Chapter 2 – Financial Markets

Introduction
• Financial Market refers to a marketplace, where creation and trading of
financial assets, such as shares, debentures, bonds, derivatives, currencies, etc.
take place.

• It acts as an intermediary between the savers and investors by mobilizing

funds between them.

• The financial market may or may not have a physical location, i.e. the exchange
of asset between the parties can also take place over the internet or phone also.
 FINANCIAL MARKETS

MONEY CAPITAL
MARKET MARKET

BOND EQUITY DERIVATIVES

MARKET MARKET MARKET

PRIMARY SECONDARY
MARKET MARKET

FUTURES OPTIONS
MARKET MARKET
Primary Market
• A primary market is that segment of the capital market, which deals
with the raising of capital from investors via issuance of new
securities. New stocks/bonds are sold by the issuer to the public in the
primary market. When a particular security is offered to the public
for the first time, it is called an Initial Public Offering (IPO). IPO
market is also known as New Issue Market (NIM).
Determination of Price of IPO
• Book Building :- Under book building, the company going public offers a 20% price band on
shares to investors. Investors then bid on the shares before the final price is settled once the bidding
has closed. Investors must specify the number of shares they want to buy and how much they are
willing to pay. Unlike a fixed price offering, there is no fixed price per share. The lowest share
price is known as the floor price, while the highest share price is known as the cap price. The final
share price is determined using investor bids.

• Fixed Price :- Under fixed price, the company going public determines a fixed price at which
its shares are offered to investors. The investors know the share price before the company goes
public. Demand from the markets is only known once the issue is closed. To partake in this IPO,
the investor must pay the full share price when making the application.
Cont..
• Offer for Sale (OFS): Offer for Sale is a simpler method wherein
promoters in public companies can sell their shares and reduce their
holdings in a transparent manner through the bidding platform for the
Exchange. (Min 20% Promoter Holding,) (PSUs)

• Follow-up Offerings (FPO): When an issuer wants to issue more

securities of a category that is already in existence in the market. It is an
issuance of stock subsequent to the company's initial public offering.
Cont..
• Pricing of Security in FPO is easier compared to pricing an IPO.

• FPO = market price is available

• IPO

• Overprice = Non Subscription

• Underprice = Lower price than Intrinsic Value.

Secondary Market
• The secondary market (also known as ‘aftermarket’) is the financial market where
securities, which have been issued before are traded. The secondary market helps in
bringing potential buyers and sellers for a particular security together and helps in
facilitating the transfer of the security between the parties. Unlike in the primary market
where the funds move from the hands of the investors to the issuer (company/
Government, etc.), in case of the secondary market, funds and the securities are
transferred from the hands of one investor to the hands of another. Thus the primary
market facilitates capital formation in the economy and secondary market provides
liquidity to the securities.
Trading in Securities Markets
• Trading in secondary market happens through placing of orders by the
investors and their matching with a counter order in the trading
system. Orders refer to instructions provided by a customer to a
brokerage firm, for buying or selling a security with specific
conditions. These conditions may be related to the price of the
security (limit order or market order or stop loss orders) or
related to time (a day order or immediate or cancel order).
Types of Orders
•Limit Price/Order:
• Example:- Limit Price set for Purchase order is Rs 100
• Better Price will be less than Rs 100.
• Similarly
• Limit Price set for Sale order is Rs 100
• Better Price will be more than Rs 100.
Market Price/Order:
• Example: Market Price in case of Purchase order is the best Ask
price and in case of Sale order it is the best Bid Price

Bid Rs (Buy) Orders Quantity Ask Rs Orders Quantity

(Sale)
150 10 1000 100 500 8000
145 20 2000 125 400 7500
135 50 3000 150 350 5000
110 80 7000 200 300 3000
100 100 9500 350 100 1000
 Loss (SL) Price/Order:
Example:- If an Intraday trader has sold the Example:- If an Intraday trader has
stock for Rs 200 and is expecting the purchased the stock for Rs 270 and is
market to fall. Circuit of 10% expecting the market to rise further.
Purchase order For a Sale Order . Circuit of 10%
Limit Price is Rs 207 Limit Price is Rs 263
Trigger Price Rs 206 Trigger Price Rs 264

