Money Markets And Capital Markets

Money Market: The Money Market is defined as a market for overnight to a short-term money and for financial assets that are close substitute for money. The meaning of “short-term” refers to a duration of less than or equal to 1 year. The phrase “close substitute for money” denotes any financial asset that can be quickly converted into money with minimum transaction cost and without loss of value. Participants in this market either have excess funds which they would like to invest for short duration (from overnight to 1 year) or have an immediate shortage of funds and would like to borrow in the short-term. The market is a wholesale market for a collection of different short term debt instruments. Its principal feature is the credit worthiness of the participants.

Participants in Money Market: The main players in this market are Reserve Bank of India (RBI), Discount and Finance House of India, Mutual Funds, Banks, Corporate Investors, Non-Banking Finance Companies (NBFC), State Government, Provident Funds, Primary Dealers, Securities Trading Corporation of India (STCI), Public Sector Undertakings (PSU) and Non-resident Indians (NRI).

Until the early 1990s, participants in the Money Market in India was restricted to Banks, LIC and UTI. There were no other participants who could actively trade in the short-term money market instruments. The only available money market instruments were the call / notice money, interbank deposits/loans, commercial bills and 91-days Treasury bill. The interest rates were controlled directly by the RBI or involuntarily by means of agreement between banks through the Indian Banks Association.

Significance of Money Market: The pre-requisites for an efficient money market are the availability of low risk but highly liquid short-term money instrument, deregulated interest rates, flexibility in transactional procedures and also an existence of a number of participants including market makers – to create liquidity for instruments. 

After 1990, a liquid money market emerged in India. Specialized institutions called Primary Dealers (PD) were established. This also coincided with the formation of the Money Market Mutual Fund (MMMF). Interest rates were also deregulated, and eligible participants were enlarged. Also, many new instruments were launched.

Presently, the structure of the Indian Money Market instruments consists of Call / Notice Money Market, Commercial Bills Market, Treasury Bills (T-Bills), Commercial Papers (popularly known as CP), Certificate of Deposit (CD) and the Repo Market.

The RBI uses open market operations (OMO), bank rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), Repo transactions as active instrument of monetary policy. 

The key objective of money market is:

• To facilitate an equilibrium between demand and supply of short-term funds.
• Provide a focal point for central bank intervention for influencing liquidity in the economy.

Facilitate easy access for users and suppliers of short-term funds to meet their requirements at an efficient market clearing price. 

Instrument Traded in Money Market:

• Treasury Bills: Treasury Bills (T-Bills) are short-term instruments issued by the RBI on behalf of the Government of India. This provides short-term credit to Government for any intermittent financing requirements – this bridges the temporary gap between revenue and expenditure. T-Bills are rapid at par upon maturity. RBI usually issues the 91-day, 182-day and 364-day T-Bills.
• Commercial Paper: A Commercial Paper (CP) is an unsecured short-term promissory note that is negotiable and transferable by endorsement and delivery with a fixed maturity period. It is usually issued at a discount of the face value of the CP, by companies with a high credit rating in the form of promissory note redeemable at par to the holder on maturity. CP is used to meet the working capital requirements of the company. The tenor of issue for CP is between 7 days to 1 year (effective from April 2004). 

Capital Markets: Capital Markets involve raising finance through issue of publicly traded financial instruments in equity and debt that can be bought and sold at any time for a longer duration. For facilitating this framework, financial intermediaries play a very important role. The “financial claims” – bonds, fixed deposits receipts, share, etc. The investors – comprising participants in the financial markets such as individual, banks, high net worth individual (HNI) and other entities – could buy these “financial claims” in the primary markets. Such instruments can also be traded in the secondary markets. 

“Primary Markets” enable fresh issue of “financial claims” (in the form of Initial Public Offering or IPO, Follow-on Public Offering or FPO, Open Market Operations by the RBI for issue of Government Securities or even sale of corporate bonds and debentures). The establishment of “Secondary Markets” in the form of stock exchanges (for trading in equity market offering such as shares) and Primary Dealers (PD) – who provide two-way quotes for Government Securities and Corporate Bonds – facilitated the liquidity for the purchase of these financial claims.

Typically, an investor can directly purchase these “financial claims”. Alternatively, investors can purchase these financial claims directly by way of mutual funds units, security receipts or pass through certificates. Even insurance companies commenced issuing innovative financial products called “Unit Linked Insurance Products” (ULIP) to facilitate a portion of the funds are invested in the capital markets.

Capital Market also offer a wide scope of raising debt capital through issue of long-term debt. Capital through issue of debt securities, as distinguished from loans provided by banks and financial institutions. This enabled corporates, who were until then, dependent on banks and financial institutions for raising capital, could directly approach the markets by issue of corporate bonds. This kind of debt capital is convenient for both the issuers as well as investors, because of the tradable nature of these securities in the secondary markets.

Thus, the capital markets become an avenue of bank disintermediation, in that, it not only brings the investors of funds and issuers of “financial claims” together on an alternative platform but also helps in movement of debt capital – a function that was primarily the domain of banks and financial institutions until the mid-1980s and early 1990s.

