Class 12-commerce NCERT Solutions Business Studies Chapter 2 - Financial Markets

A treasury bill is a short-term borrowing instrument of the government. They are issued by the RBI on behalf of the government. They are issued as promissory notes and are generally bought by banks, LIC, UTI and non-banking financial institutions. They are highly liquid instruments because RBI is always ready to purchase them. Moreover, since it is the RBI which issues these instruments, they are regarded as the safest. Treasury bills can be bought for a minimum amount of Rs 25,000 and in multiples thereof. They are issued at a value lower than the face and are repaid at par. (The difference being the interest receivable called discount).

National Stock Exchange of India was established in 1992. It was recognised as a stock exchange in 1993 and it commenced operations from 1994. There are two main segments of NSE-Wholesale Debt Market Segment and Capital Market Segment.

1. Wholesale Debt Market Segment: This segment of NSE (also known as National Exchange for Automated Trading) was started in June 1994. It provides a platform for trading in fixed income securities. Trading can take place in state development loans, bonds issued by public sector undertakings, corporate debentures, commercial paper, mutual funds, central government securities, zero coupon bonds and treasury bills. It is the first fully computer-based trading system. In this market, there are two parties involved in trading, namely trading members (i.e. recognised brokers of NSE) and participants (i.e. buyers and sellers of securities). Any transaction among participants (in the form of buying and selling of securities) is settled through members. For instance, if a member wishes to sell a security, then he would place an order with the member. The order is then suitably matched by another member for a participant willing to purchase the security.
2. Capital Market Segment: This segment of NSE deals in trading of equity shares, preference shares, debentures, exchange traded funds and retail government securities. This segment is also known as NEAT-Capital Market (National Exchange for Automated Trading-Capital Market) and commenced operations in November 1995. The trading operations in this segment are the same as that in the Wholesale Debt Market Segment. 

Investing public can expect safe and fair deal in stock market due to these two reasons:

i. The function of the stock exchange is to protect the rights and interests of the investors. It should be guiding individual investors and educating them on the ways to deal in stock exchange.

ii. The function is to develop fair practices and codes of conduct by the intermediaries involved like merchant bankers, brokers.

Beneficial owner is the type of person who enjoys the ownership benefits even when the property title is in name of someone else. In other words, any individual or individuals who have the power to vote or influence any transaction decisions such as company shares either directly or indirectly.

The investor needs to provide following details to the broker at the time of filling a client registration form

i. Date of birth and address

ii. PAN Number

A financial market is a market for the creation and exchange of financial assets (such as shares and debentures).

Major functions of a financial market:

1. Mobilising savings: The financial market acts as a channel for mobilising savings to productive use. This is done by providing savers a platform for transferring investment. It provides savers a wide choice in investment. In this way, it ensures that the funds are directed towards the most productive investment.
2. Establishing price: The financial market facilitates the interaction between those who demand securities (households) and the suppliers of securities (business firms). This helps in establishing a competing price for the securities.
3. Providing liquidity to assets: By easing the process of sale and purchase of securities, the financial market provides liquidity to securities. That is, through the financial market, securities can be easily converted to cash.
4. Reduction in the cost of transaction: Information required for trading in securities is provided by the financial market. In this way, it helps reduce the cost in terms of both time and money. 

The money market is the market which deals in short-term securities and whose maturity is less than one year. Because of their short maturity period, the assets in the money market can be regarded as very close substitutes of cash. Accordingly, they are also called 'near money instruments'. Securities traded in the money market are comparatively safe as they are issued by established financial institutions or financially strong companies. Some common money market instruments are treasury bills, commercial paper, call money and certificates of deposit.

Points highlighting the difference between Capital Market and Money Market:

A stock exchange refers to a market wherein the sale and purchase of securities occur. The main functions of the stock exchange:

1. Provides Liquidity and Marketability: The stock exchange provides a platform where sale and purchase of existing securities can take place. In this way, the stock exchange facilitates the conversion of securities to cash as and when required. In addition, it renders liquidity to long-term securities and can be converted to medium-term and short-term securities.
2. Determination of Prices: A stock exchange acts as a link for the interaction of buyers and sellers. In other words, it helps in the interaction of demand and supply forces, and thereby helps in establishing the price of securities.
3. Fair and Safe Market: A stock exchange provides a safe and fair market for trading of securities. It functions according to a well-regulated legal framework.
4. Facilitates Economic Growth: By facilitating the sale and purchase of securities, the stock market helps in channelising the savings to most productive investment. This in turn promotes capital formation and economic growth.
5. Spreading Equity Cult: The stock exchange regulates the trading of securities and promotes fair trading. It helps in educating the people about investment in securities and thereby promotes investment.
6. Acts as an Economic Barometer: Changes in the stock exchange are an indicator of the economic conditions. For instance, a rise in the general prices indicates a condition of boom.
7. Scope for Speculation: It is a general perception that a certain degree of speculation is essential to maintain the continuous process of demand and supply of securities. This function is performed by the stock exchange. 

