MODULE 2: CAPITAL MARKET AND MONEY MARKET

Capital market
Introduction
The capital market is a segment of the financial market where long-term securities, such as
stocks and bonds, are bought and sold. It serves as a platform for individuals, businesses, and
governments to raise funds by issuing financial instruments to investors. Capital markets play
a crucial role in facilitating economic growth and development by channelling savings and
investments into productive activities such as business expansion, infrastructure
development, or government projects. It provides a means for investors to potentially earn
returns on their investments while allowing issuers to access the funds necessary for growth
and development.

Meaning
The capital market is a financial market where individuals, businesses, and governments can
buy and sell long-term financial assets, such as stocks, bonds, and other securities.

Structure /Components of Capital market

Capital market

Primary market Secondary market

( New issue market) (Stock Exchange)

Eg: IPO, Right Issue, Bonus iss issue Eg: NSE,BSE, NASDAQ

1. Primary Market:
• The primary market is where newly issued securities are first time offered to
the public.
• Companies and governments use the primary market to raise capital.
• In the primary market, securities are issued through processes like initial
public offerings (IPOs) for stocks and bond auctions for debt securities.
• Investment banks and underwriters often play a key role in facilitating primary
market transactions.

2. Secondary Market:
• The secondary market is where existing securities that have already been
issued in the primary market are bought and sold among investors.
 • Stock exchanges (e.g, BSE, NSE, NASDAQ) and bond markets (e.g.,
corporate bond markets, government bond markets) are examples of secondary
markets.
• Secondary markets provide liquidity to investors by allowing them to buy and
sell securities after their initial issuance.

Importance / Functions of capital market

1. Raising Capital: One of the fundamental functions of the capital market is to provide
a platform for businesses and governments to raise long-term capital. Companies can
issue stocks (equity) or bonds (debt) to raise funds for expansion, research and
development, debt repayment, or other purposes.
2. Liquidity Provision: The secondary market within the capital market provides
liquidity to investors by allowing them to buy and sell existing securities, such as
stocks and bonds, after their initial issuance. This liquidity enables investors to enter
and exit investments more easily.
3. Risk Diversification: Investors can diversify their portfolios by investing in a range
of securities in the capital market. This diversification helps spread risk and reduces
the impact of poor performance in any single investment.
4. Capital Formation: The capital market facilitates the formation and development of
new enterprises by allowing entrepreneurs to raise capital through initial public
offerings (IPOs) and other equity offerings. This promotes innovation and economic
growth.
5. Wealth Creation: Investing in the capital market can lead to wealth creation for
individuals and institutions. Over time, investments in stocks, bonds, and other
securities can generate returns in the form of capital appreciation and income from
dividends or interest.
6. Hedging and Risk Management: The capital market provides tools such as
derivatives (e.g., futures and options contracts) that enable investors and businesses to
hedge against price fluctuations and manage risk associated with their assets and
liabilities.
7. Economic Indicator: The performance of capital markets, including stock market
indices, can serve as indicators of broader economic health. Rising stock prices, for
example, may reflect optimism about economic growth, while falling prices may
signal concerns.
8. Encourages Savings and Investment: The capital market encourages savings and
investment by offering individuals and institutions the opportunity to earn a return on
their investments. This encourages people to save for retirement, education, and other
long-term goals.
9. Innovation and Entrepreneurship: Capital markets provide access to funding for
innovative startups and entrepreneurs, fostering economic dynamism and the
development of new technologies and products.
Players in the Capital market
A. Fund Raisers:
1) Corporations: Private and publicly traded companies are among the most
prominent fund raisers in the capital market. They raise funds by issuing stocks
(equity) or bonds (debt). Corporations use these funds for various purposes,
including expanding operations, launching new products, or financing mergers
and acquisitions.
2) Startups and Small Businesses: Emerging businesses often use the capital
market to raise funds for growth and development. This can involve venture
capital, private equity, or initial public offerings (IPOs) if they decide to go public.
3) Non-Profit Organizations: Some non-profit organizations may issue bonds or
seek other financial instruments in the capital market to raise funds for their
charitable or operational activities.
4) Government Entities: Governments, both national and local, are significant fund
raisers in the capital market. They issue government bonds to finance public
projects, infrastructure development, and budget deficits. These bonds are
typically considered low-risk investments.
5) International Organizations: Multilateral institutions like the World Bank and
the International Monetary Fund (IMF) may raise capital in the capital market to
finance development projects and provide financial assistance to member
countries.
6) Public Sector Units (PSUs): Government-owned companies, also known as
public sector units (PSUs), may issue securities in the capital market to raise funds
for operations, expansion, or privatization initiatives.