Purchase will take place at limit Sale will take place at limit price or at
price or at less than limit price(better more than limit price (better price)
price)
Type of orders – Time related conditions
• Day Order (Day):

• Immediate or Cancel order (IOC):

Matching of Orders
• When the orders are received, they are time-stamped and then immediately processed for
potential match. The best buy order is then matched with the best sell order. For this purpose, the
best buy order is the one with highest price offered, also called the highest bid, and the best sell
order is the one with lowest price also called the lowest ask (i.e., orders are looked at from the
point of view of the opposite party). If a match is found then the order is executed and a trade
happens. An order can also be executed against multiple pending orders, which will result in
more than one trade per order. If an order cannot be matched with pending orders, the order is
stored in the pending orders book till a match is found or till the end of the day whichever is
earlier. The matching of orders at NSE is done on a price-time priority i.e., in the following
sequence:

• • Best Price

• • Within Price, by time priority

Cont..
• Orders lying unmatched in the trading system are ‘passive’ orders and orders that
come in to match the existing orders are called ‘active’ orders. Orders are always
matched at the passive order price. Given their nature, market orders are instantly
executed, as compared to limit orders, which remain in the trading system until
their market prices are reached. The set of such orders across stocks at any point in
time in the exchange, is called the Limit Order Book (LOB) of the exchange.
The top five bids/asks (limit orders all) for any security are usually visible to
market participants and constitute the Market By Price (MBP) of the security.
The Third Market (OTC)
• OTC stocks are stocks of companies that are not listed on the recognized stock
exchanges of India. It may be due to various reasons such as non-compliance with
listing norms or ineligibility. However such companies may be operating in
interesting spheres such as a popular technology or have a product that has scope
for growth that investors are keen to invest in. OTC markets provide this
opportunity for investors to pick up shares of companies that are not formally
listed on the stock exchanges.
How to buy OTC stocks in India?
• Unlike Stock Exchanges, trading on the OTC Market is not directly possible.
Therefore one needs to buy or sell OTC stocks through registered stocks who deal
in such stocks :-
• Full Service brokers
• Discount Brokers
• Things to keep in mind :-
• Low cost of Investment
• No transparency
• Growth potential
• High Risk
• Low Liquidity
The Money Market
Treasury Bills
• Government wants to issue Treasury Bill for Rs 1500 Crores.

• Issue Date:- July 2022 Maturity Date :- September 2022

• Issued at discount and redeemed at Face Value.

• Interest to be decided through “Yield based Auction”

Bid Yeild quoted Amount Subscribed in Crores Cumulative

No.. Amount
1 5.75% 300 300
2 5.95% 450 750
3 6.00% 200 950
4 6.25% 400 1350
5 6.40% 150 1500
6 8.00% 250
• In India, T-bills are issued by the Reserve Bank of India for
maturities of 91-days, 182 days and 364 days. They are issued
weekly (91-days maturity) and fortnightly (182-days and 364- days
maturity).
Commercial Paper
• Commercial papers (CP) are unsecured money market instruments issued in the
form of a promissory note by large corporate houses in order to diversify their
sources of short-term borrowings and to provide additional investment avenues to
investors. Issuing companies are required to obtain investment-grade credit ratings
from approved rating agencies. CPs are also issued at a discount to their face
value. In India, CPs can be issued by companies, primary dealers (PDs), satellite
dealers (SD) and other large financial institutions, for maturities ranging from 15
days period to 1-year period from the date of issue. CP denominations can be Rs.
500,000 or multiples thereof.
Certificates of Deposits
• A certificate of deposit (CD), is a term deposit with a bank with a specified interest
rate. The duration is also pre-specified and the deposit cannot be withdrawn on
demand. Unlike other bank term deposits, CDs are freely negotiable and may be
issued in dematerialized form or as a Usance Promissory Note. CDs are rated
(sometimes mandatory) by approved credit rating agencies and normally carry a
higher return than the normal term deposits in banks (primarily due to a relatively
large principal amount and the low cost of raising funds for banks). Normal term
deposits are of smaller ticket-sizes and time period, have the flexibility of
premature withdrawal and carry a lower interest rate than CDs.
Cont.…
• In many countries, the central bank provides insurance (e.g. Federal Deposit
Insurance Corporation (FDIC) in the U.S., and the Deposit Insurance and Credit
Guarantee Corporation (DICGC) in India) to bank depositors up to a certain
amount (Rs. 100000 in India). CDs are also treated as bank deposit for this
purpose.

