1

GLOBAL FINANCIAL
MARKETS
LEARNING OUTCOMES
After going through the chapter student shall be able to understand:
❑ Introduction to Global Financial Market
❑ Role of Financial Market in Economic Development of a country
❑ Stakeholders in Financial Market (Domestic and Global)
❑ Indian Financial Market Scenario

1. INTRODUCTION TO GLOBAL FINANCIAL MARKETS

Source: Google to https://slideplayer.com/slide/5917511/

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 1.2 FINANCIAL SERVICES AND CAPITAL MARKETS

Financial markets are a marketplace that provides an avenue for the sale and purchase of financial
assets such as equity stocks, bonds, foreign exchange, commodities, derivatives, etc.
1.1 Major types of financial markets
1.1.1 Stock market
Stock market is the market for trading in equity stocks of companies. Typically, dividend yield in
stocks is on the lower side, as dividend is declared as a percentage of the face value of the stock
whereas the price in the secondary market runs up. That is, as a percentage of market price, the
return to the investor is on the lower side. Gains come from capital price appreciation in the
secondary market. This market is volatile, as the price in secondary market reflects expectations
going forward, on the economy and corporate earnings.
1.1.2 Bond market
The bond market offers an avenue for companies and the government to raise money to finance a
project or a deficit, with a defined repayment timeline. In a bond market, investors b uy bonds from
a company, and the company returns the amount of the bonds on the stipulated date, along with
the coupon or interest payment as agreed.
1.1.3 Commodities market
The commodities market is where traders and investors buy and sell natural resour ces or
commodities such as corn, oil, pulses, meat, gold, etc. In the commodities futures market, prices of
items to be delivered at a given future date are decided in the present.
1.1.4 Derivatives market
This market deals in derivatives or contracts whose value is based on the market value of the
asset being traded, called the underlying. The commodities futures mentioned above are an
example of a derivative. Currency and equity derivatives are popular. Further, according to one
study, India and China top the world’s commodity market.

Source: https://www.accountingfoundation.org/jsp/Foundation/Page/FAFSectionPage&cid=1351027541272

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 GLOBAL FINANCIAL MARKETS 1.3

1.2 Importance of Financial Markets

There are many social benefits that financial markets facilitate, including:
• They provide individuals, companies, governments and quasi-government organizations
access to capital;
• People with surplus funds for investment get channels for investment and are assured of
fair treatment as there is a regulator. If it is an unorganized place and not a proper market,
transactions may go in the wrong direction. For instance, people with extra money access
the stock market inspite of being aware of the risk inherent in it as the y look for higher
return and assured of the transparency in the market because of the presence of SEB I.
• Financial markets create jobs as there are many people involved in direct and indirect
activities. For instance, the involvement of the brokers, underwriters, merchant bankers,
custodians, depositories etc. in the financial markets.
1.3 Size of the Global Financial Market
The biggest markets are that of derivatives, though conventionally we tend to think of Equity or
Bond markets as large. Globally, derivatives markets are much more developed.

Source: Google to https://topforeignstocks.com/2011/08/23/how-big-is-the-global-financial-industry/

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 1.4 FINANCIAL SERVICES AND CAPITAL MARKETS

The chart above shows that the notional amount of financial derivatives outsta nding is much higher
than the traded volume of stocks and bonds.

2. ROLE OF FINANCIAL MARKET IN ECONOMIC

DEVELOPMENT OF A COUNTRY
For economic development, a country needs capital, and the capital markets discussed above e.g.
equities, bonds, etc. channelize those resources. Through the financial market or capital market
system, funds flow from those who have surplus funds to those who have a shortage of funds,
either by direct, market-based financing or by indirect, bank-based finance. Without a properly
functioning stock market, price discovery of corporations would not happen and resource
mobilization through IPOs would be hampered.
2.1 Functions of Financial Markets
The role of financial markets in the success and strength of an economy is immense. S ome
important functions of financial markets are:
✓ Puts savings into more productive use
Money in savings account should be put to productive use. Financial institutions like banks loan it
out to individuals and companies that need it for say home loan, stu dy loan, business purposes,
big projects, etc. Further, savings as such does not have any meaning; it is investment that puts it
to productive use.
✓ Determines the price of securities
Once a security is listed, buyers and sellers trade in it, and the traded price reflects the prospects
of the company whose instruments are being traded. This is called price discovery. Prices of
securities are determined in financial markets, which is an important function.
✓ Makes financial assets liquid
Buyers and sellers can decide to trade their securities anytime, provided there is a counterpart y.
Financial markets provide this avenue, and that creates liquidity in the security. This imparts
liquidity to investors and incentivize them to invest.
✓ Lowers the cost of transactions
In financial markets, various types of information regarding securities can be acquired without the
need to spend. The Exchanges and market participant associations disseminate relevant
information. The companies also can disseminate information, but they would put forth only what
they want to propagate, not what is useful for investors.

