What are Financial Markets? What are the Securities traded in these Markets?

What are financial markets?

Financial markets serve as an intermediary between those who have excess funds and those who need funds. For example- a college student (who needs funds) can avail of an education loan from the bank. A working person (who has extra funds) can deposit in a bank to save for retirement.

Similarly, if a company wants money to make investments, it can issue shares in the stock market. Investors who have extra money can buy these shares.

In these examples, the bank and stock market serve as an intermediary.

These institutions that serve as an intermediary are also referred to as financial institutions. Examples of financial institutions are- Commercial banks, Mutual Funds, Insurance companies, Investment banks, etc. Individuals can also serve as intermediaries like brokers, dealers, etc

[You may read: Mutual Fund basics: What is a mutual fund and how does it work?]

What are the different types of Financial markets?

As per the maturity structure of the securities traded, the Financial market is classified into Money Markets and Capital markets.

Those markets that are involved in trading of short-term securities (with the maturity of one year or less) are known as Money markets

Those markets that are involved in trading of long-term securities (with the maturity of more than one year) are known as Capital markets.

As per the trading structure of the securities traded, Financial market is classified into Primary Market and Secondary markets.

Primary Market facilitates the issuance of new securities. Eg- If a company wants to issue new shares (Initial Public Offering/ IPO) or Government wants to issue bonds, it will be done in the Primary market

Secondary Market facilitates the trading of existing securities. Therefore, securities already issued will be bought and sold in the secondary market. An example of secondary market is a stock exchange.

What are the securities traded in financial markets?

First, let us understand what are securities. Securities are certificates that represent a claim on the issuer.

Debt securities are certificates that represent debt incurred by the issuer. For eg- If the Government issues debt security worth Rs.100 to you, it means that the Government has incurred a debt or borrowed Rs.100 from you. This certificate represents your claim of Rs.100 on the Government.

Equity securities (stocks) are certificates that represent equity or ownership in the issuer. For eg- A new company issues stock/ shares worth Rs.100000. You buy shares worth Rs.10000 (10 % of the total shares). It means that you have a 10 % ownership stake in the company.

Money Market Securities: These are debt securities with maturity of less than 1 year. Money-market securities are:

1. Treasury Bills: Treasury bills are Government bonds with a maturity of less than 1 year. The T-bills are issued through auctions conducted by the RBI. [You may read: Treasury Bills in India]
2. Call Money: Call money is short-term finance available with a maturity of 1 (overnight) to 14 days. Banks are the dominant participants in the Call Money Market and hence it is often known as interbank call money market. [Surplus banks will give loans to other banks. Deficit banks that need funds will purchase it.] It is used to bridge short-term liquidity mismatches. The money that is lent for one day in this market is known as “call money” and, if it exceeds one day, is referred to as “notice money.” [You may read: What is Call Money/ Notice Money Market?]
3. Commercial Papers (CP): Commercial papers are issued by the companies to meet their short-term funding requirements
4. Certificate of Deposit (CD): Certificates of deposit are short term instruments issued by commercial banks and financial institutions when they need short-term liquidity. It is issued to individuals and companies. It is negotiable (transferable). It is like a fixed deposit receipt issued by the bank on the receipt of a deposit. But, unlike FD, it is for a short duration and the amount will be paid to whoever will be holding the CD.
5. Commercial Bills: It is issued by the seller of goods when they sell goods on credit. It is basically a promise that the buyer will pay the amount on the due date. If the seller wants money before the due date, he can go to the bank to ‘discount the bill’ by paying a commission. The buyer will have to pay the amount to the bank on the due date. [The bank can also go to other financial institutions to ‘rediscount’ the bill]

Capital Market Securities: These are securities with maturity of more than 1 year. Capital market securities are:

1. Government Bonds: These are bonds issued by the Government to borrow money for more than 1 year. These are also known as dated securities. [You may read- What is Bond, Bond Yield and Yield Curve?]
2. Debentures: These are long-term bonds issued by the companies to borrow money. Corporate bonds are known as debentures.
3. Stocks/ Shares: These are certificates that represent equity or ownership in the issuer. It is issued by the companies to raise money. [You may read: What is SENSEX? How is it calculated?]

Therefore, a company can raise long-term money either by issuing shares or debentures.

We have derivative securities as well. These are financial instruments that derive their value/ price from the value of another asset, known as an underlying asset. The common underlying assets are stocks, bonds, commodities (like rice, oil, etc) currencies, interest rates, etc.

The basic types of derivatives are forward, futures, options,  and swap.

[You may read: Forward, Futures, Option & Swap- Explained

Other articles that you may read:

• What are Masala bonds or Rupee bonds?
• Gold Monetisation and Sovereign Gold Bond Scheme: Demystified
• The RBI hikes Way and Means Advances (WMA) limit- What is it?
• Debt monetisation- Should it be done in light of the corona-induced crisis?

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