term funds. It provides institutional arrangements for borrowing and lending funds.
The market consists of a number of individuals and institutions like IDBI, ICICI, UTI, LIC etc., which play the role of lenders in the capital market. Business houses and corporate firms are the borrowers in the capital market, including the government that mobilise the supply and demand for long term capital and claims on it. (this in case of money market is for short term i.e. a term not exceeding one year but long term is more than one year, if it is up to 3 years it called mid-term and if more than 3 years it is called long term).
The demand mostly comes from big private business houses, industries, manufacturers, traders, agricultural sector and government agencies inter alia other sources. So far as supply is concern it comes largely from banks, individuals, corporate, insurance companies, financial institutions and government etc.
Any transaction in the capital market can be done through brokers only who are registered with the exchange to carry out the trading on behalf of their clients. Any individual cannot just walk in the stock exchange and invest on the stocks or bonds.
Transactions in the capital market or not risk free. In many cases transactions are highly risky. The Indian capital market has many segments for trading and transecting business. In fact capital market cannot be classified into different specified segments because it is a vital part of every Financial Market and any financial market has several and different aspects.
It becomes therefore necessary to know about specific features of capital market. The capital market is a market for financial assets which have a long or indefinite maturity unlike money market. It is an institutional arrangement to borrow and lend money for a longer period of time.
Capital market is one of the pillars of any financial system. The financial system of any country is centered around the financial markets of that country.
Financial markets largely facilitate:
1. The raising of Capital (Capital Market).
2. The transfer of risk (Derivatives market).
3. International trade (Currency Market).
If even the categorization is divided in so many segments the financial markets serve two main purposes throughout the world:
1) To provide capital to those who are in need of it.
2) To enable those who wish to deploy their surplus funds.
In view of above two basic points any market known as money market, capital market, debt market, equity market, commodity market or any other type of market all are made to meet the demand and supply along with earning profits. All are part of one or other financial markets.
Again this Capital market is divided into further two parts:
A) Primary Market, and
B) Secondary Market.
A. Primary Market:
The Primary market is also known as the New Issue market. It is meant to issue new securities. Many companies, specially small and medium scale, enter the primary market to raise money from the public to expand their business. The primary market is a market for new capitals that will be traded over a longer period.
The primary market provides a channel of sale of new securities, the government as well as corporate, to raise resources to meet their requirements of investments and/or discharge their obligations. In the primary market securities are issued through exchange.
The underwriters (under writers engage to buy and pay for any shares issued by a company which are not taken up by the public) play an important role in this market for setting the initial price range for a particular share and supervision of the sale of that particular share. However before selling a security on the primary market, the companies are required to fulfill all the requirements according to the exchange.
Basically it is the Primary Market which accelerates the process of capital formation in a country’s economy as the primary market provides a channel for sale of new securities (shares of companies for raising capital). The primary market plays a vital role of providing opportunity to issuers of securities (may be government of corporate), to raise resources to meet their requirements of investment or meeting their obligations.
Such securities are issued on face value, discount or premium in a domestic or international markets. This is done typically through a syndicate of security dealers. The process of selling new issues to investors is called underwriting.
Different Kinds/Methods of Issue:
Primarily there are three methods for issuing securities in the primary market:
a) IPOs (Initial Public Offering;) Literal meaning is an issue of shares publicly offered to investors. An IPO is when an unlisted company makes either a fresh issue of securities of an offer for sale of its existing securities or both for the first time to the public.
b) Preferential Issue is an issue of stock available only to select and designated buyers say employees of an organization allowed under section 81 of the companies act 1956. This can be either shares or convertible securities by listed companies.
c) Right Issue:
A listed company when decides to issue fresh securities (shares) only to existing shareholders on record is called right issue. It is also a method of raising capital but shares are offered to existing share holders in proportion to their current share holdings usually at discount to the current share price within a fixed period.
The rights are often transferable, allowing the holder to sell them on the open market. In this way the organizations issuing the right issues can raise the required capital without loosing the stake of its existing shareholders.
Features of Primary Market:
1. It is called new issue market because new issues are first traded in this market.
2. It provides long term equity capital.
3. Securities/shares are issued directly to the investors.
4. Primary issues are mostly meant either to start a new business by the companies or for expanding, deviation or modernization of existing business.
5. The financial assets sold can only be redeemed by the original holder.
B. Secondary Market:
Literal meaning of a secondary market is trading in stocks and shares after the closing of an issue. That is why it is also known as the “After market”. In the secondary market the securities like stock, bonds, options and futures which had already been previously issued are bought or sold.
