Financial Markets

Financial Markets

Concept Explanation

Think of India’s financial market as the circulatory system of the economy. Just like your body needs blood to reach every organ, the economy needs capital to flow from people who have surplus (households saving in FDs, PPF) to people who need it (a startup building a factory, the government building highways). Financial markets are the channels that make this possible.

The Money Market handles short-term borrowing and lending — think of it as the economy’s emergency liquidity ward. Tenures typically run from one day to one year. Instruments here are high-liquidity, low-risk, and boring in the best possible way. When a company needs working capital for 90 days, or the government wants to raise funds quickly, this is where they come. The Reserve Bank sits at the centre of this market, running daily Liquidity Adjustment Facility (LAF) operations to ensure banks don’t run dry.

The Capital Market is where long-term dreams get funded. This is where companies raise equity by listing on stock exchanges, where the government issues long-dated bonds, and where investors build wealth over decades. It has two parts: the Primary Market (where companies literally create new shares for the first time via IPOs or rights issues) and the Secondary Market (where investors trade existing securities on exchanges like NSE and BSE). Derivatives like futures and options then add a layer of sophisticated risk management on top.

The genius of having both markets working together is that money can flow efficiently — from your Savings Account into Fixed Deposits, into T-Bills or bonds, into equity shares, into economic growth.

Key Terms & Definitions

Term	Definition
Treasury Bill (T-Bill)	Government debt instrument with tenure of 91, 182, or 364 days; sold at a discount and redeemed at face value
Commercial Paper (CP)	Unsecured, short-term debt instrument issued by large corporates to meet working capital needs (typically 7-90 days)
Commercial Bill	A bill of exchange accepted by a buyer; can be discounted with a bank before maturity
Call Money	Overnight inter-bank borrowing/lending market used to meet immediate CRR requirements
LAF (Liquidity Adjustment Facility)	RBI’s main operating framework: repo (RBI injects liquidity, banks borrow against securities) and reverse repo (RBI absorbs excess liquidity)
Primary Market	Market where new securities are issued and sold for the first time (IPOs, FPOs, rights issues)
Secondary Market	Market where already-issued securities are bought and sold among investors (NSE, BSE)
Depository (NSDL/CDSL)	Institutions that hold securities in electronic (demat) form and enable paperless settlement
Market Capitalisation	Total market value of all listed shares = share price × total number of shares outstanding

Real-World Example (RBI Context)

In October 2023, the RBI conducted an unscheduled repo operation under LAF when system liquidity turned deficit. Banks that needed funds tendered government securities (G-Secs, T-Bills) as collateral and received funds at the repo rate. This operation temporarily eased the liquidity crunch and brought call money rates back toward the policy repo rate of 6.5%. As an RBI Grade B candidate, notice how a single LAF operation simultaneously affects short-term rates across the entire money market curve.

Exam Pattern / How It Appears

• Conceptual questions: “Distinguish between money market and capital market” or “What is the role of NSDL?”
• Numerical questions: Simple yield calculations on T-Bills, computing holding period yield
• Case-based: A scenario where RBI changes the repo rate — you need to trace the impact on various money market rates and explain transmission
• Memory-based: Match instruments to their correct market segment; identify which entity regulates which market

Step-by-Step Example

Q: A 91-day Treasury Bill is issued at a discount price of ₹97.50 per ₹100 face value. Calculate the annualized yield.

Answer:

Step 1: Identify the discount and tenor.

• Discount = ₹100 - ₹97.50 = ₹2.50
• Tenor = 91 days

Step 2: Use the T-Bill yield formula:

$$\text{Yield} = \frac{\text{Discount}}{\text{Face Value}} \times \frac{365}{\text{Days to Maturity}} \times 100$$

Step 3: Plug in numbers:

$$\text{Yield} = \frac{2.50}{100} \times \frac{365}{91} \times 100 = 0.025 \times 4.0109 \times 100 = 10.03%$$

Answer: The annualized yield is approximately 10.03%

Note: The bank discount yield and the annualised yield can differ slightly depending on which convention you use — in exams, watch whether they ask for “simple annualised yield” or “bond equivalent yield.”