A financial market is a place or system where people buy and sell financial

assets like stocks, bonds, and currencies. The main financial markets are the
money market and the capital market. The capital market is a significant source
of long-term financing. Long-term financing refers to obtaining funds for an
extended period, usually more than a year, to support business operations,
investments, or projects. In the capital market, companies and governments
raise money by issuing stocks (equity) or bonds (debt) to investors. These
financial instruments are traded among investors in the market. Stocks
represent ownership in a company, while bonds represent loans that need to
be repaid with interest over time.. The requirement for short-term financing
primarily emerges due to investments made in current assets, known as
working capital.
The money market is formed by connections between those who have short-
term funds to lend and those who need to borrow, typically for a year or less. It
involves financial instruments like Treasury bills and commercial paper, and it's
a place where organizations and governments manage their short-term cash
needs. The money market is established due to investors having short-term
excess funds they want to invest in liquid assets or short-term interest-earning
tools At the same time, numerous other entities or organizations need seasonal
or temporary financing. The money market serves as a meeting point for these
providers and seekers of short-term liquid fund.
Trade credit, often referred to as spontaneous credit, stands as the main
working capital financing source. Trade credit refers to the credit extended by
suppliers in the ordinary course of business transactions. This practice allows
purchases to be paid for after an agreed-upon period, creating a deferral of
payment that becomes a source of financing for credit purchases. Various
examples of trade credit include account receivables, account payables, and
notes payable. Suppliers of goods do not offer credit without careful
consideration. Their choice to provide credit and the approved amount depend
on factors like the company's historical earnings, liquidity status, and previous
payment track record. Trade credit is readily available and nearly automatic,
positioning it as a readily available financial option. For instance, if a firm needs
credit purchases of 7 lakhs per day to support existing sales and purchases are
on a 30-day credit, the average outstanding accounts payable will be 2.1 crore
Trade credit doesn't involve direct interest fees, yet it carries an implied
expense linked to credit terms. For instance, if the credit period is 40 days
without a discount provision, the amount owed to the supplier remains
constant whether settled on the purchase date or the 40th day. Consequently,
trade credit is perceived as cost-neutral. However, in cases like 2/10 net 40,
where a 2% discount is offered if payment occurs within the discount window,
costs become significant without the discount. When credit terms provide a
discount, not availing it results in a 2% extra charge for utilizing the funds for
the extended 30 days. If a firm experiences this scenario twelve times a year,
assuming a 2% disc0unt forgone every 30 days, the yearly expense reaches
24%. This cost varies based on the gap between payment and the discount
period. Bank credit aimed at working capital is facilitated through four distinct
methods. The first method involves offering overdrafts, while the second
entails providing short-term loans. The third avenue is accessed via bill
discounting, and the fourth mechanism employs letters of credit.
In scenarios where cash credit or overdraft arrangements are utilized, the bank
establishes a prearranged borrowing credit limit. Within this established limit,
borrowers are allowed to access a defined credit overdraft allocation. This
credit line allows for multiple withdrawals to fulfill their needs, and repayment
flexibility is granted during this period.
The interest rate is calculated based on the actual amount that the borrower
utilizes from the ongoing balance, rather than being determined by the
sanctioned limit. Nevertheless, a minimum commitment charge might apply to
any unused balance, irrespective of borrowing levels. To avail of this facility, a
line of credit agreement is entered into between the bank and the business.
This agreement outlines the short-term borrowing amount that the bank will
make accessible to the business within a specific timeframe.
The utilization of the cash credit arrangement gave rise to troublesome
behaviors because bank credit accessibility was not linked to actual production
necessities. Consequently, borrowers obtained more credit facilities than their
genuine needs, and in some instances, there was a phenomenon of dual
financing. This situation arose when credit was procured from various sources
for the identical activity, like acquiring goods on credit while simultaneously
securing cash credit against the same transaction.

