Financial Markets and Capital Markets

Financial markets are the platforms where buyers and sellers trade financial assets — from short-term money market instruments to long-term equity and debt securities. For an IBPS PO, understanding financial markets is essential because banks operate within these markets (as borrowers, lenders, and intermediaries), and bank officers must understand how capital markets function, how to advise customers on investment products, and how market conditions affect the bank’s balance sheet. The IBPS PO examination tests knowledge of India’s money market, capital market, bond market, forex market, and the institutions that regulate and operate these markets.

Overview: Types of Financial Markets

Financial markets are broadly divided into:

1. Money Market: Short-term borrowing and lending (tenor from overnight to 1 year). Instruments include Treasury Bills, commercial papers, certificates of deposit, call money, and REPOs. Money markets provide liquidity to the financial system.

2. Capital Market: Long-term borrowing and lending (tenor > 1 year). Includes:

• Primary Market: Where new securities are issued (IPOs, FPOs, bond issuance)
• Secondary Market: Where existing securities are traded (stock exchanges — NSE, BSE)

3. Forex Market: Where currencies are traded (USD/INR, EUR/INR, etc.)

4. Derivatives Market: Where financial contracts (futures, options, swaps) are traded

5. Commodity Market: Where commodities (gold, silver, crude oil, agricultural products) are traded

Money Market

The Money Market is an organized financial market for short-term funds and liquid financial instruments with maturities of less than one year.

Key Money Market Instruments

1. Treasury Bills (T-Bills): Short-term government securities issued by the RBI on behalf of the Government of India. They are the safest money market instruments since they are backed by the government.

• 91-day T-Bills: Most liquid
• 182-day T-Bills: Issued on auction basis
• 364-day T-Bills: Standard tenure
• ** Issued at a discount:** Investors buy at a discount and receive face value at maturity (difference = interest)

2. Commercial Paper (CP): Short-term, unsecured promissory notes issued by large corporations and financial institutions to raise short-term funds (typically for working capital). Maturity: 7 days to 1 year. Issued at discount; rated by credit rating agencies.

3. Certificate of Deposit (CD): A negotiable, short-term deposit issued by banks to depositors. Banks issue CDs to raise large sums for a specified period at competitive rates. Can be traded in the secondary market. Maturity: 7 days to 1 year (for banks); up to 3 years for corporate CDs.

4. Call Money/Notice Money: Overnight interbank borrowing and lending. Banks with surplus funds lend to banks with shortfalls on an overnight basis to meet their CRR requirements or to manage day-to-day liquidity. Call money has no notice period; Notice Money requires one-day notice.

5. REPO (Repurchase Agreement): A transaction in which a securities dealer sells securities to an investor with an agreement to repurchase them at a specified future date and price. In India, REPOs are the primary tool for liquidity management by the RBI. The RBI conducts Repo auctions to inject liquidity into the system.

Liquidity Adjustment Facility (LAF)

LAF is the RBI’s primary tool for daily liquidity management. It consists of:

• Repo auction (injecting liquidity — banks sell G-secs to RBI with agreement to repurchase)
• Reverse Repo auction (absorbing liquidity — RBI buys G-secs from banks with agreement to sell back)

Liquidity Coverage Ratio (LCR)

Under Basel III, banks must maintain an LCR of at least 100% — meaning they must hold enough High Quality Liquid Assets (HQLA) to survive a 30-day liquidity stress scenario. LCR = HQLA / Total Net Cash Outflows over 30 days × 100.

Capital Market: Equity

Stock Exchanges

India has two major stock exchanges:

1. National Stock Exchange (NSE):

• Established in 1992; commenced operations in 1994
• First dematerialized electronic exchange in India
• Located in Mumbai
• NSE’s benchmark index is Nifty 50 (comprising 50 of the largest and most liquid stocks listed on the NSE)
• NSE’s trading platform is entirely electronic (屏幕 based on Bloomberg technology, later replaced by own system)

2. Bombay Stock Exchange (BSE):

• Established in 1875 as the Native Share and Stock Brokers’ Association — the oldest stock exchange in Asia
• Located in Mumbai (Dalal Street)
• BSE’s benchmark index is Sensex (Sensitive Index) — comprises 30 stocks
• Sensex is the oldest index in India

Key Indices

• Nifty 50: 50 stocks, free-float market cap weighted
• Sensex (BSE 30): 30 stocks, free-float market cap weighted
• Nifty Next 50: 51–100 stocks by market cap
• Nifty Midcap 50 / BSE Midcap: Mid-sized companies
• Nifty Smallcap 100 / BSE Smallcap: Smaller companies

Primary Market: Equity Issuance

Initial Public Offering (IPO): When a company first offers its shares to the public. Companies must be listed on SEBI before issuing shares to the public.

Book Building Process: The most common method for IPO pricing:

1. The issuer company fixes a Floor Price (minimum price) and a Ceiling Price (maximum price)
2. Qualified institutional investors (QIBs) bid at various prices within the range
3. The final price (cut-off price) is determined based on demand
4. Retail investors can bid at the cut-off price

Offer for Sale (OFS): Existing shareholders (promoters, PE investors) sell their shares to the public through the exchange platform.

