Understanding Financial Markets
1. What are the various types of financial markets?
The financial markets can broadly be divided into money and capital market.
- Money market is a market for debt securities that pay off in the short term usually less than one year, for example the market for 90-days treasury bills.
- This market encompasses the trading and issuance of short term non equity debt instruments including treasury bills, commercial papers, bankers acceptance, certificates of deposits, etc.
- Capital market is a market for long-term debt and equity shares.
- 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.
2. What is meant by Secondary Market?
- Secondary Market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange. .
- Majority of the trading is done in the secondary market.
- Secondary market comprises of equity markets and the debt markets.
For the general investor, the secondary market provides an efficient platform for trading of his securities. For the management of the company, Secondary equity markets serve as a monitoring and control conduit—by facilitating value-enhancing control activities, enabling implementation of incentive-based management contracts, and aggregating information (via price discovery) that guides management decisions.
3. What is the difference between the primary market and the secondary market?
- In the primary market, securities are offered to public for subscription for the purpose of raising capital or fund.
- Secondary market is an equity trading avenue in which already existing/pre- issued securities are traded amongst investors. Secondary market could be either auction or dealer market.
- While stock exchange is the part of an auction market, Over-the-Counter (OTC) is a part of the dealer market.
SEBI and its Role in the Secondary Market
4. What is SEBI and what is its role?
The SEBI is the regulatory authority established under Section 3 of SEBI Act 1992 to protect the interests of the investors in securities and to promote the development of, and to regulate, the securities market and for matters connected therewith and incidental thereto.
5. What are the various departments of SEBI regulating trading in the secondary market?
The following departments of SEBI take care of the activities in the secondary market.
Name of the Department
Market Intermediaries Registration and Supervision department (MIRSD)
Registration, supervision, compliance monitoring and inspections of all market intermediaries in respect of all segments of the markets viz. equity, equity derivatives, debt and debt related derivatives.
Market Regulation Department (MRD)
Formulating new policies and supervising the functioning and operations (except relating to derivatives) of securities exchanges, their subsidiaries, and market institutions such as Clearing and settlement organizations and Depositories (Collectively referred to as ‘Market SROs’.)
Derivatives and New Products Departments (DNPD)
Supervising trading at derivatives segments of stock exchanges, introducing new products to be traded, and consequent policy changes
Products available in the Secondary Market
6. What are the products dealt in the secondary markets?
Following are the main financial products/instruments dealt in the secondary market:
Equity: The ownership interest in a company of holders of its common and preferred stock. The various kinds of equity shares are as follows:-
An equity share, commonly referred to as ordinary share also represents the form of fractional ownership in which a shareholder, as a fractional owner, undertakes the maximum entrepreneurial risk associated with a business venture. The holders of such shares are members of the company and have voting rights.
- Rights Issue / Rights Shares: The issue of new securities to existing shareholders at a ratio to those already held.
- Bonus Shares: Shares issued by the companies to their shareholders free of cost by capitalization of accumulated reserves from the profits earned in the earlier years.
- Preferred Stock / Preference shares: Owners of these kinds of shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid regularly before dividend can be paid in respect of equity share. They also enjoy priority over the equity shareholders in payment of surplus. But in the event of liquidation, their claims rank below the claims of the company’s creditors, bondholders / debenture holders.
- Cumulative Preference Shares: A type of preference shares on which dividend accumulates if remains unpaid. All arrears of preference dividend have to be paid out before paying dividend on equity shares.
- Cumulative Convertible Preference Shares: A type of preference shares where the dividend payable on the same accumulates, if not paid. After a specified date, these shares will be converted into equity capital of the company.
- Participating Preference Share: The right of certain preference shareholders to participate in profits after a specified fixed dividend contracted for is paid. Participation right is linked with the quantum of dividend paid on the equity shares over and above a particular specified level.
- Security Receipts: Security receipt means a receipt or other security, issued by a securitisation company or reconstruction company to any qualified institutional buyer pursuant to a scheme, evidencing the purchase or acquisition by the holder thereof, of an undivided right, title or interest in the financial asset involved in securitisation.
- Government securities (G-Secs): These are sovereign (credit risk-free) coupon bearing instruments which are issued by the Reserve Bank of India on behalf of Government of India, in lieu of the Central Government's market borrowing programme. These securities have a fixed coupon that is paid on specific dates on half-yearly basis. These securities are available in wide range of maturity dates, from short dated (less than one year) to long dated (up to twenty years).
- Debentures: Bonds issued by a company bearing a fixed rate of interest usually payable half yearly on specific dates and principal amount repayable on particular date on redemption of the debentures. Debentures are normally secured / charged against the asset of the company in favour of debenture holder.
- Bond: A negotiable certificate evidencing indebtedness. It is normally unsecured. A debt security is generally issued by a company, municipality or government agency. A bond investor lends money to the issuer and in exchange, the issuer promises to repay the loan amount on a specified maturity date. The issuer usually pays the bond holder periodic interest payments over the life of the loan. The various types of Bonds are as follows-
Ø Zero Coupon Bond: Bond issued at a discount and repaid at a face value. No periodic interest is paid. The difference between the issue price and redemption price represents the return to the holder. The buyer of these bonds receives only one payment, at the maturity of the bond.
Ø Convertible Bond: A bond giving the investor the option to convert the bond into equity at a fixed conversion price.
- Commercial Paper: A short term promise to repay a fixed amount that is placed on the market either directly or through a specialized intermediary. It is usually issued by companies with a high credit standing in the form of a promissory note redeemable at par to the holder on maturity and therefore, doesn’t require any guarantee. Commercial paper is a money market instrument issued normally for tenure of 90 days.
- Treasury Bills: Short-term (up to 91 days) bearer discount security issued by the Government as a means of financing its cash requirements.