B. Fund providers
1) Retail Investors: These are private individuals who invest their personal savings
in various financial securities, such as stocks, bonds, mutual funds, exchange-
traded funds (ETFs), and other investment vehicles.
2) Pension Funds: Pension funds manage retirement savings on behalf of employees
and retirees. They invest in a diversified portfolio of assets to generate returns and
fund future pension payments.
3) Insurance Companies: Insurance companies invest their policyholders' premiums
in a mix of assets to meet future policy obligations while earning returns on their
investments.
4) Mutual Funds: Mutual funds pool money from multiple investors to invest in a
diversified portfolio of stocks, bonds, or other securities. Investors in mutual funds
purchase shares of the fund.
5) Venture Capital Firms: Venture capital firms invest in startups and early-stage
companies in exchange for equity ownership. They provide capital and expertise
to help these businesses grow.

C. Other players capital market

 1) Banks and Financial Institutions: Banks often participate as lenders in the
capital market by investing in various financial instruments. They may also serve
as intermediaries between borrowers and investors.
2) Stock Brokers: Stock brokers are intermediaries that execute buy and sell orders
for stocks and other equity securities on behalf of investors.
3) Bond Brokers: Bond brokers specialize in trading bonds and other debt
securities. They help match buyers and sellers and facilitate bond transactions.
4) Underwriters: Underwriters provide a level of assurance to investors by
committing to purchase the securities from the issuer and then reselling them to
the public. Their primary function is to manage the issuance of securities and
mitigate the risk for issuers.
5) Merchant bankers: Merchant bankers or corporate finance advisors, are
financial professionals or institutions that provide a range of financial services to
corporations, governments, and other entities in the capital market. These services
typically revolve around helping clients raise capital, manage financial
transactions, and make strategic financial decisions.
6) Registrar and Transfer agents (R&T agents):
A registrar and transfer agent (RTA) acts as a mediator or agent between investors
and mutual fund houses. These financial institutions hire RTAs for managing and
maintaining proper records of investors’ data.

MARKET REGULATORS
( consider market regulators also as players )
SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)
The Securities and Exchange Board of India (SEBI) is the primary regulatory
authority overseeing and regulating the securities and capital markets in India.
SEBI was established on April 12, 1992, through the SEBI Act, 1992. Its mission is
to protect the interests of investors in securities, promote the development and regulation of
the securities market, and ensure the proper functioning of the market.

RESERVE BANK OF INDIA(RBI)

Reserve Bank of India (RBI) was established on 1 April 1935 by the RBI Act 1934.
The Reserve Bank of India (RBI) is the central bank of India, and it plays a vital role in
regulating and supervising various aspects of the financial and banking sector in the country.
While its primary focus is on monetary policy and the banking system, the RBI also has
regulatory authority over certain segments of the financial markets.
The Reserve Bank of India (RBI) is not primarily a market regulator in the same
way as the Securities and Exchange Board of India (SEBI). Instead, the RBI is India's central
bank, responsible for regulating and supervising the country's banking and financial system,
as well as formulating and implementing monetary policy.

DEPARTMENT OF COMPANY AFFAIRS (DCA)

The Department of Company Affairs (DCA) was a government department in India
responsible for regulating and administering company law and corporate affairs. However,
the DCA no longer exists in its previous form. In 2013, the DCA was replaced by the
Ministry of Corporate Affairs (MCA). The Ministry of Corporate Affairs is the primary
regulatory body in India responsible for regulating companies, corporate governance, and
related matters. The MCA plays a crucial role in regulating various aspects of the corporate
sector in India.
Department of Company Affairs (now the Ministry of Corporate Affairs) in India
primarily deals with matters related to corporate governance, company registration, investor
protection and corporate compliance.

Instruments of Capital market

In the capital market, various financial instruments are used by individuals and entities
to raise capital and invest. Here are some of the key instruments in the capital market:
1. Equity: Equity instruments represent ownership in a company. Common stock is the
most common form of equity. When you buy shares of a company's stock, you
become a shareholder and have ownership rights, including the right to vote at
shareholder meetings and receive dividends if the company distributes them. The risk
factor in this instrument is high and thus yields a higher return.
2. Preference Shares: Preference shares are a type of equity instrument, but they come
with specific preferences over common shareholders. Preference shareholders
typically receive a fixed dividend before common shareholders, and they may have
other preferential rights, such as priority in case of liquidation.
3. Debt Instruments: Debt instruments represent loans that individuals or entities
provide to governments, corporations, or other borrowers in exchange for regular
interest payments and the return of the principal amount at maturity. Common debt
instruments include bonds, debentures, and notes.
4. Long-Term Securities: Long-term securities are financial instruments with a
maturity period typically exceeding one year. This category can include both equity
and debt instruments, as well as hybrid securities that have characteristics of both.
5. Derivatives: Derivatives are financial contracts whose value is derived from the
performance of an underlying asset, index, or interest rate. Common derivatives
include futures, options, swaps, and forwards. They are often used for hedging,
speculation, or managing risk.
6. Mutual Funds: Mutual funds pool money from multiple investors to invest in a
diversified portfolio of securities, such as stocks, bonds, or other assets. Investors in
mutual funds receive shares of the fund, and the fund's performance is based on the
underlying securities it holds.