In the primary market the securities are issued directly to the investors but in case of secondary market the investors can buy securities from any other investor in place of original issuers of securities. First the securities are issued in the primary market, and then they enter into secondary market.
According to the nature of market and its name it is also known as the market of used goods or assets. In this market shares are operated from one investor to another investor where one investor buys shares from another investor instead of from issuing entity.
The secondary market facilitates investors interest for liquidity and users’ interest for using their investment as a capital for longer period. This is done through trading in equity and long term debt instruments.
In other words it can be said as an active market in which there is much buying and selling, of the stock exchange, stock or shares having frequent and regular dealings, so that would-be buyers may be assumed of obtaining the amounts they want. Simply the secondary market is a big source of liquidity.
2. Stock or Equity Market:
Stock Market or Equity Market mainly provides financing through the issuance of shares or common stock and subsequent trading thereof. It also includes Bond markets which provides financing through the issuance of bonds and subsequent trading thereof. Stock or Equity market is integral part of the capital market. This market is a system through which shares of companies are traded. In this market anybody can participate.
Mostly the investors who purchase the shares of any company get the opportunity to earn profit if the price of the stock is increased. It can be vice-versa also, In order to ascertain secure investments investors seek help of brokers or financial consultant to know about the rating or financial health of different companies.
Some instruments traded in this market include, share, preference, right, bonus shares, debentures, bonds, private equity funds and venture funds etc. The market is largely affected by factors like Foreign investment, performance of corporate houses and monsoon etc. Some of the transactions of this market are based on two type of indices- Bombay Stock Exchange(BSE) and National Stock Exchange of India Ltd.(NSE).
The larger companies are listed with BSE and NSE. Smaller and medium companies are listed with OTCEI (Over the counter Exchange of India) All functions of the Equity Market are supervised by SEBI (Security and Exchange Board of India). So for Indian Stock Exchanges were handling the transactions in a traditional manner where buyer and sellers had to face many difficulties. OTCEI is first electronic stock exchange established in 1992.
The trading at OTCEI can be done all over the country where share and debentures of the companies listed on the OTC (not listed anywhere else) can be bought or sold at any OTC counter throughout the country. However certain shares, debentures listed on other exchanges are also given permission to be traded.
3. Commodity Market:
Commodities are products found naturally or are grown but for the purpose of commodity market it includes all type of commodities that have value for commerce and goods for merchandise. It is natural that everything having some value can be bought and sold. Buying and selling of such items is known as commodity trading and the system where such trading is done is known as commodity market.
The commodity in this market is treated like undifferentiated product the market value of which mostly arises from the right of its owner rather than the right to use. In simple words a commodity is produced in large quantity by many different producers with similar standard of quality but may vary to some extend in terms of quality of one producer to another producer but is treated like uniform quality. It is contract and the underlying standard which defines the commodity and the quality.
Commodity trading is a special form of investing. Although it is similar to stock or equity trading but instead of buying and selling of companies shares, an investor buys and sells commodities such as metals, sugar, cotton, coffee, grains oil, and everything else having value for goods.
There are two types of commodity markets One where a person is in need of any particular commodity and is ready to make the payment on the spot to receive the delivery on the spot. Such type transactions are called on the spot delivery market. You also go to market to purchase some commodity, you pay to the shopkeeper the value for the commodity and he hands you over the commodity purchased by you.
For an example if some commodity is in short supply and the shopkeeper does not possesses the enough stock of that particular commodity but promises to deliver you the commodity on some future date and you agree to his promise and make payments. In this transaction future date is which decided is known as delivery date.
On date of delivery you shall get the commodity purchased but for one or the other reason the price of commodity may either increase or decrease. If increased you shall be in profit if decreased you shall be in loss.
But when one does not need any commodity for personal use but wants to purchase for the sake of investment it is called commodity trading which is a sophisticated form of investment because commodities provide a hedge against inflation for their price rises with the consumer price index. So far as commodity market is concerned the trading is done on the Exchanges but in various forms including future contracts.
Future contracts are delivery of goods at some future time. Contracts of purchase or sale are made in the produce markets at prices fixed at the contract dates, but for the future receipts or delivery of the commodities dealt in, and therefore at prices appropriate to the agreed delivery dates.
Like stock exchange there are commodity exchanges also which organize future trading of commodities with the result transactions remain transparent. A large number of entities participate in this market and also large scale transactions are done which provide an opportunity to wider section of people associated to different kind of commodities.
