Financial Markets: Capital and Money Markets Explained

Posted on Dec 21, 2024 in Economy

Money Market

The money market is a market for financial securities with a maturity period of less than one year.

• It is a market for low-risk, unsecured, and short-term debt instruments that are highly liquid and traded every day.
• It has no physical location but is conducted over the telephone and the internet.
• It helps to:
  • Raise short-term funds
  • Facilitate the temporary deployment of funds

The main instruments of the money market are as follows:

1. Treasury Bills: They are issued by the RBI on behalf of the Central Government to meet its short-term requirement of funds. They are issued at a price lower than their face value and are repaid at par. They are available for a minimum amount of Rs. 25,000 and in multiples thereof. They are also known as Zero Coupon Bonds. They are negotiable instruments, i.e., they are freely transferable.
2. Commercial Paper: It is a short-term unsecured promissory note issued by large, creditworthy companies to raise short-term funds at lower interest rates than market rates. They are negotiable instruments transferable by endorsement and delivery with a fixed maturity period of 15 days to one year.
3. Call Money: It is short-term finance repayable on demand, with a maturity period of one day to 15 days, used for interbank transactions. Call Money is a method by which banks borrow from each other to maintain the cash reserve ratio as per RBI. The interest rate paid on call money loans is known as the call rate.
4. Certificate of Deposit: It is an unsecured instrument issued in bearer form by Commercial Banks & Financial Institutions. They can be issued to individuals, corporations, and companies for raising money for a short period ranging from 91 days to one year.
5. Commercial Bill: It is a bill of exchange used to finance the working capital requirements of business firms. A seller of the goods draws the bill on the buyer when goods are sold on credit. When the bill is accepted by the buyer, it becomes a marketable instrument and is called a trade bill. These bills can be discounted with a bank if the seller needs funds before the bill’s maturity.

Capital Market

Facilities and institutional arrangements through which long-term securities are raised and invested – both debt and equity.

Nature of Capital Markets

1. Important component of Financial markets
2. Two segments (primary and secondary)
3. Two forms (organized and unorganized)
4. Long-term securities
5. Satisfies long-term requirements of funds
6. Performs trade-off functions
7. Creates dispersion in business ownership
8. Helps in capital formation
9. Creates liquidity

Features of Capital Market Instruments

1. Provide long-term funds
2. Lesser outlay required as unit value of instruments is low
3. Duration more than 1 year
4. Liquidity
5. Lower safety
6. Higher expected returns compared to short-term securities

The capital market can be divided into two parts:

1. Primary Market
2. Secondary Market

Methods of Floatation of New Issues in Primary Market

1. Offer through Prospectus: It involves inviting subscription from the public through the issue of a prospectus. A prospectus makes a direct appeal to investors to raise capital through an advertisement in newspapers and magazines.
2. Offer for Sale: Under this method, securities are offered for sale through intermediaries like issuing houses or stock brokers. The company sells securities to an intermediary/broker at an agreed price, and the broker resells them to investors at a higher price.
3. Private Placements: It refers to the process in which securities are allotted to institutional investors and some selected individuals.
4. Rights Issue: It refers to the issue in which new shares are offered to the existing shareholders in proportion to the number of shares they already possess.

Secondary Market

1. Refers to a market where existing securities are bought and sold.
2. The company is not involved in the transaction at all. It is between two investors.

Features of the Secondary Market

1. Creates liquidity
2. Fixed location
3. Comes after the primary market
4. Encourages new investment

Stock Exchange/Share Market

A Stock Exchange is an institution that provides a platform for buying and selling existing securities. It facilitates the exchange of a security, i.e., share, debenture, etc., into money and vice versa.

Following are some of the important functions of a Stock Exchange:

1. Gives liquidity and marketability to existing securities
2. Pricing of securities (demand and supply)
3. Safety of transactions (membership = regulated + dealings well defined)
4. Contributes to economic growth (ensures that savings are channelized to most productive investment avenues)
5. Spreading of equity cult (ensures wider share ownership)
6. Provides scope for speculation (in a restricted and controlled environment)

Benefits of a Demat Account

1. Reduces paperwork.
2. Elimination of problems on the transfer of shares such as loss, theft, and delay.
3. Exemption of stamp duty when transferring shares.
4. The concept of an odd lot stands abolished.
5. Increase liquidity through speedy settlement.
6. Attract foreign investors and promoting foreign investment.
7. A single Demat account can hold investments in both equity and debt instruments.
8. Traders can work from anywhere.
9. Automatic credit into a Demat account for shares arising out of bonus/split/consolidation % merger.
10. Immediate transfers of securities.
11. Change in address recorded with a DP gets registered with all companies in which an investor holds securities, eliminating the need to correspond with each of them.