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 GLOBAL FINANCIAL MARKETS 1.5

Source: Google to https://slideplayer.com/slide/5737595/

Financial markets facilitate the flow of savings and investment in the economy for generation o f
capital and the production of goods and services.
2.2 The linkages in financial flows
As we see in the diagram above, households save, and invest through financial institutions. Apart
from households, the corporate or business sectors also may have surplus from time to time,
which is invested through financial institutions. For economic development of a country, the
business sector and the government needs resources, which is mobilized by the financial
institutions and markets? The government may need to borrow from the market, which is facilitated
by financial markets. Resources may be mobilized from abroad as well, depending on the relative
growth potential of the two economies.
The resources i.e. funds are deployed in the real economy by the government and pr ivate sector
business firms, for creation of capacities and for running the wheel i.e. necessary revenue
expenditure. The production of business firms is consumed by the household sector. Government
taxes are collected from the business sector. Economic development happens through increasing
the size of the pie shown above, which is denoted by the GDP growth rate, by generating
efficiencies in the production process and increasing the speed of the cycle. While generating
efficiencies is the job of the participants in the production process, the resource that moves the
wheel is finance.

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 1.6 FINANCIAL SERVICES AND CAPITAL MARKETS

Financial markets provide this resource. It has to be done at an optimum cost; it should be low
enough to incentivize producers to raise resources and high enough for house holds to save. The
more efficient financial markets are, the more efficient is this process of price discovery.
2.3 Contribution of market to economy
The state of development of the financial markets reflects the state of development of the
economy, and vice versa. It is a relationship of symbiosis, as the market and the economy feed
from each other.
According to Baily and Elliott, there are three major functions of the financial system:
Credit Provision - Credit supports economic activity. Governments can invest in infrastructure
projects by reducing the cycles of tax revenues and correcting spends, businesses can invest
more than the cash they have and individuals can purchase homes and other utilities without
having to save the entire amount in advance. Banks and other financial service providers give this
credit facility to all stakeholders.
Liquidity provision - Banks and other financial providers protect businesses and individuals
against sudden cash needs. Banks provide the facility of demand deposits which the business or
individual can withdraw at any time. Similarly, they provide credit and overdraft facility to
businesses. Moreover, banks and financial institutions offer to buy or sell securities as perneed
and often in large volumes to fulfill sudden cash requirements of the stakeholders.
Risk management services - Finance provides risk management from the risks of financial
markets and commodity prices by pooling risks. Derivative transactions e nable banks to provide
this risk management. These services are extremely valuable even though they receive a lot of flak
due to excesses during financial crisis.
According to Global Financial Development Report of World Bank of 2014, “Fundamentally,
financial sector development concerns overcoming “costs” incurred in the financial system. This
process of reducing costs of acquiring information, enforcing contracts, and executing transactions
results in the emergence of financial contracts, intermediaries, and markets. Different types and
combinations of information, transaction, and enforcement costs in conjunction with different
regulatory, legal and tax systems have motivated distinct forms of contracts, intermediaries and
markets across countries in different times.”
According to Levine, “The five key functions of a financial system in a country are: (i)
information about possible investments and capital allocation; (ii) monitoring investments and the
exercise of corporate governance after providing financing; (iii) facilitation of the trading,
diversification, and management of risk; (iv) mobilization and pooling of savings; and (v) promoting
the exchange of goods and services.”