Securities and Exchange Board of India (SEBI) was established with the basic objective of promoting orderly growth of the securities market. Points highlighting the overall objectives of SEBI:

1. Regulation: SEBI regulates the functions of the stock exchange and the securities market. It ensures that the issuers of securities (i.e. companies) are able to raise funds in an easy manner.
2. Protection: SEBI provides investors with information about companies as required by them. It also provides guidelines related to investment in securities. In this way, it enables investors to take well-informed decisions.
3. Prevention: One of the major objectives of SEBI is to check malpractices such as insider trading, violation of rules and non-adherence to the Companies Act. In addition to providing legal statutory regulations, it promotes self-regulation by the business.
4. Code of Conduct: SEBI provides a code of conduct for the trade practices of various intermediaries such as brokers and merchant bankers. It keeps a check on the activities of these intermediaries and provides them a competitive environment. 

The National Stock Exchange of India was established in 1992. It was recognised as a stock exchange in 1993 and it commenced operations from 1994. The basic objectives of NSE:

1. NSE aims at establishing a country-wide facility for trading of securities. A nation-wise common system helps in building the confidence of investors.
2. It ensures that all investors get equal access to the securities market through a proper communication network. In this way, it helps in increasing the liquidity of securities.
3. It provides for an electronic trading system which is fair and efficient. It renders transparency to trading. Any person who wishes to get information with regard to trading of securities can get so from the local terminals of NSE. Thus, it helps in combating fraudulent trade practices.
4. NSE enables shorter settlement cycles and book entry settlements for trading in securities.
5. NSE ensures that various operations and activities meet international stock exchange standards. 

Once the trade is conducted, the broker issues a Contract Note. The contract note contains number of shares that are sold and brought, price, date and time of the deal and the brokerage charges. It is an important document as it has legal validity and can be submitted as a proof during claim settlement or disputes which can arise between broker and the investor. The contract note contains the unique order code number that is assigned by stock exchange for each transaction.

The money market refers to the market for short-term securities whose maturity period is less than one year.

The following are various money market instruments:

1. Treasury Bill (T-Bills): A treasury bill is a short-term borrowing instrument of the Government of India. It is a promissory note having a maturity period of less than one year. They are issued by the Reserve Bank of India on behalf of the Central Government. They are highly liquid instrument. They are available for a minimum of Rs 25,000 and in multiples thereof. T-Bills are also called Zero-Coupon Bonds and have very low risk and offer an assured return.

Generally, the RBI issues three types of treasury bills-91-days, 182-days and 364-days. They are issued at a value lower than the face value and are repaid at par. The difference between the two being the interest receivable called discount. In other words, they are issued at a price lower than their face value, and at the time of redemption, the investor gets the amount equal to the face value. The difference between the value at which they are issued and the redemption value is the interest received on them.

For example, suppose an investor purchases a 182-days treasury bill with a face value of Rs 60,000 for Rs 52,000. At the time of maturity, he will receive the amount equal to the face value, i.e. Rs 60,000. The difference of Rs 8,000 (60,000 - 52,000) is the interest received.

2. Call Money: Call money is a money market instrument which is used by commercial banks for interbank transactions. Commercial banks use call money for meeting their cash reserve requirements. In other words, through call money, commercial banks borrow from each other to fulfil any shortage of funds required to maintain CRR. Call money has a maturity period of less than fifteen days. Interest is paid on the call money, which is called the call rate. This rate is highly variable, and it varies from day to day. There exists an inverse relationship between the call rate and the demand for other money market instruments such as commercial papers and certificates of deposit. With an increase in the call rate, the other instruments of the money market become comparatively cheaper and thereby their demand increases.
3. Commercial Paper (CPs): Commercial papers introduced in India in 1990 are short-term unsecured money market instruments. It is a promissory note which is negotiable and transferable. They have a maturity period ranging from a minimum of 15 days to a maximum of one year. They are primarily used by large and creditworthy companies for bridge financing. In other words, they are used as an alternative to borrowings from bank and capital market. On commercial paper, the companies pay an interest rate lower than the market rates. They are used for purposes such as to meet the flotation cost on long-term borrowings from the capital market.
4. Certificates of Deposit (CDs): Certificates of deposit are time deposits which are issued for a certain specific period of time (from one month to 5 years). They are negotiable. CDs are said to be a secured form of investment because they are issued by commercial banks and development financial institutions. For CDs, higher the deposit amount, higher is the interest rate offered. They are used to meet credit requirements during situations of tight liquidity.
5. Commercial Bill: A commercial bill is a short-term money market instrument used by firms to finance their working capital requirements. It is also known as a bank bill or bill of exchange. They are negotiable in nature. Generally, commercial bills are used by companies to finance their credit sales. This can be understood with the help of an example. Suppose a seller makes a sale on credit to a buyer. Then, the buyer becomes liable to make the payment on a specific future date. In this case, the seller would draw a bill of exchange mentioning a specific date of the maturity period. When accepted, the bill becomes a marketable instrument which can be discounted with a bank. So, if the seller wishes, he can discount the bill with a commercial bank before the maturity period as well. 