• In India, scheduled banks can issue CDs with maturity ranging from 7 days – 1
year and financial institutions can issue CDs with maturity ranging from 1 year – 3
years. CD are issued for denominations of Rs. 1,00,000 and in multiples thereof.
Other Money Market Instruments:

• Call Money:- Maturity extends to overnight

• Notice Money:- Maturity in between 2 to 14 days.
• Term Money:- maturity ranges between fortnight to 1 year
• Money Market Mutual Funds:- Maturity lasts up to 1 year.
Introduction
• The Debt / Bond Market is the market where fixed income securities
of various types and features are issued and traded. Debt Markets are
therefore, markets for fixed income securities issued by Central and
State Governments, Municipal Corporations, Govt. bodies and
commercial entities like Financial Institutions, Banks, Public Sector
Units, Public Ltd. companies and also structured finance instruments.
Trading Structure in Wholesale Debt Market
•The issue and trading of fixed income securities by each of
these entities are regulated by different bodies in India. For
eg: Government securities and issues by Banks, Institutions
are regulated by the RBI. The issue of non-government
securities comprising basically issues of Corporate Debt is
regulated by SEBI.
Treasury Notes (T-Notes) and T-Bonds
• Treasury notes and bonds are debt securities issued by the Central
Government of a country.
• Treasury notes maturity range up to 10 years, whereas treasury bonds
are issued for maturity ranging from 10 years to 30 years. Another
distinction between T-notes and T-bonds is that T bonds usually
consist of a call/put option after a certain period. In order to make
these instruments attractive, the interest income is usually made
tax-free.
State and Municipal Government Bonds
• Apart from the central Government, various State Governments and
sometimes municipal bodies are also empowered to borrow by issuing
bonds. They usually are also backed by guarantees from the respective
Government. These bonds may also be issued to finance specific
projects (like road, bridge, airports etc.) and in such cases, the debts
are either repaid from future revenues generated from such projects or
by the Government from its own funds.
• Similar to T-notes and T-bonds, these bonds are also granted
tax-exempt status. In India, the Government securities (includes
treasury bills, Central Government securities and State
Government securities) are issued by the Reserve Bank of India on
behalf of the Government of India.
Corporate Bonds
• Bonds are also issued by large corporate houses for borrowing money
from the public for a certain period. The structure of corporate bonds is
similar to T-Notes in terms of coupon payment, maturity amount (face
value), issue price (discount to face value) etc. However, since the
default risk is higher for corporate bonds, they are usually issued at a
higher discount than equivalent Government bonds. These bonds are not
exempt from taxes. Corporate bonds are classified as secured bonds and
unsecured bonds
International Bonds
• These bonds are issued overseas, in the currency of a foreign country
which represents a large potential market of investors for the bonds.
Bonds issued in a currency other than that of the country in which it is
issued are usually called Eurobonds.
• Eurodollar bonds are US dollar-denominated bonds issued outside
the United States.
• Euro-yen bonds are yen denominated bonds issued outside Japan.
• Yankee bonds are US dollar denominated bonds issued in U.S. by a
non-U.S. issuer
• Samurai bonds are yen-denominated bonds issued in Japan by
non-Japanese issuers.
Zero Coupon Bonds
• Zero coupon bonds (also called as deep-discount bonds or discount
bonds) refer to bonds which do not pay any interest (or coupons)
during the life of the bonds. The bonds are issued at a discount to the
face value and the face value is repaid at the maturity. The return to
the bondholder is the discount at which the bond is issued, which is the
difference between the issue price and the face value.
Convertible Bonds
• Convertible bonds offer a right (but not the obligation) to the
bondholder to get the bond converted into predetermined number of