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 GLOBAL FINANCIAL MARKETS 1.7

3. STAKEHOLDERS IN FINANCIAL MARKET (DOMESTIC

AND GLOBAL)
Various stakeholders in the financial market can be categorized into following four segments:
(i) Primary stakeholders in financial market
❖ Shareholders
❖ Lenders
❖ Companies
❖ Mutual fund Organizations/holders/fund managers
(ii) Service providers in financial market
❖ Merchant Bankers
❖ Brokers
❖ Underwriters
❖ Depositories
❖ Custodians
(iii) Regulators in financial market
❖ Securities and Exchange Board of India (SEBI)
❖ Reserve Bank of India
❖ Insurance Regulatory and Development Authority of India (IRDAI)
❖ Pension Fund Regulatory and Development Authority (PFRDA)
(iv) Administrators to facilitate the financial market
❖ Association of Mutual funds of India (AMFI)
❖ Foreign Exchange Dealers Association of India (FEDAI)
❖ Fixed Income Money Market and Derivative Association of India (FIMMDA)
❖ Association of Investment Bankers of India (AIBI)
(i) Primary stakeholders in financial market
(a) Shareholders: In simple language, shareholders are the owners of a company. So, a
shareholder is any person such as an individual, company or other institution who hold at
least one share out of company’s total shares. As shareholders are owners of the company

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 1.8 FINANCIAL SERVICES AND CAPITAL MARKETS

they get benefit when the share prices increase. In the same way, the shareholders lose out
when the company’s shares plummet.
The shareholders participate in the financial market (secondary market) by buying and
selling shares. Their actions depend upon which way the market is behaving. If the market
price is low, they tend to buy more shares. On the other hand, if the market price of shares
is high, they will sell more shares to book profit. Thus, they provide the much needed
liquidity in the stock market.
(b) Lenders: A lender in relation to a financial market is either a company or any other form of
corporation that issues bonds or debentures to make its end meet. Funds are available to
another with the expectation that the funds will be repaid, in addition to any interest and/or
fees, either in increments or as a lump sum. They also provide the much needed liquidity in
the financial market by facilitating the flow of funds from deficit spending to surplus
spending sectors.
(c) Corporates: Corporates raise money either through the share market route or through the
bond market route. Raising money by issuing shares to the public generally helps the
companies to amass huge amount of capital. It keeps the financial market ticking by
enabling mobilization and allocation of saving from the people, be it, individual investors,
companies and institutional investors whether foreign or domestic.
However, raising of equity share capital has its repercussions. Cost of equity share capital
is costly. Moreover, companies have to meet a lot of regulatory compliances at the time of
initial public offerings which takes a lot of time, energy and money. But, if the company
managed to keep its share prices on the higher side, it will easily get more funds in the
future whether through equity or debt. If the company opting to raise funds through the debt
route, it has certain advantages and disadvantages. The benefits are lower cost of capital in
comparison to equity. The debt route also tends to increase the earning per share (EPS) of
the company which consequently leads to escalation of share prices of the company.
However, the demerit is that a debt has to be repaid alongwith interest. So, too much of
debt may lead an organization to financial/default risks and may land it in fina ncial distress.
(d) Mutual fund Organizations: A mutual fund is a financial institution or intermediary that
pools the savings of investors for collective investment in a diversified portfolio of securities.
A fund is ‘mutual’ as all of its returns, minus its expenses, are shared by fund’s investors. A
mutual fund serves as a link between the investor and the securities market by mobilizing
savings from the investor and investing them in the securities market to generate returns.
(ii) Service providers in financial market
(a) Merchant Bankers: As per the Securities and Exchange Board of India (Merchant Banker)
Regulations, 1992, merchant banker means any person who is engaged in the business of
issue management, either by making arrangements regarding selling, buying, or subscribing
to securities, or acting as a manager, consultant, or advisor, or rendering corporate -

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advisory services in relation to such issue management. It is mandatory to appoint a