FPO (Follow-on Public Offer): A listed company issues new shares to the public after its IPO.

Secondary Market Trading

Trading Process on NSE/BSE:

1. Orders are placed through brokers (or online trading platforms)
2. Orders are matched on the exchange’s electronic limit order book
3. T+2 settlement: Trades settled two business days after trade date (T+2)
4. Securities are transferred through demat accounts (CDSL or NSDL)

Demat and Depository System: India’s dematerialization system is operated by two depositories:

• NSDL (National Securities Depository Ltd): Largest depository
• CDSL (Central Depository Services Ltd)

Investors hold securities in demat accounts (like bank accounts but for securities).

Regulatory Framework

SEBI (Securities and Exchange Board of India): Established in 1992 as the regulator for India’s securities markets. SEBI’s mandate includes:

• Protecting investor interests
• Promoting the development of securities markets
• Regulating securities market participants

Key SEBI regulations:

• Disclosure norms for listed companies (quarterly results, material events)
• Insider trading regulations (prohibiting trading on unpublished price-sensitive information)
• Takeover regulations (mandatory open offers when acquirer crosses thresholds)
• Mutual fund regulations (regulating AMC operations)
• Credit rating agency regulations (for CRISIL, ICRA, etc.)

Capital Market: Debt Instruments

Government Securities (G-secs)

G-secs are debt instruments issued by the Government of India (and state governments for state development loans). They are the safest instruments since they carry no default risk (backed by the government).

Types of G-secs:

• Treasury Bills (T-bills): Short-term (91, 182, 364 days)
• Government Bonds: Medium to long-term (1–40 years)
• Floating Rate Bonds (FRBs): Interest rate resets periodically
• Inflation-Indexed Bonds: Principal linked to inflation (WPI/CPI)
• Sovereign Gold Bonds (SGBs): Denominated in grams of gold; pay 2.5% annual interest; no physical delivery

Corporate Bonds

Debt securities issued by corporations to raise long-term capital. Features:

• Listed on stock exchanges
• Rated by credit rating agencies (CRISIL, ICRA, CARE, Fitch, Moody’s)
• Typically pay semi-annual coupon (interest)
• Have a fixed maturity date
• If the issuer defaults, bondholders can recover money through the IBC process

Yield: The return an investor earns on a bond. Yield depends on:

• Coupon rate
• Current market price
• Time to maturity
• Credit risk (higher risk → higher yield → lower price)

Yield Curve: A graph showing the relationship between bond yields (interest rates) and time to maturity. It can be:

• Normal/upward sloping: Longer maturity → higher yield
• Inverted/flat: Short-term rates higher than long-term rates (often signals recession)

Foreign Exchange Market

The forex market is where currencies are bought and sold. India has a managed floating exchange rate system — the rupee is free to fluctuate, but the RBI intervenes to prevent excessive volatility.

USD/INR:

• The most actively traded currency pair in India
• Influenced by: oil prices (India imports most of its oil; oil importers need dollars), foreign institutional investor (FII) flows, RBI interventions, US dollar strength
• When the rupee depreciates sharply, RBI sells dollars from its reserves to support the rupee
• When the rupee appreciates sharply, RBI buys dollars

Foreign Exchange Reserves: India’s forex reserves (~$650 billion as of 2024) are held in:

• Foreign Currency Assets (FCA) — major currencies (USD, EUR, GBP, JPY)
• Gold (held by RBI and also in the form of gold deposits with the Bank of England)
• SDRs (Special Drawing Rights) allocated by the IMF
• RBI’s reserve position with the IMF

Derivatives Market

Futures: Contracts to buy/sell an asset at a future date at a predetermined price. In India, equity futures and options are traded on NSE and BSE.

Options:

• Call option: Right to buy at a specified price (strike price)
• Put option: Right to sell at a specified price

Options have a premium (the price paid for the option).

Index Derivatives: Nifty 50 futures and options are the most traded derivatives in India.

Mutual Funds

Mutual funds pool money from investors and invest in a diversified portfolio of securities. Regulated by SEBI.

Types:

• Equity funds: Invest primarily in stocks (high risk, high return)
• Debt funds: Invest in bonds and fixed income securities (lower risk)
• Hybrid funds: Mix of equity and debt
• Index funds: Mirror a market index (Nifty 50 index fund)
• Sectoral funds: Invest in specific sectors (IT, pharma, banking)
• ELSS (Equity Linked Savings Scheme): Tax-saving mutual funds with 3-year lock-in; qualify for Section 80C deduction

SIP (Systematic Investment Plan): Small periodic investments (monthly) that average out market volatility over time (Rupee Cost Averaging).

⚡ Exam tip: NSE was established in 1992 and is the first dematerialized electronic exchange. NSE’s benchmark is Nifty 50; BSE’s benchmark is Sensex (30 stocks). Nifty is named after “National” and “Fifty.” SEBI was established in 1992. Settlement in Indian stock markets is T+2. G-secs are backed by the government (no default risk). Corporate bonds are rated by rating agencies (CRISIL, ICRA). India’s forex reserves are approximately $650 billion, primarily held in foreign currency assets. RBI uses REPO and Reverse REPO for liquidity management.

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