Objectives of SEBI

1. To regulate stock exchanges and the securities market to promote their orderly functioning.
2. To protect the rights and interests of investors and to guide & educate them.
3. To prevent trade malpractices such as internal trading.
4. To regulate and develop a code of conduct and fair practices by intermediaries like brokers, merchant bankers, etc.

Functions of SEBI

1. Protective Functions:
   1. Prohibit fraudulent & unfair trade practices in the secondary market (e.g., Price rigging & misleading statements).
   2. Prohibit insider trading.
   3. Educate investors
   4. Promote fair practice & code of conduct in the securities market
2. Development Functions:
   1. Promotes training of intermediaries of the securities market.
   2. Investor education
   3. Promotion of fair practices code of conduct of all SRO‘s.
   4. Conducting research & publish information useful to all market participants
3. Regulation Functions:
   1. Registration of brokers and sub-brokers & other players in the market.
   2. Registration of collective investment schemes & mutual funds.
   3. Regulation of stock bankers & portfolio exchanges & merchant bankers.

Characteristics of Direction

1. Pervasive Function: Directing is required at all levels of the organization. Every manager provides guidance and inspiration to his subordinates.
2. Continuous Activity: Direction is a continuous activity as it continues throughout the life of the organization.
3. Human Factor: The directing function is related to subordinates, and therefore it is related to the human factor. Since the human factor is complex and behavior is unpredictable, the direction function becomes important.
4. Creative Activity: The direction function helps in converting plans into performance. Without this function, people become inactive, and physical resources are meaningless.
5. Executive Function: The direction function is carried out by all managers and executives at all levels throughout the working of an enterprise; a subordinate receives instructions from his superior only.
6. Delegate Function: Direction is supposed to be a function dealing with human beings. Human behavior is unpredictable by nature, and conditioning people’s behavior towards the goals of the enterprise is what the executive does in this function. Therefore, it is termed as having delicacy in it to tackle human behavior.

Principles of Effective Direction

Effective direction leads to a greater contribution of subordinates to organizational goals. The directing function of management can be effective only when certain well-accepted principles are followed.

The following are the basic principles of effective direction:

1. Harmony of Objectives: It is an essential function of management to make people realize the objectives of the group and direct their efforts towards the achievement of their objectives. The interest of the group must always prevail over individual interest. The principle implies harmony of personal interest and common interest.
2. Unity of Direction: To have effective direction, there should be one head and one plan for a group of activities having the same objectives. In other words, each group of activities having the same objectives must have one plan of action and must be under the control of one supervisor.
3. Direct Supervision: The directing function of management becomes more effective if the superior maintains direct personal contact with his subordinates. Direct supervision infuses a sense of participation among subordinates that encourages them to put in their best to achieve the organizational goals and develop an effective system of feedback of information.
4. Participative or Democratic Management: The function of directing becomes more effective if a participative or democratic style of management is followed. According to this principle, the superior must act according to the mutual consent and the decisions reached after consulting the subordinates. It provides necessary motivation to the workers by ensuring their participation and acceptance of work methods.
5. Effective Communication: To have effective direction, it is very essential to have an effective communication system that provides for the free flow of ideas, information, suggestions, complaints, and grievances.
6. Follow-up: In order to make direction effective, a manager has to continuously direct, guide, motivate, and lead his subordinates. A manager has not only to issue orders and instructions but also to follow up the performance so as to ensure that work is being performed as desired. He should intelligently oversee his subordinates at work and correct them whenever they go wrong.

Importance of Leadership

1. Makes people contribute positively:
   • Influences behavior and makes people contribute positively and produce good results.
2. Creates a congenial work environment:
   • Maintains personal relations, helps followers fulfill their needs, and provides confidence, support, and encouragement.
3. Introduces change:
   • Persuades, clarifies, and inspires people to accept changes.
   • So overcomes resistance to change with minimum discontent.
4. Handles conflict:
   • Does not allow adverse effects.
   • Allows followers to express their feelings and disagreements and gives suitable clarifications.
5. Trains subordinates:
   • Builds up successors and helps in a smooth succession process.