merchant banker in case of a public issue. The functions of merchant banker includes –
submitting offer documents to SEBI, due diligence i.e. certifying that all the disclosures
made in the draft prospectus or letter of offer are true and fair and will enable the investors
to make an informed decision etc.
Globally, merchant banker plays more or less the same role as discussed above. Some of
the top Merchant Bankers in USA are Merrill lynch, Citigroup, Goldman Sachs, J.P. Morgan
and Morgan Stanley. They provide services to top companies in the world. For example ,
Morgan Stanley has been responsible for hundreds of technology financing and M&A
transactions aggregating over $500 billion in value. Further, Goldman Sachs has served all
the big names in tech, including Microsoft, Apple, Facebook, Twitter, Ebay and Ali baba.
(b) Brokers: Stock Brokers participate in the stock market on behalf of their clients. They buy
and sell shares on behalf of the clients on their instructions. In order to actively participate
in the capital market, they should be SEBI registered. So, they facilitate trading in the
stock market (secondary market) by undertaking buy and sell transactions on behalf of the
client.
In USA, most "brokers" must be registered with the Securities Exchange Commission
(SEC) and join a "self-regulatory organization," or SRO. Globally, margin financing is
popular, in which, many large broking houses provide financing facilities to clients who
borrow money to invest in stocks. Therefore, Stock exchanges monitor the extent to which
brokers are lending in line with their net worth.
(c) Underwriters: Underwriters are those persons who assume the risk of others. In capital
market, in case of new issues, they assume risk by guaranteeing that in case the shares
are not subscribed fully by the public, the unsubscribed portion will be subscribed by the
underwriter itself. They do it by charging a small fee.
So, how do the underwriters make profit? They buy the shares of the company before they
are actually listed on a stock exchange. The underwriters make their profit on the difference
in price between what they paid before the IPO and when the shares are actually offered to
the public.
(d) Depositories: Depository is an institution which maintains investors account in electronic
form. One of the main functions of the Depository is to transfer the ownership of shares
from one investor to another whenever the trading of shares takes place. It helps in
reducing the paper work involved in trade, expedites the transfer and reduces the risk
associated with physical shares such as damage, theft, and subsequent misuse of the
certificates or fake securities.
There are two types of depositories in India which are known as NSDL (National Securities
Depository Limited) and CSDL [Central Depository Services (India) Limited]. They interface
with the investors through their agents called Depository participants (DPs). DPs could be

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 1.10 FINANCIAL SERVICES AND CAPITAL MARKETS

the banks (private, public and foreign), financial institutions or SEBI registered trading
members.
Globally, depositories provide the same set of services as has been rendered by CDSL and
NSDL.
(e) Custodians: Custodians provide custodial services for safe keeping of securities. Besides
safe keeping, they provide other services for a fee (generally 1% of the total volume of
transactions) such as physical transfer of share certificates, collecting dividends and
interest warrants and conforming to transfer regulations. Besides that, it also updates client
status on their investment status. Even though securities are in the custody of depositories,
the custodians act as a complementary to them by providing various services as mentioned
above. In India, The Stock Holding Corporation of India (SHCIL) and the SBI Share Holding
Corporation are the leading custodians.
After liberalization in 1991, foreign institutional investors (FIIs) were allowed to invest in
the Indian Capital Market. Most of the FII business in India is routed through foreign
custodians. According to the US laws, no US fund is allowed to use a custodian that does
not have a capital adequacy of USD 200 million. No Indian custodian meets this
requirement. Therefore, only foreign banks operate as custodians for US based FIIs,
pension funds, and corporates. Hong Kong Bank, Deutsche Bank, Citi Bank, and Standard
Chartered Bank are some leading foreign banks which operate as custodians.
(iii) Regulators in financial market
(a) Securities and Exchange Board of India (SEBI): SEBI was born in 1992. The basic
objective was to protect the interest of investors in securities and promotes the
development of securities market. The important objectives of SEBI are:
i) Protect the interest of investors in securities.
ii) Promotes the development of securities market.
iii) Regulating the securities market.
Outside India: Securities Exchange Commission (SEC) in USA performs more or less the
same functions as given to SEBI. But the stark difference is the amount of penalty. SEC can
impose an unlimited amount of fine which SEBI cannot. That is the reason SEC has more
teeth in comparison to SEBI and acts as an effective deterrent against malpractices i n the
stock market.
(b) Reserve Bank of India: The Reserve Bank of India was established in 1935 with the
provision of Reserve Bank of India Act, 1934. Though privately owned initially, in 1949 it
was nationalized and since then fully owned by Government of India (GoI). The preamble of
the Reserve Bank of India describes its main functions as to regulate the issue of Bank