Recent trends in capital market

1. Digital Transformation: The capital markets were increasingly digitizing their
operations. This included the adoption of blockchain technology for settlements and
record-keeping, the use of algorithmic trading, and the development of digital
investment platforms for retail investors.
2. Low Interest Rates: Central banks in many countries maintained low-interest rates to
stimulate economic growth. This environment made it challenging for fixed-income
investors to find attractive yields, pushing some towards riskier assets like stocks.
 3. Remote Trading: More people are trading from home or other remote locations,
which has become easier with the rise of online brokerages and mobile apps.
4. Cryptocurrencies: Digital currencies like Bitcoin and Ethereum are gaining attention
as alternative investments. Some people see them as a store of value or a way to
diversify their portfolio.
5. Robo-Advisors: Automated services that help investors pick investments based on
their goals and risk tolerance are becoming popular. These "robo-advisors" use
algorithms to manage portfolios.

Money market
Introduction
The money market is a segment of the financial market where short-term borrowing and
lending of funds occur. It plays a crucial role in facilitating the smooth functioning of the
economy by providing a platform for various financial instruments and transactions that help
manage liquidity, meet short-term financing needs, and influence interest rates.
Meaning
The money market is a component of the economy that provides short-term funds. The
money market deals in short-term loans, generally for a period of a year or less.

Structure of Money Market

The money market can be categorized organized money market, the unorganized money
market, and the interbank call money market. Each of these segments serves different
purposes and involves different participants and instruments.

1. Organized Money Market:

The organized money market refers to the formal and regulated segment of the money
market. It includes financial institutions, government entities, and corporations that engage in
short-term borrowing, lending, and investment activities with a high degree of transparency.
• Key instruments in the organized money market include Treasury Bills (T-bills),
Certificates of Deposit (CDs), Commercial Paper (CP), and Repurchase Agreements
(Repos).

2. Unorganized Money Market:

The unorganized money market is the informal and less regulated segment of the money
market. It involves a variety of informal lending and borrowing arrangements, often among
smaller financial institutions, businesses, and individuals.
• In the unorganized money market, transactions may take place without the same level
of documentation, regulation, or standardization as in the organized segment.
• Instruments used in the unorganized money market can include promissory notes,
informal lending agreements, and private loans.
• The unorganized money market can be less transparent and may carry higher risks due
to the absence of formal oversight.
3. Interbank Call Money Market:
The interbank call money market is a specialized segment of the money market where banks
lend and borrow funds from each other on an overnight basis.
 • It serves as a crucial component of a country's monetary policy framework, allowing
banks to manage their daily liquidity requirements.
• In this market, banks with excess funds lend to banks that need short-term financing
to meet reserve requirements or to cover sudden cash flow gaps.
• Transactions in the interbank call money market are typically short-term and highly
liquid, with lending banks providing collateral to borrowing banks.

Importance and functions of money market

1. Liquidity Management:
The money market allows financial institutions, corporations, and government entities
to manage their short-term liquidity needs effectively. Participants can easily convert
their financial assets into cash by trading highly liquid money market instruments like
Treasury Bills and Certificates of Deposit.
2. Short-Term Financing:
Businesses and government entities can raise short-term capital quickly and cost-
effectively through the issuance of money market instruments like Commercial Paper.
This enables them to meet immediate financial obligations, invest in projects, or
bridge temporary cash flow gaps.
3. Risk Management:
The money market provides participants with opportunities to diversify their
investment portfolios and manage risks.
4. Interest Rate Determination:
Money market interest rates, such as the federal funds rate, serve as benchmarks that
influence broader interest rates in the economy. Central banks often use money
market operations to implement monetary policy and control short-term interest rates,
impacting borrowing and lending costs throughout the financial system.
5. Investment Opportunities:
Individual and institutional investors can earn competitive yields on their surplus
funds by investing in money market instruments or money market funds.
Money market investments are generally considered safe, making them attractive
options for those seeking stability.
6. Financial System Stability:
A well-functioning money market contributes to overall financial system stability by
ensuring the smooth flow of funds and liquidity throughout the banking and financial
sectors.
7. Government Financing:
Governments can raise funds efficiently by issuing Treasury Bills in the money
market, helping them cover budget deficits and fund essential programs.

