Big Bank Theory: Understanding Financial Markets

Dear aspirants,

In continuation with our “Big Bank Theory” initiative, today we will discuss an important topic of Economics i.e. “Understanding Financial Markets”.

Understanding Financial Markets

Financial Market – Let us explain first, If we talk about market it is not a particular tangible place but it’s refer to a group of entities which participate in borrowing and lending. The products can be classified as – bonds, equities, currencies and derivatives. It is a medium of channel between depositors and borrowers.

Financial Market is divided into two parts:

1. Money Market

2. Capital Market

Money Market

Money Market is a key element of the financial system. It is also known as “Short Term Market” because here trading is done between 1 day to 365 days. In this market, trading is done for a small span of time so “Risk Factor” is very low as well as “returns are very less”. Short –term instrument like – Treasury bills, Commercial papers, Certificates of deposits, etc are issued and traded in this market.

The money market provides facilities to the banks and primary dealers (PDs) to lend or borrow money when there is a mismatch of funds. Scheduled Commercial Banks (except RRB),Co-operative Banks and Primary Dealers participates in these markets. In Call and Notice Money both the borrowers and lenders need to maintain a current account with RBI because this trading happens for very small tenure. This borrowing and lending are on unsecured basis which are –

1. Call Money – When money is lend or borrowed only for 1day.

2. Notice Money – Where money is borrowed or lend for the period between 2 days and 14 days.

3. ‘Term Money’ – I Where money is borrowed or lend for a period exceeding 14 days.

Capital Market

Capital market is another key component of the financial system. It is also known as “Long Term Market” where trading is done for more than a year. In this market, the capital funds comprising of both equity and debt are issued and traded. This also includes private placement sources of debt and equity as well as organized markets like stock exchanges.

Capital market can be further divided into primary and secondary markets.

(i) Primary Market – It is a market which deals with deals with trading & issuance of stocks and other securities.

(ii) Secondary Market – It is a market which comprises of equity and debt markets. It deals with the exchange of existing or previously-issued securities.

In this article, we will discuss on some money market instruments –

1. Treasury bills (T-bills) –    In Money Market, if we talk about lowest risk instruments then it is Treasury Bills. It is also known as T-Bills. It is issued by Central Government with fixed day and fixed amount. They are highly liquid as bill holder can transfer or get discount of bill any time from RBI. They are issued as well as auctioned by RBI only but can be purchased by Individuals, Firms, Trusts, Institutions and Banks.
Generally, they are of three types-

Generally, they are of three types-91 days-They are issued with maturity is in 91 days.

(i) 91 days-They are issued with maturity is in 91 days.

(ii) 182 days-They are issued with a maturity of 182 days.364 days.

(iii) 364 days-They are issued with a maturity of 364 days.

Note:

(i) Treasury bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000.

(ii) Kindly note government has also introduced T-Bills for 14 days as well, these are known as intermediate bills.
In T-Bills,most of the time investors request instruments in demat form instead of securities. Hence, RBI maintains this ledger in SGL (Subsidiary General Ledger).

2. Commercial Paper – It is unsecured money market instrument which was introduced in 1990. It is issued in the form of a promissory note.

Who can issue CP – All India financial Institutions (FIs), Primary dealers (PDs), big companies are permitted to issue commercial paper to enable them to meet their short-term funding requirements.

Tenor – CP shall be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue. The maturity date of the CP shall not go beyond the date up to which the credit rating of the issuer is valid.

Denomination – CP shall be issued in denominations of Rs. 5 lakh and multiples thereof. The amount invested by a single investor should not be less than Rs. 5 lakh (face value).

3. Certificate of Deposits – It is negotiable money market instrument which was introduced in 1989.

Who can issue CD – CDs can be issued by (i) scheduled commercial banks {excluding Regional Rural Banks and Local Area Banks}; and (ii) select All-India Financial Institutions (FIs) that have been permitted by RBI.

Tenor – CD shall be issued for maturities between a minimum of 7 days and a maximum of up to one year from the date of issue.

Note: Financial Institutions can issue for a period not less than 1 year and not exceeding 3 years.

Denomination – CD shall be issued in denominations of Rs. 1 lakh and multiples thereof. The amount invested by a single investor should not be less than Rs. 1 lakh (face value).

4. Cash Management Bills – It is a short-term instrument issued by Central Government to meet the temporary cash flow mismatches of the Government. The announcement of the auction of the Bills is be made by the Reserve Bank of India.

Tenor – It is a non-standard, discounted instruments issued for maturities less than 91 days.

Note: In next post, we will discuss in detail on Capital Market.

Thanks