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Notes and keeping of reserves with a view to securing monetary stability in India and
generally to operate the currency and credit system of the country to its advantage.
Outside India: Federal Reserve (Fed) in the USA’s policies is primarily driven by growth
and employment figures, at the expense of inflation. On the other hand, we have the RBI,
whose policies are primarily driven by inflation, at the expense of growth. So which
approach is better depends upon the situation of the economy. In the USA and European
Union, where rate of interest is very low encourages the industry to borrow at cheaper cost
and contributes towards economic development and growth. However, in India, the aim of
RBI is to keep the rate of interest high to discourage the industry to borrow large amount of
money and consequently to contain inflation.
However, recently, due to the Covid–19 pandemic, RBI has lowered the interest rates to
give a firm push to the dwindling economic growth, but not by much. The reason is that too
much lowering of interest rates will give not contain the rising inflation rate. So, what is the
way out to keep interest rates low and bring them down further?
One solution is - given the prevailing environment, more proactive bond purchases will be
required over a longer period of time to provide support to the bond market and the overall
economy. Bank credit growth is expected to rise in the coming quarters even though NBFCs
are likely to stay in consolidation mode. Banks are unlikely to be able to support both
private credit demand and higher borrowings simultaneously. In this backdrop, the RBI
needs to step in proactively to buy bonds and keep longer duration yields from inching
higher.
(c) Insurance Regulatory and Development Authority of India (IRDAI): IRDA Act was
passed in 1999. The main aim of the Insurance Regulatory and Development Authority of
India is to protect the interest of holders of Insurance policies to regulate, promote and
ensure orderly growth of Insurance industry & for matters connected therewith or incidental
thereto. Under this Act, Controller of Insurance under Insurance Act,1938 was replac ed by
newly established authority called Insurance Regulatory and Development Authority (IRDA).
Outside India: In USA, insurance is almost regulated by the individual state governments.
In Canada, Office of the Superintendent of Financial Institutions Can ada (OSFI)sets the
minimum regulatory requirements and expectations to support policyholder and creditor
protection, giving due regard to the need to allow institutions to compete effectively. As
healthy companies are in the best position to protect policyholders and creditors, OSFI is
aware of the impact of its requirements and expectations on competition domestically and
internationally.
Insurance regulators in other jurisdictions pursue similar goals but with different legislative
and policy tools and with different economic experiences and conditions. OSFI considers
the pace, scope and impact of reforms while renewing the regulatory frameworkensuring

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that we are able to incorporate best practices, and limit – to the extent practical –
unintended consequences and an uneven playing field.
(Source: Office of the Superintendent of Financial institutions, Canada)
(d) Pension Fund Regulatory and Development Authority (PFRDA): The objective of
PFRDA is to be a model Regulator for promotion and development of an organized pension
system to serve the old age income needs of people on a sustainable basis. Pension
systems throughout the world have been under close scrutiny over the last couple of
decades. Numerous reforms have been carried out to tackle the sustainability and
adequacy of pension arrangements in the face of the rising global demographic challenge.
Outside India: The main law which governs the establishment, maintenance, and
termination of pension plans in the United States is the Employee Retirement Income
Security Act (ERISA).
Prudential supervision of Australian pension funds started in 1993.The objec tive of the
regulation regarding superannuation aimed at reducing the riskiness of superannuation
investments, dealing with retirement incomes policy, equal treatment of members and
various other matters.
(iv) Administrative authorities to facilitate the financial market
(a) Association of Mutual funds of India (AMFI): The Association of Mutual Funds of
India (AMFI) is dedicated to developing the Indian Mutual Fund Industry on professional,
healthy and ethical lines and to enhance and maintain standards in all areas with a view to
protecting and promoting the interests of mutual funds and their unit holders.
AMFI, the association of SEBI registered mutual funds in India of all the registered Asset
Management Companies, was incorporated on August 22, 1995, as a non-profit
organization. As of now, all the 42 Asset Management Companies that are registered with
SEBI are its members.
The Mutual Fund Dealers Association of Canada (MFDA) is the national self-regulatory
organization (SRO) that oversees mutual fund dealers in Canada. The MFDA was
established in mid-1998 at the initiative of the Canadian Securities Administrators (CSA) in
response to the rapid growth of mutual funds in Canada in the late 1980s from $40 billion to
$400 billion and recognition by the CSA that the mutual fund industry and investors would
benefit from more effective regulation and oversight. As an SRO, the MFDA is responsible
for regulating the operations, standards of practice and business conduct of its Members
and their representatives with a view to enhancing investor protection and strengthening
public confidence in the Canadian mutual fund industry.
(b) Foreign Exchange Dealers Association of India (FEDAI): Foreign Exchange Dealers
Association of India (FEDAI) was set up in 1958 as an Association of banks dealing in
foreign exchange in India (typically called Authorised Dealers - ADs) as a self-regulatory

