Financial Market

Money always flows from surplus sector to deficit sector. That means persons having excess of money lend it to those who need money to fulfil their requirement. Similarly, in business sectors the surplus money flows from the investors or lenders to the businessmen for the purpose of production or sale of goods and services.

So, there are two different groups, one who invest money or lend money and the others, who borrow or use the money. The financial markets act as a link between these two different groups. It facilitates this function by acting as an intermediary between the borrowers and lenders of money. So, financial market may be defined as ‘a transmission mechanism between investors (or lenders) and the borrowers (or users) through which transfer of funds is facilitated’.

It consists of individual investors, financial institutions and other intermediaries who are linked by a formal trading rules and communication network for trading the various financial assets and credit instruments.

Credit Instruments

A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to or to the order of a certain person, or to the bearer of the instrument.

For example, suppose A has given a loan of Rs. 50,000 to B, which B has to return. Now, A also has to give some money to C. In this case, A can make a document directing B to make payment up to Rs. 50,000 to C on demand or after expiry of a specified period. This document is called a bill of exchange, which can be transferred to some other person’s name by C.

A promissory note is an instrument in writing (not being a bank note or a currency note) containing an unconditional undertaking, signed by the maker, to pay a certain sum of money only to or to the order of a certain person or to the bearer of the instrument.

Suppose you take a loan of Rs. 20,000 from your friend A. You can make a document stating that you will pay the money to A or the bearer on demand. Or you can mention in the document that you will pay the amount after three months. This document, once signed by you, duly stamped and handed over to A, becomes a negotiable instrument.

Now A can personally present it before you for payment or give this document to some other person to collect money on his behalf. He can endorse it in somebody else’s name who in turn can endorse it further till the final payment is made by you to whosoever presents it before you. This type of a document is called a Promissory Note.

Main Functions of Financial Market

  1. It provides facilities for interaction between the investors and the borrowers.

  2. It provides pricing information resulting from the interaction between buyers and sellers in the market when they trade the financial assets.

  3. It provides security to dealings in financial assets.

  4. It ensures liquidity by providing a mechanism for an investor to sell the financial assets.

  5. It ensures low cost of transactions and information.

Types of Financial Markets

A financial market consists of two major segments:

  1. Money Market
  2. Capital Market

While the money market deals in short-term credit, the capital market handles the medium term and long-term credit.

Difference Between Capital Market and Money Market

Capital Market differs from money market in many ways:

  1. While money market is related to short-term funds, the capital market is related to long term funds.

  2. While money market deals in securities like treasury bills, commercial paper, trade bills, deposit certificates, etc., the capital market deals in shares, debentures, bonds and government securities.

  3. While the participants in money market are Reserve Bank of India, commercial banks, non-banking financial companies, etc., the participants in capital market are stockbrokers, underwriters, mutual funds, financial institutions, and individual investors.

  4. While the money market is regulated by Reserve Bank of India, the capital market is regulated by Securities Exchange Board of India (SEBI).