A capital market is a market which deals in trading medium and long-term securities which have a maturity period of at least one year. Some common instruments traded in the capital market are equity and preference shares, debentures, bonds, mutual funds and public deposits.

A capital market can be classified in two main categories-primary market and secondary market. While the primary market deals in the sale of new securities, the secondary market deals in trading already existing securities.

The capital market in India-in the form of the stock exchange-started way back in the eighteenth century. As a first step towards generating interest of the investors in corporate securities, the Government of India introduced the Companies Act in 1850. The first stock exchange was established in 1875 as 'The Native Share and Stock Brokers Association' in Bombay. It was later named 'Bombay Stock Exchange' (BSE). Subsequently, over the years, stock exchanges were also developed in Ahmedabad, Calcutta and Madras. Till the 1990s, the Indian secondary market comprised only regional stock exchanges. After the economic reforms of 1991, the Indian Stock Market acquired a three-tier system comprising Regional Stock Exchanges, National Stock Exchange and Over The Counter Exchange of India (OTCEI).

Regional Stock Exchange:

The first regional stock exchange was established in 1894 in Ahmedabad as Ahmedabad Stock Exchange (ASE). Then, in 1908, Calcutta Stock Exchange (CSE) was established. Later, in the subsequent years, other regional stock exchanges were established in Madras, Delhi, Hyderabad and Indore. The more recent ones were established in Coimbatore as Coimbatore Stock Exchange and in Meerut as Meerut Stock Exchange. At present, there are 22 regional stock exchanges in India.

National Stock Exchange:

The National Stock Exchange of India was established in 1992. It was recognised as a stock exchange in 1993 and it commenced operations from 1994. NSE aims at establishing a country-wide facility for trading of securities. A nation-wise common system helps in building the confidence of investors. It ensures that through a proper communication network, all investors get equal access to the securities market. In this way, it helps in increasing the liquidity of securities. It provides for an electronic trading system which is fair and efficient. It renders transparency to trading. Any person can get information with regard to trading of securities from the local terminals of NSE. So, it helps in combating fraudulent trade practices. NSE enables shorter settlement cycles and book entry settlements for trading in securities. NSE ensures that various operations and activities meet international stock exchange standards.

NSE has greatly transformed the Indian capital market and has been able to greatly popularise the stock market by bringing it to the investor's doorstep.

Over The Counter Exchange of India (OTCEI):

OTCEI refers to Over The Counter Exchange of India (OTCEI). It was established in 1990 under the Companies Act, 1956. It was recognised as a stock exchange under the Securities Contracts Regulation Act, 1956. It began operations in 1992 with the basic objective of ensuring easy access to the capital market for small and medium companies. It is a fully computerised single window exchange system which was established along the lines of NASDAQ (the OTC exchange of USA). It was promoted by financial institutions such as UTI, ICICI, IDBI, LIC, IFCI, GIC and SBI financial services. It provides a platform for the interaction of buyers and sellers. It provides for an exclusive limited list of companies. One of the major objectives of OTCEI is to provide a fair, cheap and easy means of trade to the public and to small companies. 

The Securities and Exchange Board of India (SEBI) was established in 1988 with the basic objective of promoting orderly growth of the securities market. It aimed at investor protection along with promoting the development and regulation of the functions of the securities market.

Major objectives of SEBI:

1. Regulation: SEBI regulates the functions of the stock exchange and the securities market. It ensures that the issuers of securities (i.e. companies) are able to raise funds in an easy manner.
2. Protection: SEBI provides investors with information about companies as required by them. It also provides guidelines related to investment in securities. In this way, it enables investors to take well-informed decisions.
3. Prevention: One of the major objectives of SEBI is to check malpractices such as insider trading, violation of rules and non-adherence to the Companies Act. In addition to providing legal statutory regulations, it promotes self-regulation by businesses.
4. Code of Conduct: SEBI provides a code of conduct for the trade practices of various intermediaries such as brokers and merchant bankers. It keeps a check on the activities of these intermediaries and provides them a competitive environment. 