The main commodity exchanges in India are the NCDEX (National Commodity & Derivatives Exchange of India Ltd. And MCX (Multi Commodity Exchange of India. Both of which offer on line trading facility. The contracts trading in this market are for the underlying asset which is a commodity like wheat, soybeans, rapeseed, cotton or precious metals like gold and silver. There may be any number of commodities of different types.
On line trading in commodity market provides a platform for market participants to trade in wide range of commodity derivatives. Derivatives a type of financial instrument in the commodity market plays a role of ensuring the price of the commodity under trade. It is also a type of contract between two or more people. The value of derivative goes on changing with price change of its underlying asset that may be a commodity, share etc.
Background of Commodity Market:
Commodity market can be said to be as old as barter system where commodities were traded in exchange of one commodity to another. In the initial stages of banking done in Templers money changers also worked as commodity traders. With growing need of large scale trading the modern day commodity market had to under go a number of changes regulated by different type of regulations.
During British period although more emphasis was given to regulate stock exchanges related with transactions of stocks or equities. But the number of companies participating on such exchanges were limited in numbers. Resultantly the commodity market though not much regulated was taking up most activities in commodity trading.
In post independent India in 1952 Forward Contract Regulation Act was passed to regulate this market. But due to some hard economic policies and rising of prices the activities of commodity market slowed down.
In the absence of proper market commodity trading in the underhand and illegal way increased and in order to restrict such trading a Forward Market Commission was constituted under the Forward Contract Regulation Act 1952. But with the economic liberalisation programs of the government of India the commodity market survived again after 1991.
4. Derivatives Market:
In simple words derivative means transfer to some one other. It is a layman meaning of the word. But when we talk about the derivatives in terms of financial market it has more than one meanings. To make it understand in financial terms a derivate is a financial instrument used as security in any financial contract.
In such a contract the value is derived (link it with derivatives) from the value of something else (i.e transfer to some one other) than be it a commodity price, stock price, a currency exchange rate or something else. Broadly speaking derivatives is a financial instrument whose characteristics and value depend of an underline, (under sale) a commodity, bond, equity or currency.
Such derivatives are mostly used to manage the risk associated with underlying securities (underlying security means such physical and financial assets to which a single/more security holders has/have a claim. This type of asset while underlies gives value to the security) to protect against fluctuations in value to cover the risk of losses. It is financial contract whose value is derived from the value of something else, like a stock price, commodity price, Bond, currency rate etc.
Types of Derivatives:
A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. A future market enables buyers and sellers to exchange contracts for the future delivery of commodities or financial instruments. If a commodity producer wishes to sell a commodity in the future, he can assure the ability to do so by selling a future contract today.
Alternatively, if a commodity user needs to buy a commodity in the future, he can make certain that it can be done by buying a future contract today. Future market therefore makes it possible for producers and consumers to act today to make sure that they will be able to do what they want to do in the future.
Future contracts have been standardized and therefore a future contract is an agreement that takes place under the rules prescribed by the future exchange oh which the contract is traded. Each buyer or seller deals through the exchange clearing house, and also each is insured against default by the exchange itself.
Previously the facility was available for certain restricted items but with the more liberalized norms today, organized future markets for exchange of standardised contracts for future delivery exists for a large number of items like, grains(any kind), wheat, corn, soybeans, live stock, metals, timber, and financial assets(foreign currency, stocks, debt instruments etc.)
In simple words forward is sale or purchase done today for delivery at a future date. Technically forwards are contracts between two parties to buy or sell an asset on or before a future date where settlement takes place on a specific date in the future at a price pre-fixed as on today (the day of entering into contract)
There is difference between future and forward contracts. Future contract is a standardised contract traded through the exchange i.e. any sale or purchase can be operated at the exchange only whereas the forward contract is a non-standardised contract written by the parties themselves.
Forward contracts are especially important in the foreign exchange market because they allow individuals and firms to protect themselves against foreign exchange risk Suppose a company is going to import some machinery and plant from abroad into India in a period of three months of time at a price fixed in terms of dollars.
If the company waits for three months to buy dollars(required by the company), it assumes foreign exchange risk because meanwhile dollar price may appreciate ultimately raising the price of the machinery and plant in question.
Instead of assuming the risk, the company may choose to purchase a forward contract today for the delivery dollars three months from now. Then even if the price of dollar appreciates, the company has guaranteed that it will be able to purchase the goods at a price in dollars that it is willing to pay.