Bill discounting Bill financing is crafted to synchronize credit with the process of
buying and selling goods, thereby lessening the potential for misusing or
diverting credit. The approach involves generating bills stemming from trade
deals that encompass credit-based sales and purchases .Sellers create bills
addressed to buyers, which are either payable on demand or within a specific
period, usually not exceeding 90 days from acceptance. Following this, the
seller presents the bill to a bank for discounting, resulting in the bank releasing
funds. As the bill reaches maturity, the bank presents it to the buyer for
payment. Let's say Company A sells goods worth $10,000 to Company B on
credit. As part of the transaction, Company B agrees to pay the amount within
60 days. In order to manage their cash flow, Company A doesn't want to wait
for 60 days to receive the payment. Instead, they decide to discount the
bill.Company A takes the bill of $10,000 to a bank for discounting. The bank
agrees to buy the bill from Company A before its maturity date. The bank
calculates the discount based on the agreed-upon interest rate and the number
of days left until the bill's maturity. Let's say the bank offers a discount of
$200.So, Company A receives $9,800 from the bank immediately (original bill
amount minus the discount). The bank holds onto the bill until the maturity
date.When the bill matures after 60 days, Company B pays the bank the full
$10,000. The bank's profit is the difference between the discounted amount
they initially paid to Company A ($9,800) and the full bill amount they received
from Company B ($10,000), which is $200. In this example, Company A gets
immediate access to funds by selling the bill to the bank at a discount, and the
bank earns a profit by receiving the full bill amount from Company B at
maturity.

A letter of credit (LC) is closely related to working capital financing, particularly

in the context of international trade. When a business engages in international
trade, it may face challenges related to the timing of payments and the need
for immediate funds to support its operations.
A letter of credit addresses this challenge by providing a form of payment
guarantee to the seller. When the buyer's bank issues an LC in favor of the
seller, it essentially assures the seller that they will receive payment once
certain conditions are met, such as the shipment of goods. This assurance helps
the seller manage their working capital needs more effectively, as they can
confidently engage in transactions knowing that they will receive payment
upon fulfilling their obligations.
From the buyer's perspective, an LC can also impact their working capital
management. Instead of making an immediate upfront payment, the buyer can
arrange for a letter of credit to be opened in favor of the seller. This allows the
buyer to preserve their working capital by delaying the actual payment until
the agreed-upon conditions are satisfied. In the meantime, the buyer can use
these funds for other operational needs. In essence, a letter of credit acts as a
financial instrument that not only secures the payment process in international
trade but also influences how working capital is utilized by both the buyer and
the seller. It provides a balance between ensuring timely payments for sellers
and optimizing the use of funds for buyers, contributing to the overall
efficiency and reliability of cross-border transactions.

Commercial paper represents a financing method comprising short-term,

unsecured promissory notes issued by a well-credited company. Investors can
opt for maturity periods that closely match their investment preferences and
directly obtain the commercial paper from the issuing company. When
securities dealers issue these notes on behalf of corporate clients, they are
known as dealer papers. These papers are acquired at a price below their
nominal value and sold at a premium. They often benefit from ongoing support
through a revolving underwriting arrangement with banks, ensuring a
continuous stream of funds during each renewal. Unlike commercial bills,
commercial papers offer adaptable maturity choices that can be personalized
to meet specific requirements. Commercial papers offer numerous benefits to
both issuers and investors. They serve as straightforward instruments that
involve minimal documentation between parties. Their flexibility regarding
maturity periods allows issuers to synchronize with their cash flow needs.
Additionally, commercial papers generally yield higher returns for investors in
comparison to the banking system. Companies capable of raising funds through
commercial papers enhance their visibility within the financial landscape and
are better positioned to secure long-term capital. These papers lack collateral
and provide significant liquidity, with no restrictions on how raised funds can
be employed. Companies looking to release commercial paper must secure
credit ratings from accredited agencies like CRISIL Care and Fitch. Corporate
primary dealers and recognized Indian financial institutions authorized to
acquire short-term resources under RBI guidelines can issue commercial
papers. Maturity periods for these papers span from a minimum of seven days
to a maximum of one year, with denominations of at least 5,00,000 or
multiples thereof. Investors are required to remit the discounted value of the
commercial paper through a crossed account check to the issuer's account via
the Issuing and Paying Agent (IPA) upon maturity. In cases where the paper is in
physical form, holders present the instrument to the issuer through IPA for
payment. For papers held in dematerialized form, holders redeem them
through the depository and receive payment from IPA.