The contemporary market microstructure provides for co-existence of banks and financial institutions as well as capital markets. The inherent competition in the form of availability of capital has spurred competition among the different market participants to provide capital at optimal cost. This has also resulted in depositors of funds and investors multiple avenues to choose from, based on their risk appetite. The formation of stock exchanges for trading in equity products, primary dealers for bonds and other intermediaries such as Asset Management Companies offering mutual funds units, the opening up of the insurance companies has greatly resulted in the growth of the Indian Financial Markets. Investors have alternate avenues for choosing their investments across multiple asset classes and financial products.

Modern Capital Markets have become a catalyst for wealth creation. A vibrant and efficient Capital Market is the backbone of a healthy economy. India has become a global reference point and the Indian Capital Markets structure – systems, processes and institutions – have become a global benchmark to be emulated. Many developing countries have taken cues from Indian Capital Markets for establishing similar structure in their respective countries. 

Functions of Capital Markets: The major functions of Capital Markets are as follows:

• Improve the efficiency of capital allocation through a competitive pricing mechanism.
• Lower the costs of transactions.
• Encourage broader ownership of productive assets.
• Providing liquidity with mechanism enabling the investor to sell financial assets – in the form of active secondary markets.
• To mobilize long-term savings to finance long-term investments.
• Provide risk-capital in the form of equity or quasi-equity to entrepreneurs.
• Disseminate information efficiently. 
• Price discovery of financial instruments.
• Risk Management to mitigate against market risk (price volatility)
• Enable wider participation.
• Improve operational efficiency simplified procedures for transactions, faster settlement process and lower transactions costs.
• Improved integration between different markets and different asset classes, real and financial sectors of the economy, long and short-term funds, private and Government sectors, domestic and external funds.
• Direct flow of funds into efficient channels through investment, disinvestment and reinvestment.

Capital Market Segments – Primary and Secondary Market: Capital Markets may be classified into Primary and Secondary Markets, which deal with issue of new securities and trading of existing, respectively. Leyus understand the characteristics of Primary and Secondary markets.

1- Primary Market: Primary Market is a segment of capital markets that deals with the issuance of new securities. Corporate, Government, Public Sector Units, Banks and Financial Institutions can obtain funding through the sale of financial claims such as stocks, bonds, debentures, etc. This is typically done through a syndicate of securities dealers. In the case of a new stock issue, this sale is usually referred to as an “Initial Public Offering” (IPO). Dealers earn a commission i.e., built into the price of the security offering, through it can be found in prospectus. 

The fund raising in the Primary Markets can be classified as follows:

1. Public Issue by Prospectus
2. Private Placement
3. Rights Issues
4. Preferential Issues

2- Secondary Markets: Secondary Market is the segment of Capital Markets relating to trading of already-issued (outstanding) securities. After the security is issued in the Primary Market, it is listed on recognized stock exchange in the case of equity shares or is traded on the Negotiated Dealing System of RBI in case of debt market securities. Secondary markets provide liquidity for investors. Secondary Markets usually follow either can an auction-based system or dealer-based system. While the stock exchange is part of an Auction Market, Over the Counter (OTC) market is a dealer-based system. 

For the general investor, the Secondary Market provides an efficient platform for trading of securities. The fair price of the security is “discovered” in the secondary markets – thus leading to either price appreciation or depreciation. Banks facilitate secondary market transactions by opening direct accounts to individuals and companies. Banks also extend credit against securities. Banks may also act as clearing house banks.

The Indian Secondary market can be segregated into two parts:

• Secondary market for corporate and financial intermediaries on recognized stock exchanges such as BSE and NSE, OTCEI, ISE and other regional exchanges. The participants in these markets are registered brokers – both individual and institutions. They operate through a network of sub-brokers and sub-dealers and are connected through a network of electronic trading system.
• Secondary market for Government Securities, PSU Bonds, corporate debt instruments. The Government Securities market is divided into short term money market instrument such as treasury bills and long-term Government bonds of maturity up to even 30 years. The main participants in the secondary debt markets are primary dealers, banks, mutual funds, and financial institutions. Since the September 1994, trading in Government Securities were conducted through the subsidiary general ledger (SGL). Presently, Government Securities and PSU bonds are traded on the Wholesale Debt Market (WDM) segment of NSE, BSE and OTCEI.

Financial Instrument Traded in Secondary Markets include: 

• Equity Shares, Rights Issue/Rights Shares, Bonus Shares.
• Preferred Stock/Preference shares, Cumulative Preference Shares, Cumulative Convertible Preference Shares, Participating Preference Share.
• Security Receipts.
• Government Securities, PSU Bonds.
• Debentures, Corporate Bonds.
• Commercial Paper, Treasury Bills.

Following is some of the Financial Products/Instruments traded in Indian Securities Markets:

• Equity Shares, Rights Issue/Rights Shares, Bonus Shares.
• Preferred Stock/Preference Shares, Cumulative Preference Shares.
• Security Receipts.
• Government Security, PSU Bonds.
• Debentures, Corporate Bonds.
• Commercial Paper, Treasury Bills.