5. Foreign Exchange Market:
In the foreign exchange market, the forward price and the post price are linked by the interest parity condition. This conditions says that that the percentage difference between the forward rate and the spot rate, called the forward premium, will equal the difference between the real (inflation adjusted) foreign interest and the real; domestic rate interest.
An opinion is a marketable security that provides for the future exchange of cash and common shares contingent upon the option owner’s choice. An option is created when a seller writes (means sells) an option contract to a buyer. Option seller may be corporation, company or individual trader.
There are two types of option contracts Calls Option and Puts Option. In case of calls option the owner (the buyer) has the right but not the obligation to buy specified quantity of underlying asset. In case of puts the buyer has the right but not the obligation to sell. The price at which the sales take place is known as strike price and is decided at the time the parties enter into an option.
For example, the underlying interest might be 100 shares of common stock or a specified amount of debt obligation, or foreign currency buying call (put) option offers the opportunity to make money when a stock’s price rises (falls). Options provide significant leverage to trading. Leverage to the ability to gain from the increasing value of a common stock with an investment that’s only a percentage of what it would cost to own the stock.
Swap literally means to exchange, to barter, an exchange. In foreign exchange operations, “swap” means a spot sale against a forward purchase, or spot purchase against a forward sale. “Swap Agreements” or “Swap Arrangements” are devices to increase international liquidity.
One central banks agrees to lend its currency to another central bank in exchange for a loan from that bank of an equivalent in its country’s currency. Each country thereby strengthens the backing for its own currency and improves its resources against speculative attacks.
Swaps are contract to exchange cash(flow) by way of an agreement entered between two private parties for exchanging cash on or before a specified future date on the underlying value of currencies/ exchange rate, commodity stock or other assets.
In case the contract entails only the interest component of related cash flows in the same currency it is called Interest rate swap and if it entails currency only including principal and interest it is called Currency swap even if cash flow between different currencies are not going in the same direction.
It can be simply described as the transformation of one stream of future cash flows into another stream of cash flows with different features. The essence of a swap contract is the binding of two counter parties two exchange two different payment streams over time, the payment being tied at least in part to subsequent – and – uncertain – market price developments.
In most cases, the prices concerned have been exchange rates or interest rates but they have increasingly reached out to equity indices and physical commodities, notably oil and oil products.
6. Debt Market:
In simple words a debt market is meant to raise long term loans by companies, governments and other entities. The market refers to the financial market where debt securities are bought or sold by the investors. This includes private placement as well as organized markets and exchanges.
It is important to note that debt market instruments have a specific feature that the return on investment is fixed. It is therefore also known as fixed income market without any risk.
Investors therefore tend to deploy funds for log terms which form the capital structure or debt capital. Although equity is also a source of raising capital with high rate of returns but are also classified as high value risk instruments. But debt instruments, though with low risk, are with almost no default risk.
Advantage of Debt Market is that the return that the market offers is almost risk free (with exception to little extent). Mostly Government securities and the securities of Corporate, Financial Institutions, Public Sector Undertakings etc. The securities of debt market are highly liquid. But it has disadvantage of low rate of return and very less retail participation.
There are mainly two types of debt instruments which are popular in the Indian debt market. One type of instruments are instruments either issued by Central Government or State Governments and the second type of debt instruments are issued by Public and Private Sector.
The Reserve Bank of India issues Government securities also known as G-Secs on behalf of the government of India. Every type of debt instrument has different types of investors with different maturity periods.
Some of which are as follows:
Securities issued by central government:
i) A-Zero Coupon Bonds:
The maturity period of such bonds varies between one year to 30 years. Investor in such securities include Individuals, Mutual Funds, RBI, Insurance companies and Provident Fund Trusts, Banks.
ii) Treasury Bills:
The maturity period is between 91 days to 364 days and investors are same as of Zero Coupon bonds.
Securities issued by State Governments:
Coupons bearing state government securities: Maturity period is 5-10 years invested by Banks, Insurance companies, PF Trusts.
Securities of government of India and state governments are also known as gilt-edged securities.
Securities issued by Public and Private Sector:
i) These securities include Bonds issued by Public sector undertakings and other government organizations but are guaranteed by the government and have a maturity period of 5-10 years invested by Banks, Insurance companies, Individuals.
ii) PSU Bonds and Zero coupon bonds are issued by Public Sector Undertakings with maturity of 5-10 years with similar investors.
iii) Debentures and Bonds are issued by Private Sector Corporate with maturity period of 1-12 years with similar type of investors.
iv) In addition to above Commercial Papers are issued both by private and public sectors.
v) Certificate of Deposits are issued by Banks and Financial Institutions.