CBSE Class 12 Business Studies Notes: Financial Markets

Key Definitions

Financial Market

A market for the creation and exchange of financial assets. It facilitates the transfer of funds from savers to investors.

Money Market

A market for short-term funds (maturity period up to one year) and financial assets that are close substitutes for money. It is an unorganised market.

Capital Market

A market for long-term funds (maturity period exceeding one year), both debt and equity. It channels long-term savings into long-term investments.

Primary Market

Also known as the 'New Issue Market', it deals with the issue of new securities directly from the company to investors for the first time.

Secondary Market

Also known as the 'Stock Market' or 'Stock Exchange', it deals with the buying and selling of existing securities. It provides liquidity and marketability to securities.

SEBI (Securities and Exchange Board of India)

The regulatory body for the Indian securities market, established to protect the interests of investors, promote the development of the securities market, and regulate it.

Dematerialisation

The process by which physical share certificates are converted into an electronic format and held in a Demat account.

Depository

An institution (like NSDL or CDSL in India) that holds securities (shares, debentures, bonds, etc.) of investors in electronic form.

Functions of Financial Markets

Financial markets play a pivotal role in the economic development of a country by efficiently allocating capital. Understanding their core functions is essential:

1. Mobilisation of Savings and Channelising them into Most Productive Uses: Financial markets act as an intermediary between savers (households, institutions) and investors (businesses seeking capital). They attract funds from those who have surplus money and direct them to those who need capital for investment, thereby facilitating capital formation.

1. Facilitating Price Discovery: The interaction between the forces of demand and supply of financial assets in the financial market helps in determining the price of securities. For instance, in the stock market, the price of a share is determined by how many buyers and sellers are willing to transact at various price levels.

1. Providing Liquidity to Financial Assets: Financial markets provide a mechanism for investors to easily buy and sell existing financial assets. For example, a stock exchange allows investors to convert their shares into cash whenever needed, thus providing liquidity to their investments without affecting the issuing company's operations.

1. Reducing the Cost of Transactions: Financial markets provide detailed information about securities traded, which helps in reducing the time, effort, and money that buyers and sellers would otherwise have to spend to find each other. This availability of information makes the process of buying and selling more efficient and less costly.

Money Market vs. Capital Market

Trading Procedure on a Stock Exchange

1. —
2. —
3. —
4. —
5. —

Key Points to Remember

• Financial Markets link savers and investors, facilitating capital formation.
• Money Market instruments are highly liquid and used for short-term funding.
• Capital Market handles long-term financing through primary and secondary markets.
• Primary Market is for new issues; Secondary Market for existing securities, providing liquidity.
• SEBI's main objectives are investor protection, market development, and regulation.
• Stock Exchange functions include providing liquidity, pricing securities, safety of transactions, and capital formation.
• Depositories (NSDL, CDSL) hold securities in electronic form, making transactions paperless.
• Dematerialisation converts physical shares into electronic form, while Rematerialisation is the reverse.
• The Trading Procedure on a stock exchange involves selecting a broker, opening Demat/Trading accounts, placing order, execution, and settlement (T+2).

Exam Tip: Differentiating Market Concepts

Examiners often test your ability to differentiate between similar concepts. Pay close attention to the distinctions between:

• Money Market vs. Capital Market (especially maturity period, instruments, and purpose).
• Primary Market vs. Secondary Market (focus on new vs. existing securities, and direct vs. indirect fund raising for the company).

Practice drawing comparison tables to solidify these differences. Also, ensure you can list and explain the functions of SEBI and Stock Exchange clearly, as these are frequent long-answer questions. Use clear headings and bullet points in your answers for better readability and marking.

Worked Examples / Illustrations

• {"title":"Money Market Instrument: Treasury Bill (T-Bill)","description":"A company needs short-term funds for 91 days to manage its working capital. It approaches the RBI, which issues a Treasury Bill on behalf of the government. The T-Bill is issued at a discount (e.g., ₹95 for a face value of ₹100) and redeemed at par (₹100) after 91 days. The difference (₹5) is the interest earned, making it a zero-coupon bond. This allows the company to meet its short-term liquidity needs."}
• {"title":"Primary Market Activity: Initial Public Offer (IPO)","description":"Xpert Solutions Ltd., a privately held tech company, decides to raise capital for expansion by issuing shares to the public for the first time. They do this through an Initial Public Offer (IPO). They appoint merchant bankers, fix the issue price, and invite applications from the public. Once subscribed, the shares are allotted, and the company receives the capital directly from the public. This is a primary market activity as new securities are being issued."}
• {"title":"Secondary Market Activity: Share Trading","description":"An investor, Mr. Sharma, owns 100 shares of Reliance Industries Ltd. and decides to sell them to buy shares of Tata Motors Ltd. He places a 'sell' order with his broker for Reliance shares and a 'buy' order for Tata Motors shares. These transactions happen on the stock exchange between Mr. Sharma (through his broker) and other investors. Reliance Industries Ltd. itself is not involved in these transactions, as they are trades of existing shares, providing liquidity to Mr. Sharma's investments."}

Practice Questions with Solutions

• Q: Name any two instruments traded in the money market. A: Treasury Bills, Commercial Papers, Certificates of Deposit, Call Money, Commercial Bills.
• Q: What is the primary function of a stock exchange? A: To provide a platform for the buying and selling of existing securities, ensuring liquidity and marketability, and facilitating price discovery.
• Q: Mention any two regulatory functions of SEBI. A: Regulating stock exchanges and intermediaries, registering collective investment schemes like mutual funds, prohibiting fraudulent and unfair trade practices.
• Q: Distinguish between Dematerialisation and Rematerialisation. A: Dematerialisation is the process of converting physical share certificates into electronic form. Rematerialisation is the reverse process, converting electronic holdings back into physical certificates.

Frequently Asked Questions