7. Financial Markets
Free Economy rapid revision notes for UPSC, APPSC and TGPSC. Original notes are presented below with their tables, images and visual aids preserved.
7. Financial Markets
7.1 The Financial System
The financial system moves savings from those who have surplus money to those who need it for investment. It has four parts: financial institutions, financial markets, financial instruments and financial services.
Part |
Examples |
Institutions |
Banks, NBFCs, insurance companies, mutual funds, development finance institutions |
Markets |
Money market, capital market, forex market, government securities market |
Instruments |
Shares, bonds, treasury bills, commercial paper, derivatives |
Services |
Credit rating, merchant banking, depository services, stock broking |
Financial regulators
Regulator |
Area |
RBI |
Banks, NBFCs, money market, government securities and forex market, payment systems |
SEBI |
Securities market, stock exchanges, mutual funds, brokers |
IRDAI |
Insurance sector |
PFRDA |
Pension sector, including the National Pension System |
IFSCA |
Financial services in International Financial Services Centres such as GIFT City (set up 2020) |
The Financial Stability and Development Council (FSDC), set up in 2010 and chaired by the Union Finance Minister, coordinates among regulators.
The Forward Markets Commission, which regulated commodity futures, was merged into SEBI in 2015.
Non-Banking Financial Companies (NBFCs)
Companies registered under the Companies Act that lend and invest, but are not banks.
They cannot accept demand deposits, do not issue cheques drawn on themselves, and do not get DICGC deposit insurance.
They are regulated by the RBI.
7.2 Money Market
The money market deals in short-term funds, with maturity of up to one year. It helps banks and companies manage their day-to-day cash needs, and it is the first place where RBI's policy changes are felt.
Instrument |
Key Point |
Call money |
Overnight lending between banks. Notice money is for 2 to 14 days, and term money for more than 14 days |
Treasury Bills (T-bills) |
Issued by the Government at a discount in 91, 182 and 364 days; repaid at face value; no interest paid separately |
Commercial Paper (CP) |
Unsecured short-term note issued by large, well-rated companies to raise funds |
Certificate of Deposit (CD) |
Short-term deposit certificate issued by banks and financial institutions |
Repo and TREPS |
Short-term borrowing against government securities; TREPS is a tri-party repo run by the Clearing Corporation of India |
Commercial bills |
A bill of exchange drawn by a seller on a buyer for goods sold on credit |
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7.3 Government Securities Market
Government securities (G-secs) are debt instruments issued by the Government to borrow. They carry no risk of default and are the safest investments.
T-bills are short term (under one year); dated securities are long term (5 to 40 years) and pay a fixed coupon.
State Governments issue State Development Loans (SDLs).
The RBI manages the issue as the Government's debt manager.
The Sovereign Gold Bond (2015) lets investors hold gold in paper form and earn interest.
The RBI Retail Direct scheme (2021) lets small investors buy G-secs directly.
7.4 Capital Market
The capital market deals in long-term funds (more than one year) through equity and debt. It has a primary market (new issues) and a secondary market (trading of existing securities).
Primary market: ways of raising money
Method |
Meaning |
Initial Public Offer (IPO) |
A company offers shares to the public for the first time |
Follow-on Public Offer (FPO) |
A listed company issues more shares to the public |
Rights issue |
New shares offered to existing shareholders first, in proportion to what they hold |
Qualified Institutional Placement (QIP) |
A listed company raises money quickly from institutional buyers |
Offer for Sale (OFS) |
Existing promoters or large shareholders sell their shares through the exchange |
Private placement |
Shares or bonds sold directly to a small group of selected investors |
In book building, investors bid within a price band; in a fixed price issue the price is set in advance.
ASBA (Application Supported by Blocked Amount) keeps the money in the investor's account until shares are allotted. UPI can also be used for IPO applications.
Anchor investors are large institutions that bid a day before the IPO opens, giving confidence to others.
Secondary market: stock exchanges
Exchange |
Key Point |
BSE |
Established in 1875; Asia's oldest stock exchange. Index: Sensex of 30 companies, started in 1986, base 1978-79 = 100 |
NSE |
Set up in 1992; started trading in 1994; India's first fully electronic, demutualised exchange. Index: Nifty 50, base November 1995 = 1000 |
Demat account: shares are held in electronic form with a depository. India has two, NSDL (1996) and CDSL (1999), under the Depositories Act, 1996.
Settlement cycle: trades are settled on T+1 (the next working day), which India adopted in 2023.
Circuit breakers stop trading for a time when prices move too sharply; the market-wide limits are 10%, 15% and 20%.
Bull market: rising prices. Bear market: falling prices.
India VIX measures expected market volatility and is called the "fear index".
7.5 SEBI
Feature |
Detail |
Established |
1988 as a non-statutory body; given statutory status by the SEBI Act, 1992. Headquartered in Mumbai |
Aim |
Protect investors, develop the securities market and regulate it |
Regulates |
Stock exchanges, brokers, mutual funds, FPIs, depositories, credit rating agencies, AIFs, REITs and InvITs |
Appeals |
Against SEBI orders, to the Securities Appellate Tribunal (SAT), then the Supreme Court |
Insider trading |
Trading on unpublished price-sensitive information is banned and punished by SEBI |
7.6 Mutual Funds
A mutual fund pools money from many investors and invests it in shares, bonds and other securities through a professional Asset Management Company (AMC).
Regulated by SEBI under the SEBI (Mutual Funds) Regulations, 1996. The Association of Mutual Funds in India (AMFI) is the industry body.
The first mutual fund was the Unit Trust of India (UTI), set up in 1963.
NAV (Net Asset Value) is the price per unit: (Value of assets − Liabilities) ÷ Number of units.
SIP (Systematic Investment Plan) invests a fixed amount at regular intervals.
ELSS funds are tax-saving equity funds with a three-year lock-in.
Types: equity, debt, hybrid, index funds and ETFs (traded on exchanges).
7.7 Derivatives
A derivative is a contract whose value comes from an underlying asset such as a share, index, currency or commodity. India introduced index futures in 2000 and options in 2001.
Contract |
Futures |
Options |
Obligation |
Both buyer and seller must complete the deal |
Buyer has a right, but no obligation |
Cost |
Margin deposit |
Premium paid by the buyer |
Types |
Index futures and stock futures |
Call (right to buy) and Put (right to sell) |
Uses: hedging (reducing risk), speculation (betting on price moves) and arbitrage (profiting from price gaps between markets).
7.8 Bond Market
A bond is a loan by the investor to the issuer, paying a fixed coupon and returning the face value at maturity.
Bond prices and yields move in opposite directions. When interest rates rise, existing bond prices fall.
Corporate bonds are issued by companies; their safety is shown by a credit rating from agencies such as CRISIL, ICRA and CARE.
Masala bonds (from 2014) are rupee-denominated bonds sold to investors abroad, so the exchange rate risk is borne by the investor.
Green bonds raise money for projects that help the environment; India issued its first sovereign green bonds in 2023.
7.9 Foreign Investors and Cross-border Instruments
Term |
Meaning |
FPI |
Foreign Portfolio Investor: buys shares and bonds without taking control of the company; regulated by SEBI |
FDI |
Foreign Direct Investment: a long-term stake with management control |
P-Notes |
Participatory Notes: issued by registered FPIs to overseas investors who are not directly registered with SEBI |
ADR and GDR |
Depository receipts that let an Indian company list shares abroad: ADRs in the US, GDRs in other foreign markets |
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