Commerce · Ch 7 — Fundamentals of Financial Markets
Meaning and Classification of Financial Markets
Meaning and Classification of Financial Markets
1. Meaning and Classification of Financial Markets
A financial market is a mechanism — not necessarily a physical place — that brings together persons and institutions with surplus funds (savers/lenders/investors) and persons and institutions needing funds (borrowers), enabling the transfer of funds from the former to the latter through the purchase and sale of financial instruments such as shares, debentures, bonds and short-term credit instruments. A financial market performs, in effect, the same basic function that a produce market performs for goods — except that what changes hands here is money itself, or a claim to money, rather than a physical good.
Financial markets are classified, on the basis of the TIME PERIOD for which funds are made available, into two broad kinds:
- Money Market — deals in funds and instruments with a SHORT-TERM maturity, ordinarily up to one year. It meets the working-capital and short-term liquidity needs of governments, banks, financial institutions and businesses.
- Capital Market — deals in funds and instruments with a MEDIUM- to LONG-TERM maturity, ordinarily beyond one year (and, for equity shares, with no fixed maturity at all). It meets the fixed-capital and long-term investment needs of businesses and governments, and is the subject of both this chapter's second half and the whole of the next chapter, Stock Exchange and SEBI.
| Basis | Money Market | Capital Market |
|---|---|---|
| Maturity of instruments dealt in | Short-term, up to 1 year | Medium- to long-term, beyond 1 year (equity shares: no fixed maturity) |
| Purpose served | Working capital / short-term liquidity needs | Fixed capital / long-term investment needs |
| Main instruments | Treasury Bills, Commercial Paper, Certificates of Deposit, Call Money, Commercial Bills | Equity shares, Preference shares, Debentures, Bonds |
| Main participants | RBI, commercial banks, financial institutions, large corporates, the government | Companies, individual and institutional investors, merchant bankers, stock exchanges |
| Principal regulator in India | Reserve Bank of India (RBI) | Securities and Exchange Board of India (SEBI) |
| Risk and return, generally | Comparatively lower risk, lower return | Comparatively higher risk, potentially higher return |
| Liquidity of instruments | Very high — instruments are designed to be converted to cash quickly | Varies — listed securities on a stock exchange are liquid; a fresh issue is not liquid until listed |
Why the money market/capital market line is drawn on TIME, not on the type of institution …
A mechanism that brings together those with surplus funds and those needing funds, enabling the transfer of funds through the purchase and sale …
The segment of the financial market dealing in short-term funds and instruments, ordinarily of maturi …
The segment of the financial market dealing in medium- to long-term funds and instruments, ordinarily of matur …