Importance of Money Markets
The Money Market
the component of financial markets that involves short-term borrowing/lending, or the buying and selling of financial assets with original maturities of one year or less.
Are used by governments, banks, and other large institutions for the raising of short term finance to fund short-term cash flow needs;
sometimes for loans that are expected to be paid back as early as overnight.
Funds borrowed from the money markets are typically used for general operating expenses or to cover brief periods of illiquidity.
Money markets also allow individual investors to invest small amounts of money in a low-risk setting, usually through a money market fund.
Functions of the Money Market 3
Financing Trade: Money Market plays crucial role in financing both internal as well as international trade.
Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market.
The acceptance houses and discount markets help in financing foreign trade.
Financing Industry – Money market contributes to the growth of industries in two ways:
Money market helps the industries in securing short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc.
The short-term interest rates of the money market influence the long-term interest rates of the capital market; as it serves as the benchmark.
Functions of the Money Market 4
Self-Sufficiency of Commercial Bank – money market enables the commercial banks to use their excess reserves in profitable investment and become self sufficient. Commercial banks can earn income from its excess reserves as well as maintain
liquidity to meet the uncertain cash demand of the depositors.
In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without losing liquidity.
In situations of emergency and commercial banks have scarce funds, they don’t have to borrow from the central bank at higher interest rates.
They can meet their requirements by recalling their old short-term loans from the money market.
Functions of the Money Market 5
Help to Central Bank: Though the central bank can function and influence the banking system in the
absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank.
Money market helps the central bank in two ways: The short-run interest rates of the money market serves as an indicator of the
monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy.
The sensitive and integrated money market helps the central bank to secure quick and widespread influence on the sub-markets, and thus achieve effective implementation of its policies.
The Importance of Capital Markets 6
Capital Markets are financial markets for the buying and selling of long-term debt or equity-backed securities.
These markets channel the wealth of savers to those who can put it to long-term productive use
such as companies or governments making long-term investments.
Capital Market securities includes: Stocks/Equities Corporate Bonds Long-term Government Bonds
The Importance of Capital Markets 7
Capital market plays an important role in mobilizing saving and channelling them into productive investments for the development of commerce and industry. thereby helping capital formation and economic growth of the country.
The capital market acts as an important link between savers and investors. The savers are lenders of funds while investors are borrowers of funds. The savers who do
not spend all their income are called. “Surplus units” and the borrowers are known as “deficit units”.
The capital market is the transmission mechanism between surplus units and deficit units. It is a conduit through which surplus units lend their surplus funds to deficit units.
Surplus units buy securities with their surplus funds and deficit units sells securities to raise the funds they need.
The Importance of Capital Markets 8
Funds flow from lenders to borrowers either directly or indirectly through financial institutions such as banks, unit trusts, mutual funds, etc.
Funds flow into the capital market from individuals and financial intermediaries which are absorbed by commerce, industry and government. It thus facilitates the movement of stream of capital to be used more productively
and profitability to increase the national income.
The borrowers issue primary securities which are purchased by lenders either directly or indirectly through financial
The Importance of Capital Markets 9
The capital market provides incentives to savers in the form of interest or dividend and transfers funds to investors for capital formation.
It diverts resources from wasteful and unproductive channels such as gold, jewellery, real estate, conspicuous consumption, etc. to
A well-developed capital market comprising expert banking and non-banking intermediaries brings stability in the value of stocks and securities. It does so by providing capital to the needy at reasonable interest rates
and helps in minimizing speculative activities.
The Importance of Capital Markets 10
The capital market encourages economic growth. The various institutions which operate in the capital market give quantitative and
qualitative direction to the flow of funds and bring rational allocation of resources.
They do so by converting financial assets into productive physical assets. This leads to the development of commerce and industry through the private and public sector, thereby inducing economic growth.
In underdeveloped or developing countries where capital is scarce, the absence of a developed capital market is a great hindrance to capital formation and economic growth. Even though people are poor, they do not have any inducements to save.
Those who save, invest their savings in wasteful and unproductive channels, such as gold, jewellery, real estate, conspicuous consumption, etc.
Such countries can induce people to save more by establishing banking and non- banking financial institutions for the existence of a developed capital market.
Importance of Capital Markets 11
Capital market activities results in increase productivity within the economy leading to more employment, increase aggregate consumption and hence economic growth and development.
It diffuses stress on the banking system by matching long-term investments with long-term capital.