Qualities of a Good Leader

1. Physical features: Appearance, personality, health, and endurance inspire followers to work with the same tempo.
2. Knowledge: Knowledge and competence to instruct and influence subordinates.
3. Integrity: The leader should be a role model regarding ethics, values, integrity, and honesty.
4. Initiative: Grab opportunities instead of waiting for them.
5. Communication: Capacity to explain his ideas and also be a good listener, teacher, counselor, and persuader.
6. Motivation skills: Understand followers’ needs and devise suitable means to satisfy them.
7. Self-confidence: So that he can provide confidence to followers.
8. Decisiveness: Should be firm and not change opinions frequently.
9. Social skills: Sociable, friendly, and maintain good relations with followers.

A leader may use all styles over a period of time, but one style tends to predominate as his normal way of using power.

1. Autocratic or Authoritarian Leader: An autocratic leader gives orders and insists that they are obeyed. He determines the policies for the group without consulting them. He does not give information about future plans but simply tells the group what immediate steps they must take. Under this style, all decision-making power is centralized in the leader. He does not give the subordinates any freedom to influence his decisions. It is like “bossing people around.” This style should normally be used on rare occasions. It is best applied to situations where there is little time for group decision-making or where the leader is the most knowledgeable member of the group.
2. Democratic or Participative Leader: A democratic leader gives orders only after consulting the group and works out the policies with the acceptance of the group. He never asks people to do things without working out the long-term plans on which they are working. He favors decision-making by the group, as shown in the diagram. This improves the attitude of the employees towards their jobs and the organization, thereby increasing their morale. Using this style is of mutual benefit – it allows them (subordinates) to become part of the team and helps leaders (seniors) to make better decisions.

   When should Participative/democratic leadership be applied?

   It works best in situations where group members are skilled and eager to share their knowledge. It is also important to have plenty of time to allow people to contribute, develop a plan, and then vote on the best course of action.

3. Laissez Faire or Free Rein Leader: A free-rein leader gives complete freedom to the subordinates. Such a leader avoids the use of power. He depends largely upon the group to establish its own goals and work out its own problems. Group members work themselves as per their own choice and competence. The leader exists as a contact man with the outsiders to bring information and the resources which the group requires for accomplishing the job. Note: This is also known as laissez-faire, which means no interference in the affairs of others. [French laissez means to let/allow fair means to do].

Relationship between Planning and Controlling

Planning and controlling are interrelated and, in fact, reinforce each other in the sense that:

1. Planning is a prerequisite for controlling: Plans provide the standard for controlling. Thus, without planning, controlling is blind. If the standards are not set in advance, managers have nothing to control.
2. Planning is meaningless without controlling: It is fruitful when control is exercised. It discovers deviations and initiates corrective measures.
3. The effectiveness of planning can be measured with the help of controlling:
4. Planning is looking ahead, and controlling is looking back: Planning is a future-oriented function as it involves looking in advance and making policies for the maximum utilization of resources in the future; that is why it is considered a forward-looking function. In controlling, we look back to the performance which is already achieved by the employees and compare it with plans. If there are deviations in actual and standard performance or output, then the controlling functions make sure that in the future, actual performance matches with the planned performances. Therefore, controlling is also a forward-looking function. Thus, planning & controlling cannot be separated. The two are supplementary functions that support each other for the successful execution of both functions. Planning makes controlling effective, whereas controlling improves future planning.

Controlling Process

1. Setting Performance Standards: Standards are the criteria against which actual performance would be measured. Thus standards become the basis for comparison, and the manager insists on the following of standards.
2. Measurement of Actual Performance: Performance should be measured in an objective and reliable manner, which includes personal observation and sample checking. Performance should be measured in the same terms in which standards have been established; this will facilitate comparison.
3. Comparing Actual Performance with Standard: This step involves a comparison of actual performance with the standard. Such a comparison will reveal the deviation between actual and desired performance. If the performance matches the standards, it may be assumed that everything is under control.
4. Analyzing Deviations: The deviations from the standards are assessed and analyzed to identify the causes of deviations.
5. Taking Corrective Action: The final step in the controlling process is taking corrective action. No corrective action is required when the deviation is within the acceptable limits. But where significant deviations occur, corrective action is taken.

Limitations of Controlling

1. Difficulty in setting quantitative standards: The control system loses its effectiveness when standards of performance cannot be defined in quantitative terms. This makes comparison with standards a difficult task. E.g., areas like human behavior, employee morale, and job satisfaction cannot be measured quantitatively.
2. Little control over external factors: An enterprise cannot control external factors like government policies, technological changes, competition, etc.
3. Resistance from employees: Control is resisted by the employees as they feel that their freedom is restricted.