Instruments of Money Market ( refer detailed explanation given in notes)

A. Government and Semi Government Instruments
1. Treasury Bills (T-bills):
Treasury Bills are short-term debt securities issued by the government to raise
funds. They typically have maturities ranging from a few days to one year.
 T-bills are considered one of the safest money market instruments because they
are backed by the full faith and credit of the government.
2. Government securities: Government securities are a crucial component of the
money market, providing a safe and liquid investment option for both
institutional and individual investors. These securities are issued by governments
to raise funds, manage their finances, and influence monetary policy.
3. Repurchase Agreement (Repo): A Repurchase Agreement (Repo) is a financial
instrument commonly used in the money market. It's a short-term transaction in
which one party sells securities to another party with an agreement to repurchase
them at a specified future date and price. Repos serve various functions in the
money market and the broader financial system. Participants include banks,
financial institutions, and central banks.
4. UTI Units: UTI is a well-known asset management company in India that offers
a range of mutual fund schemes to investors. When you invest in a UTI mutual
fund, you are allocated units based on the amount you invest and the fund's net
asset value (NAV). These units represent your ownership in the mutual fund
scheme.
5. PSU Bonds: PSU bonds refer to debt securities issued by Public Sector
Undertakings, which are government-owned companies in India. These bonds
are typically used by PSUs to raise funds for various purposes, such as
infrastructure projects. They are a type of fixed-income instrument and have a
predetermined interest rate and maturity date. PSU bonds are considered
relatively safe investments because they are backed by the Indian government.

B. Private Instruments
1. Commercial Paper (CP): Commercial paper is a short-term, unsecured debt
instrument issued by corporations to raise funds for their working capital needs. It
typically has maturities ranging from a few days to 270 days.
2. Certificates of Deposit (CDs): Certificates of deposit are time deposits offered by
banks and financial institutions. While government bonds are considered safer, CDs
issued by private banks are also prevalent in the money market. They come with
maturities ranging from a few weeks to several years.
3. Commercial Bills: Commercial bills are short-term promissory notes issued by
corporations to raise funds. They are less common than some other money market
instruments.
4. Factorization Bill (Factoring Bill): Factorization bills, also known as factoring bills,
they are part of the factoring process in which a business sells its accounts receivable
(unpaid invoices) to a financial institution or factor at a discount. Factorization bills
represent the purchased accounts receivable and are evidence of the transaction. They
are used in trade finance and working capital management.

C. Interbank Instruments:
Interbank instruments are financial products and transactions that occur between
banks, typically for short-term lending and borrowing purposes. Banks use interbank
 instruments to manage their daily cash flow needs, maintain reserve requirements, and
ensure they have enough funds to meet customer demands and payment obligations.

D. Call Money Deposits:

Call money deposits refer to short-term funds that one bank places with another bank
for a very short duration, typically overnight. Banks use call money deposits to
manage their immediate liquidity needs. These deposits allow banks to earn some
interest on their excess funds while keeping them readily available for immediate use.
Call money deposits have a very short maturity, often just one day. Banks can "call"
these deposits back at very short notice, usually on the next business day.

E. Inter-corporate instruments: Inter-corporate instruments are financial products and

transactions used by corporations (business entities) to manage their short-term
financing and investment needs in the money market. These instruments facilitate
borrowing, lending, and investment activities between different corporations.

RECENT TRENDS IN MONEY MARKET

1. Low Interest Rates:
Central banks in many countries had maintained historically low interest rates as a
response to the economic challenges posed by the COVID-19 pandemic. This low-rate
environment affected yields on money market instruments, including Treasury bills and
certificates of deposit.
2. Increased Use of Repos:
The repurchase agreement (repo) market saw increased activity. Repo transactions
became a crucial source of short-term funding for financial institutions and were used
extensively in liquidity management.
3. Safety:
Investors continued to seek safety in money market instruments due to uncertainty
surrounding the global economy. Treasury bills and high-quality commercial paper
remained attractive options for those looking to preserve capital.
4. Shift to Longer-Term Instruments:
Some investors, in search of higher yields, began shifting their focus towards slightly
longer-term money market instruments, such as commercial paper with longer maturities
or longer-duration certificates of deposit.
5. Regulatory Changes:
Regulatory authorities continued to implement and refine regulations governing money
market funds (MMFs). These changes aimed to improve the resilience of MMFs and
reduce the risk of runs during market stress.
6. Digital Innovation:
Fin-tech companies and financial institutions continued to innovate in the money market
space, offering digital platforms for investing in money market funds, making
transactions more accessible and efficient.

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