To achieve the objectives as mentioned above, SEBI performs the following three main functions:

1. Regulatory Functions 

1. Registration: SEBI undertakes registration of various brokers, sub-brokers, agents and other players in the market. Registration of collective mutual schemes and mutual funds is also done.
2. Regulating Work: SEBI keeps a watch on the activities and working of the stock brokers, underwriters, merchant bankers and other market intermediaries. It provides rules and regulations for the working of intermediaries. In addition, takeover bids by companies are regulated by SEBI. Moreover, it conducts regular enquires and audits the stock exchange and intermediaries.
3. Regulation by Legislation: Under the Securities Contracts (Regulation) Act, 1956, SEBI performs various legislative functions. 

2. Development Functions

1. Training: SEBI provides training and development programmes for intermediaries of the securities market. This helps in promoting healthy growth of the securities market.
2. Research: SEBI conducts research on various important areas of the securities market, which are then published. The reports of SEBI help investors and other market players in decision making with regard to investment.
3. Flexible Approach: SEBI has adopted a flexible approach towards various activities of the securities market. For instance, it has permitted Internet trading and IPOs. This encourages the development of the capital market. 

3. Protective Functions

1. Prohibition: SEBI keeps an eye on various activities and operations in the securities market. It works towards prohibiting fraudulent and unfair trade practices. SEBI provides useful information to investors as required by them and which helps them in taking wise decisions. It keeps an eye on and prevents the spread of any misleading and manipulative statements which would affect the working of the securities market.
2. Checks on Insider Trading: Sometimes, an individual connected with a company spreads important crucial information regarding it. Such leak of information may adversely affect the share price of the company. Such a practice is known as insider trading. SEBI keeps control on such activities and imposes penalties as and when required.
3. Promotion and Protection: SEBI works towards promoting fair trade practices. It provides for a code of conduct for intermediaries. Various steps are undertaken for investor protection. 

a. The above case shows the primary market. It is the market where securities are being issued for the first time.

b. The method of floatation that is applied is right issue of shares. It is a type of privilege that existing shareholders get at the time of issue of new shares as per the terms and conditions of the company.

c. Two other methods of floatation are:

i. Offer for Sale: In this method securities are issued to the intermediaries such as stock brokers or issue house instead of issuing to the public directly. In this example securities are sold to brokers at an agreed price who will be selling those shares to the public.

ii. Offer through prospectus: It is one of the most popular method of raising funds by public companies in the share market or the primary market. It involves issuing of prospectus through inviting of subscriptions. It makes an appeal to raise investment by publishing of ads in magazines and newspapers. The contents of the prospectus should be in accordance with the Companies Act, investor protection guidelines and SEBI disclosure.

The following steps are involved and is discussed in a sequential manner

1. Investor wishing to buy or sell any type of security has to approach a broker or sub broker and make an agreement. The investor needs to sign broker-client agreement and fill client registration form prior to start trading in securities. Also, some essential details need to be filled which include the following:

i. PAN number

ii. Date of birth and address

iii. Educational qualification and the occupation

iv. Residential status

v. Bank account details

vi. Depository account details

2. The next step is opening of Demat account or Beneficial owner account with a depository participant for transferring of securities in Demat form also a bank account needs to be opened for performing cash transactions in the market.

3. An order is placed by the investor with the broker for buying and selling shares. Information should be provided about the number of shares and price of shares that need to be bought. Broker issues a order confirmation slip to investor once the order is placed.

4. Broker goes online and connects with the stock exchange for matching share and the prices which are available for the share.

5. When shares can be either bought or sold as per the price mentioned by investor, the broker will be notified about that and order will be processed electronically. On transaction being done, broker will issue a trade confirmation slip for the investor.

6. Once the trade is executed a Contract note will be issued by the broker in 24 hours. The contract note contains details of the shares that are bought or sold, it’s price, time and date of the deal and finally the brokerage charges. It is an important document which can be produced in court of law for settling disputes. Each transaction is assigned unique order code number by the stock exchange. This number is printed on the contract note.

7. After this step, the investor on receiving the contract note needs to pay for the shares that were bought and deliver shares that are sold. The broker will make payment or deliver the shares to the exchange. It is known as pay in day.

8. Cash gets paid or securities are delivered during the pay in day. This is done before T+2 day as deal gets settled and finalized on the T+2 day. Settlement follows the rolling settlement basis which is on T+2 day. T refers to the trade date.

9. Exchange delivers the shares or make payments to the broker on T+2 day. The broker has to make payment to the investor within 24 hours of pay out as already the payment is received by the broker from the exchange.

10. Delivery of shares by brokers can be in the form of Demat which is added directly to investor’s account or in the case of securities purchase the amount is transferred electronically in the Demat account of the investor.