It encourages the broader ownership of productive assets by small savers and encourages a thrift culture that is essential for rapid industrialization.
It allows for risk dispersion between investors (diversifiable risks), risks that could be realized by the help of different market operations or market orders or derivatives.
Importance of Capital Markets 12
It provides not only equity capital but also infrastructure capital that has strong socio-economic benefits through development of roads, water, housing, telecommunications, transport, etc.
Capital markets promote public-private sector partnerships by encouraging participation of private sector in productive investment by closing the financial resource scarcity gap.
It also attracts foreign portfolio investors who are critical in supplementing the domestic savings levels; thereby facilitating foreign inflows.
Functions of Capital Markets 13
Link between Savers and Investors
Encourage to Savings
Encourage to Investments
Promotes Economic Growth
Stability in Security Prices The capital market tends to stabilise the values of stocks and securities and reduce the
fluctuations in the prices to the minimum.
The process of stabilisation is facilitated by providing capital to the borrowers at a lower interest rate and reducing the speculative and unproductive activities.
Primary Market is that market in which shares,
debentures and other securities are sold for the first
time when raising long-term capital.
This market is concerned with new issues.
Therefore, the primary market is also called NEW ISSUE
In this market, the flow of funds is from savers to borrowers (industries), it helps directly in the capital formation of the country.
The money collected from this market is generally used by the companies to modernize their plants, machinery and buildings, for extending business, and for setting up new business unit.
Primary Market 15
Methods of Raising Capital in the Primary Market
The following are the methods of raising capital in the primary market:
Public Issue – the company invites subscription from the public through the issue of prospectus (and issuing advertisements in news papers). Public issue is of two types, namely, initial public offer (either a fresh issue
of securities or an offer for sale of existing securities or both by an unlisted company for the first time in its life to the public), and follow-on public offer (an offering of either a fresh issue of securities or an offer for sale to the public by an already listed company).
Offer For Sale – securities are offered to the public through an intermediary such as issue houses, merchant bank, investment bank or firm of a stock broker. The intermediary will buy from the firm at an agreed price and then sell to the public at market prices.
Methods of Raising Capital in the Primary Market 17
Private Placement – the issue of securities of a company direct to one investor or a small group of investors. Generally the investors are the financial institutions or other existing companies or
selected private persons such as friends and relatives of promoters. Company law defines a privately placed issue to be the one seeking subscription from 50 members. In a private placement, no prospectus is issued
Right Issue – an existing company issues shares to its existing shareholders in proportion to the number of shares already held by them. Thus, a right issue is the issue of new shares in which existing shareholders are given pre-emptive rights to subscribe to the new issue on a pro-rata basis. If the shareholders neither subscribe the shares nor transfer their rights, then the
company can offer the shares to public.
Electronic-Initial Public Offer – Electronic Initial Public Offers (e- IPOs) allow investors to bid for shares through internet.
The secondary market is that market in which the buying and
selling of the previously issued securities are done.
The transactions of the secondary market are generally done
through the medium of stock exchange.
The chief purpose of the secondary market is to create liquidity
To sell or purchase through the stock exchange requires the
services of a broker.
Features of Secondary Markets
It creates liquidity.
It comes after primary market.
It has a particular place.
It encourages new investments.
Economic and Industry Analysis 20
The following factors will affect the prices of shares on the stock market. Demand and Supply – The trend of the stock market trading directly
affects the price. When people are buying more stocks, then the price of that particular stock
increases. On the other hand, if people are selling more stocks, then the price of that stock falls. This is also the trend in individual stocks.
The price is directly affected by the trend of stock market trading.
Market Cap – If you are trying to guess the worth of a company from the price of the stock, you are making a huge mistake. It is the market capitalization of the company, rather than the stock, that is
more important when it comes to determining the worth of the company. You need to multiply the stock price with the total number of outstanding
stocks in the market to get the market cap of a company and that is the worth of the company.
Economic and Industry Analysis 21
Earnings Per Share – Earning per share is the profit that the company made per share in the last quarter.
It is mandatory for every public company to publish the quarterly report that states the earning per share of the company.
This is perhaps the most important factor for deciding the health of any company
they influence the buying tendency in the market, resulting in the increase/decrease in the price of that particular stock.
So, if you want to make a profitable investment, you need to keep watch on the quarterly reports that the companies publish and scrutinize the possibilities before buying stocks of particular companies.