equity stock of the issuing company, at certain, pre specified times
during its life. Thus, the holder of the bond gets an additional value, in
terms of an option to convert the bond into stock (equity shares) and
thereby participate in the growth of the company’s equity value. The
investor receives the potential upside of conversion into equity while
protecting downside with cash flow from the coupon payments. The
issuer company is also benefited since such bonds generally offer
reduced interest rate. However, the value of the equity shares in the
market generally falls upon issue of such bonds in anticipation of
the stock dilution that would take place when the option (to
convert the bonds into equity) is exercised by the bondholders.
Callable Bonds
• In case of callable bonds, the bond issuer holds a call option, which can be
exercised after some pre-specified period from the date of the issue. The
option gives the right to the issuer to repurchase (cancel) the bond by paying
the stipulated call price. The call price may be more than the face value of
the bond. Since the option gives a right to the issuer to redeem the bond, it
carries a higher discount (higher yield) than normal bonds. The right is
exercised if the coupon rate is higher than the prevailing interest rate in the
market.
Puttable Bonds
• A puttable bond is the opposite of callable bonds. These bonds have an
embedded put option. The bondholder has a right (but not the
obligation) to sell back the bond to the issuer after a certain time at a
pre-specified price. The right has a cost and hence one would expect a
lower yield in such bonds. The bondholders generally exercise the
right if the prevailing interest rate in the market is higher than the
coupon rate. Since the call option and the put option are mutually
exclusive, a bond may have both option embedded.
Fixed rate and floating rate of interest
•In case of fixed rate bonds, the interest rate is fixed and does
not change over time, whereas in the case of floating rate
bonds, the interest rate is variable and is a fixed percentage
over a certain pre-specified benchmark rate. The benchmark
rate may be any other interest rate such as T-bill rate, the
three-month LIBOR rate, MIBOR rate (in India), bank rate,
etc. The coupon rate is usually reset every six months (time
between two interest payment dates).
Common Stocks
• The shareholders of a company are its owners. As owners, they
participate in the management of the company by appointing its board
of directors and voicing their opinions, and voting in the general
meetings of the company. The board of directors have general
oversight of the company, appoints the management team to look after
the day-to-day running of the business, set overall policies aimed at
maximizing profits and shareholder value.
• Shareholders of a company are said to have limited liability. The
term means that the liability of shareholders is limited to the unpaid
amount on the shares. This implies that the maximum loss of
shareholder in a company is limited to her original investment. Being
the owners, shareholders have the last claim on the assets of the
company at the time of liquidation, while debt- or bondholders always
have precedence over equity shareholders.
Types of Shares
• In India, shares are mainly of two types: equity shares and preference
shares. In India, preference shares are redeemable (callable by issuing
firm) and preference dividends are cumulative. By cumulative
dividends, we mean that in case the preference dividend remains
unpaid in a particular year, it gets accumulated and the company has
the obligation to pay the accrued dividend and current year’s dividend
to preferred stockholders before it can distribute dividends to the
equity shareholders. An additional feature of preferred stock in India is
that during such time as the preference dividend remains unpaid,
preference shareholders enjoy all the rights (e.g. voting rights) enjoyed
by the common equity shareholders. Some companies also issue
convertible preference shares which get converted to common equity
shares in future at some specified conversion ratio.