Financial markets: Definition and Types

Meaning of financial markets

A financial market is a marketplace where transactions between financial instruments like stocks, bonds, treasury bills (T-bills), etc. takes place.

Types of financial markets

The financial market is further divided into two types: Money market and Capital market.

Money Market

The money market deals with those financial instruments through which companies raise short-term funds generally for one year or less. To fulfill the requirements of money, companies borrow money for short-term through instruments like Certificate of Deposits (CD), Commercial Papers (CP), Treasury bills (T-bills), Repurchase Agreement, etc. Generally, interbank lending takes place in the money market, where banks through money market instruments lend money. The money market is regulated by the Reserve Bank of India (RBI). One can invest in the money market through money market accounts (MMA) and money market mutual funds. A money market account is just like a savings account where one can get better returns than a savings account. But in a money market account, the requirement of maintaining a minimum account balance is more than a savings account.

Capital Market

The capital market deals with those financial instruments through which companies raise money for the long-term for a period of more than one year. To fulfill the requirements of money in the long-term, the government or companies raise money through capital market instruments like stocks, bonds, etc. The capital market is regulated by the Securities and Exchange Board of India (SEBI).

The capital market is further divided into the Primary market and Secondary market.

Primary Market

In a primary market, new securities like new shares and bonds are issued. It is also called the new issue market. The government or companies sell securities to investors for which they get funds and investors become co-owners in these organizations. There is a direct transaction between the company and the investors and the amount invested by the investors go directly to the company. The investors get the shares of the company and become co-owners in the company.

In a primary market, companies raise funds through different methods like the public issue, private placement, rights issue, etc.

Public issue– When a company sells shares to the public for the first time, then it is called Initial Public Offering (IPO).

Private placement– In a private placement, instead of selling shares to the public, it sells shares to some selected investors like mutual funds, insurance companies, venture capitals, banks, etc.

Rights issue– In a rights issue, companies sell shares to their existing shareholders to raise funds. E.g. If a company X brings a 1:2 rights issue, then shareholders of the company X will be offered to buy one extra share for every 2 shares held. The rights issue price is usually less than the current market price.

In the primary market, investors can only buy shares and cannot sell. If you want to sell shares bought in the primary market, you have to sell in the secondary market. In a primary market, the company sells shares to the investors and after the IPO process i.e after the shares get allotted to investors, the stock gets listed on the stock exchange.

Secondary Market

A stock exchange is a secondary market where the shares bought from the IPO can be sold. It is a medium where buyers and sellers meet and transactions between them take place. In a secondary market, the transaction of shares takes place between the investors and the company does not involve. E.g. If you have bought shares of a Company X, then the amount goes to the seller and not to the company. The secondary market is also called the aftermarket in which previously issued securities are bought and sold.