Economic and Industry Analysis 22
Price-Earnings Ratio or the P/E ratio gives you a fair idea of how a company’s share price compares to its earnings. If the price of the share is much lower than the earning ratio of the company, the stock is
undervalued and it has the potential to rise in the near future. On the other hand, if the price is way higher than the actual earning of the company, then the stock is said to overvalued and the price can fall at any point.
However, there are many other reasons behind the fall or rise of the share price.
Economic Growth Data- stock prices react in a positive way if the growth of all the sectors of the economy is consistent otherwise they will react by falling sharply. Sectors such as automobiles, banking and financial services, metal and commodities, capital
goods and infrastructure depend largely on economic conditions.
In times such as economic recession, you will get stocks cheaper than they were in times of market highs.
Systemic and Engineering Effects on Prices 23
News Positive news about a company can increase buying interest in the market while a
negative press release can ruin the prospect of a stock.
Always remember that often times, despite amazingly good news, a stock can show least movement. It is the overall performance of the company that matters more than news. It is always wise to take a wait and see approach in a volatile market or when there is mixed reaction about a particular stock.
Dividends act as a signalling device for share price movement. If companies announce dividends, generally share prices of those companies tend to increase. An important point to note is, if the rate of dividend announced is less than what was expected by investors, share prices would decline, whereas if they are up to or more than expectations, share prices would increase.
Systemic and Engineering Effects on Prices 24
Bonus Issue Bonus issues are additional shares distributed by the company to its shareholders. The
advantage is that, the company is able to reinvest the dividend cash for better earnings growth while awarding their loyal shareholders. Increasing the number of outstanding shares decreases the stock’s price; making the stock more affordable for investors.
Company Performance Future expansion policies of the company, present acquisitions, the kind of management
of the company, revenues, free cash flows generated, all determine the stock prices. Finding companies with impressive performance, will help you emerge successful in markets
which are hard to predict.
Investor Behaviour Investors will first of all look for profitable bets. They will be booking profits at every level
which can bring down stock prices. So, investor behaviour in stock markets affect stock prices greatly.
Stock prices see an all time high in times of bull market, while they can correct to a great extent in a bearish market trend.
Bull vs Bear Markets 25
A bull market is a market that is on the rise and is economically sound, while a bear market is a market that is receding, where most stocks are declining in value.
Although some investors are “bearish,” the majority of investors are “bullish.” The stock market, as a whole, has always posted returns.
A bear market is more dangerous to invest in as many equities lose value. Since it is hard to time a market bottom, most investors withdraw their money from the
markets and sit on cash until the trend reverses.
The most recent U.S. bear market started in 2020. The stock market crashed in March, with the Dow Jones Industrial Average and the S&P 500 Index both falling more than 20% from their 52-week highs in February. Prior to that was 2007-2009 – down 57% over 1.4 years.
Systemic and Engineering Effects on Prices 26
Foreign Institutional Investor Behaviour
These are the institutions which buy and sell stocks in huge quantities.
So, any kind of buying will be positive for stock prices and selling will affect them negatively.
By imposing restrictions on the foreign investors, many stock exchanges across the word have brought in more transparency and regulations for the benefit of retail investors. This also helps you in knowing how to predict future stock prices.
For a steady economic growth, a stable and effective government is required.
In absence of conducive political environment, the entire stock market is expected to take a hit.
Valuations of Stocks
Investors consider the valuations of stocks before purchasing them and they may postpone buying stocks if the current valuations are not good enough.
This can affect the price of the stock in a negative manner.
Economic & Industry Influences: Inflation
slows sales and reduces profits
higher prices will also often lead to higher interest rates
these changes will tend to bring down stock prices.
High inflation also causes investors to think that companies may hold back on spending
this encourages investors to lock in their cash from equities to more attractive, less risky securities, like money market funds which will cause a fall in stock prices.
Stocks can beat inflation over time because companies can raise prices to account for rising costs brought about by inflation.
For example, when cost of sales and wages increases due to inflation, companies can simply pass on the higher cost to consumers by raising prices over time. When companies increase their prices, their revenues and earnings also increase.
Economic & Industry Influences: Interest Rates
Slowly rising interest rates can have a beneficial effect on stock prices.
Rates generally creep up when the economy is booming.
Higher market interest rates can also create a “buyers’ boycott” of the stock market, as more attractive investment opportunities emerge.
For example, Treasury bonds are considered a “risk-free” asset. Many investors will choose Treasury bonds over the stock marke