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body and is incorporated under Section 25 of The Companies Act, 1956. It’s major activities
include framing of rules governing the conduct of inter-bank foreign exchange business
among banks vis-à-vis public and liaison with RBI for reforms and development of forex
market.
Internationally, forex dealers provide online trading services to allow individuals to
speculate on rapidly changing foreign exchange rates. Forex Dealer Members (FDMs) are
regulated in the United States by the Commodity Futures Trading Commission (CFTC)
and National Futures Association (NFA), as well as by national and local regulatory bodies
where they conduct business.
(c) Fixed Income Money Market and Derivative Association of India (FIMMDA)
The Fixed Income Money Market and Derivatives Association of India (FIMMDA), an
association of Scheduled Commercial Banks, Public Financial Institutions, Primar y Dealers
and Insurance Companies was incorporated as a Company under section 25 of the
Companies Act, 1956 on June 3rd, 1998. FIMMDA is a voluntary market body for the bond,
money and derivatives markets.
FIMMDA has members representing all major institutional segments of the market. The
membership includes Nationalized Banks such as State Bank of India, its associate banks
and other nationalized banks; Private sector banks such as ICICI Bank, HDFC Bank, IDBI
Bank; Foreign Banks such as Bank of America, ABN Amro, Citibank, Financial institutions
such as IDFC, EXIM Bank, NABARD, Insurance Companies like Life Insurance Corporation
of India (LIC), ICICI Prudential Life Insurance Company, Birla Sun Life Insurance Company
and all Primary Dealers.
The International Swaps and Derivatives Association (ISDA) is a trade organization of
participants in the market for over-the-counter derivatives. It’s headquarter is in New York
City, and has created a standardized contract (the ISDA Master Agreement) to enter
into derivatives transactions.
(d) Association of Investment Bankers of India (AIBI)
In the early 1990s, the merchant banking industry in India witnessed a phenomenal growth
with over 1500 merchant bankers registered with SEBI. In order to ensure the wellbeing of
the industry and for promoting healthy business practices, it became necessary to set up a
Self-Regulatory Organization within the industry. This led to the birth of the Association of
Investment Bankers of India (AIBI). AIBI was promoted to exercise overall supervision over
its members in the matters of compliance with statutory rules and regulations pertaining to
merchant banking and other activities. AIBI was granted recognition by SEBI to set up
professional standards, for providing efficient services and to establish standard practices in
merchant banking and financial services. AIBI, in consultation with SEBI, is working towards
improving the compliance of statutory requirement in a systematic manner.

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AIBI's primary objective is to ensure that its members render services to all its constituents within
an agreed framework of ethical principles and practices. It also works as a trade body promoting
the interests of the industry and of its members. (Source www.aibi.org.in)
Internationally, International Association of Investment Bankers (IAIB) since its inception in
1994 has leveraged its collective expertise, best practice knowledge, industry insights, and global
reach to assist clients in executing mergers, acquisitions, divestitures, and strategic partnerships.
Its membership is composed of established boutique investment banks from around the world
whose primary focus is advising middle market and emerging growth companies. A s a highly
collaborative group, they hold monthly conference calls and gather twice each year to review
creative transaction structures and current market dynamics, as well as to share perspectives on
important industry issues. Through these efforts, they are able to offer their clients a truly
differentiated advisory service that leverages the significant transaction experience and domain
expertise of their member firms.
The International Association of Investment Bankers (IAIB) is an affiliation of investment banking
firms from Europe, North America, Australia and Asia, working together to broaden their reach and
leverage their expertise within the global marketplace.
Since 1994, the IAIB member firms have utilized this network to offer their clients worldwide
access to providers of capital, advisory services and acquirers and sellers of businesses. With this
capability, member firms are able to provide substantial added value to their clients beyond that
typically offered by purely domestic advisors. (Source www.iaib.org)

4. INDIAN FINANCIAL MARKET SCENARIO

The Indian economy is a developing one and so is the Indian financial market ecosystem. The
market is well regulated by SEBI, along with other regulators. The pace of development, in terms
of systems and enablers, has been quite fast. Though we are yet to catch up with developed
markets like USA on many parameters, it is because we are still a developing economy.
Let us look at the components of the Indian financial market:

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Source: Google to http://practicemock.com/blog/lic-aao/insurance-financial-market-awareness-indian-financial-system/

4.1 Money Market Instruments

The money market is the market for financial assets that are close substitutes for money. It is the
market for instruments ranging from one day deployment e.g. call money market to a few months,
but upto or less than one year.
4.1.1 Treasury Bills
Treasury Bills (T-Bills) are short term instruments issued by the Central Government with
maturities in less than one year. Their purpose remains the same as Dated Securities (i.e. regular
Government Securities), but they are intended more to meeting the short term funding needs of
the Central Government. Currently, the Central Government issues T Bills of 91 -day, 182-day and
364-day maturity. Since T Bills have a maturity of less than one year, they are considered to be a
money market instrument.
4.1.2 Cash Management Bills
These are a short term instrument issued by the Government of India and meant to specifically
meet temporary cash flow mismatches of the Government. These instruments have a maturity of
less than 91 days. Further, they are issued at a discount to par value (in the nature of zero coupon
securities). CMBs have similar characteristics as Treasury Bills.
4.1.3 Call Money, Notice Money and Term Money
These are the terms used for short term borrowing and lending operations between Banks and
sometimes with and between Primary Dealers. The difference between the three is in their tenure

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of lending. Call money is for overnight deployment i.e. one day, notice money is two to fourteen
days and term money is for a tenure fifteen days and longer.
4.1.4 Certificate of Deposits (CDs)
CDs are issued by banks for short-term funding needs. Usually, banks issue CDs when credit pick-
up is higher than bank deposit growth. CDs save on operational costs of the Bank as these take
place in bulk.
4.1.5 Commercial Papers (CPs)
CPs are issued by corporates (mostly NBFCs), primary dealers and all-India financial institutions
(other than Banks), as a source of short-term finance. In a way CDs and CPs are similar,
difference being CDs are issued by Banks and CPs are issued by corporates.
4.2 Capital Market
The capital market provides the support to corporates for raising resources. The Securities and
Exchange Board of India (SEBI), along with the Reserve Bank of India are the regulatory
authorities for Indian securities market, to protect investors and improve the microstructure of
capital markets in India.
There are two components of capital market, primary and secondary. In primary market,
companies, governments or public sector institutions can raise funds through bond issues. In
primary market, the investor directly buys shares / bonds of a company. In secondary markets, the
shares / bonds are bought and sold by the customers. On the platforms provided by Exchanges
like NSE or BSE, investors buy and sell instruments like stocks and bonds through brokers / sub -
brokers.
4.2.1 Indian Capital Market scenario (Equity Market)
The market capitalization to Gross Domestic Product (GDP) ratio shows to what extent the market
is assigning a value to the listed corporates against the GDP of the economy. The perspective is
the current value against the historical average. The stock market capitalization-to-GDP ratio is
also known as the Buffett Indicator, after legendary investor Warren Buffett, who popularized its
use. This measure the total value of all listed shares divided by the GDP.

© The Institute of Chartered Accountants of India

 GLOBAL FINANCIAL MARKETS 1.17

The chart above shows that investments in, and discounting of future earnings growth of Indian
companies has been moving up during the FY 2012 to 2018 represented by the increase in the
ratio of market capitalization to GDP.
However, earnings growth of companies have not kept pace with the increase i n valuations given
by the market, as indicated in the chart above. If EPS does not grow as much and price goes up,
the market valuation, as represented by P/E ratio, moves to the higher side.

Source: PhillipCapital India Research

The P/E ratio, calculated on the basis of forward or expected EPS, has moved to the higher side.

© The Institute of Chartered Accountants of India

 1.18 FINANCIAL SERVICES AND CAPITAL MARKETS

4.2.2 Historical Returns from Equity

Returns from equity market have been volatile. The following chart shows returns from Sensex
since inception on a rolling basis. Annual rolling means returns of every one year calculated every
year, three-year rolling return means returns over past three years, calculated every year, an d so
on.

Year End Sensex Rolling 1 Rolling Rolling 5 Rolling 10 Rolling 15 Rolling 20

(1) (2) YR 3 YR YR YR YR YR
Growth Growth Growth Growth (6) Growth (7) Growth (8)
(3) (4) (5)
Mar-79 100
Mar-80 129 29%
Mar-81 173 35%
Mar-82 218 26% 30%
Mar-83 212 -3% 18%
Mar-84 245 16% 12% 20%
Mar-85 354 44% 18% 22%
Mar-86 574 62% 39% 27%
Mar-87 510 -11% 28% 19%
Mar-88 398 -22% 4% 13%
Mar-89 714 79% 8% 24% 22%
Mar-90 781 9% 15% 17% 20%
Mar-91 1168 50% 43% 15% 21%
Mar-92 4285 267% 82% 53% 35%
Mar-93 2281 -47% 43% 42% 27%
Mar-94 3779 66% 48% 40% 31% 27%
Mar-95 3261 -14% -9% 33% 25% 24%
Mar-96 3367 3% 14% 24% 19% 22%
Mar-97 3361 0% -4% -5% 21% 20%
Mar-98 3893 16% 6% 11% 26% 21%
Mar-99 3740 -4% 4% 0% 18% 20% 20%
Mar-00 5001 34% 14% 9% 20% 19% 20%
Mar-01 3604 -28% -3% 1% 12% 13% 16%
Mar-02 3469 -4% -2% 1% -2% 14% 15%
Mar-03 3049 -12% 15% -5% 3% 15% 14%
Mar-04 5591 83% 16% 8% 4% 15% 17%

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 GLOBAL FINANCIAL MARKETS 1.19

Mar-05 6493 16% 23% 5% 7% 15% 16%

Mar-06 11280 74% 55% 26% 13% 16% 16%
Mar-07 13072 16% 33% 30% 15% 8% 18%
Mar-08 15644 20% 34% 39% 15% 14% 20%
Mar-09 9709 -38% -5% 12% 10% 6% 14%
Mar-10 17528 81% 10% 22% 13% 12% 17%
Mar-11 19445 11% 8% 12% 18% 12% 15%
Mar-12 17404 -10% 21% 6% 18% 12% 7%
Mar-13 18836 8% 2% 4% 20% 11% 11%
Mar-14 22386 19% 5% 18% 15% 13% 9%
Mar-15 27957 25% 17% 10% 16% 12% 11%
Mar-16 25342 -9% 10% 5% 8% 14% 11%
Mar-17 29621 17% 10% 11% 9% 15% 11%
Probability of Gain 25/38 30/36 31/34 28/29 24/24 19/19

Source: HDFC Mutual Fund

How to read it?
Return of 29% from March 1979 to March 1980 means over a holding period of one year. Then it
goes on like this every year. Return of 30% from March 1979 to March 1982 means over a holding
period of 3 years, annualized. Similarly, the same pattern will be followed for other 3-year holding
periods.
Conclusion:
On a one-year holding period basis, returns were positive in 25 out of 38 years, hence the
probability of positive return is 25/38. Over 10-year holding periods, it is positive in 28 out of 29
years, hence over a long holding period probability of positive return is 28/29. Over 15 and 20 year
holding periods, it is always positive.
4.2.3 Bond Market
The Government and corporates issue bonds / debentures for raising resources. The market
capitalization concept is not used in the bond market as the market pric e is not much different from
the face value of instruments. To gauge the size of the market, we will look at the outstanding
quantum of securities.

© The Institute of Chartered Accountants of India

 1.20 FINANCIAL SERVICES AND CAPITAL MARKETS

Source: RBI, SEBI

As we observe from the chart above, the outstanding quantum of Government Securities, both
Centre and States, have been going up steadily. This is in line with the GDP growth of the country
and increase in size of Government budgets. The Central Government is the major issuer of
securities in the bond market.
Corporate bonds and Commercial Papers also have been increasing steadily, in line with the
growth of the corporate sector. This is another means of raising resources for them, apart from
Bank loans.
Money market instruments like Treasury Bills and Certificates of Deposit have not incre ased much
as these are means of short term funding. CPs have increased in quantum as the major issuers
are NBFCs; NBFCs require money as that is their input and output.

© The Institute of Chartered Accountants of India

 GLOBAL FINANCIAL MARKETS 1.21

4.2.4 Subscribers to Government Securities

Source: RBI

© The Institute of Chartered Accountants of India