A certificate of deposit (CD) serves as a testament to a time deposit, distinct

from a conventional time deposit due to its inherent negotiability and
consequent marketability. In simpler terms, a certificate of deposit is a tradable
confirmation of funds deposited in a bank for a fixed period at a specified
interest rate. These documents are highly negotiable and readily tradable. A
certificate of deposit functions as a negotiable money market instrument
issued in dematerialized (DMAT) form or as an unscheduled promissory note
representing funds deposited in a bank or other eligible financial institutions
for a specified purpose. Banks are authorized to issue certificates of deposit
based on demand, and financial institutions can do so within the overall
umbrella limit stipulated by the RBI, which includes other instruments like term
money, term deposits, certificates of commercial papers, and inter-corporate
deposits. The combined issuance of these instruments should not exceed 100
percent of the institution's net owned funds. The minimum amount for a
certificate of deposit stands at 1,00,000, and subscriptions should not be less
than 1,00,000, divisible in multiples of the same. Certificates of deposit are
open for subscription by individuals, corporations, companies, trusts, funds,
associations, and similar entities.
The maturity period for a certificate of deposit issued by a bank fall between a
minimum of 15 days and a maximum of one year. Physically held certificates of
deposit are transferable through endorsement and delivery. For holders of
dematerialized certificates of deposit, the process involves engaging their
respective depository participants to arrange for the transfer of the demand
security to a certificate deposit redemption account designated by the issuer.
Holders are also required to notify the issuer, providing a copy of the delivery
instruction furnished to the depository participants and specifying the desired
payment location to facilitate prompt settlement.

Factoring is the process of selling receivables to a factor at a reduced price in

order to secure funds.. These invoices represent the monetary obligations from
customers to the business for the goods or services that the business has
provided. factoring is a financial tool that allows businesses to improve their
cash flow by selling their outstanding invoices to a factor at a discounted rate.
This practice can help businesses manage their working capital, meet financial
obligations, and avoid the waiting period associated with customer payments.
The factor buys the invoices at a discounted rate. This discount is the factor's
fee for providing immediate funds to the business. The discount amount
fluctuates based on variables like the creditworthiness of the customers, the
terms of payment on the invoices, and the overall level of risk involved. When
the invoices are sold to the factor, the ownership of the receivables transfers to
the factor. This means that the factor now has the right to collect payments
directly from the customer. he factor takes on the responsibility of collecting
payments from the customers mentioned in the invoices. This can help the
business focus on its operations rather than chasing down payments
During this process, when a sales transaction takes place, the factor handles
the management of the client's sales ledger. The client sends an invoice to the
customer, and simultaneously, a duplicate copy of the transaction is forwarded
to the factor. Furthermore, the factor ensures that the client is regularly
updated about the status of their receivables, incoming customer payments,
and any pertinent details. Taking on the role of collecting receivables on the
client's behalf, the factor enables the client to concentrate on other critical
facets of their business operations.
Utilizing skilled staff and advanced resources, the factor systematically
monitors debtors to ensure prompt payment requests By capitalizing on their
knowledge and access to credit-related data, they can execute the tasks with a
higher degree of precision. Hence factors are well-equipped to offer clients a
variety of advisory services for an agreed-upon fee. Additionally, in
collaboration with the client, the factor establishes credit limits for approved
customers. Within these predefined limits, the factor acquires the customer's
trade credits. Factors implement commissions based on a percentage of the
purchased debt for tasks such as managing collections and overseeing the sales
ledger. Furthermore, they introduce discounts, which essentially serve as
interest charges for short-term financing that bridges the gap between the
advance payment and the confirmed payment collection.
There are two types of factoring: recourse factoring and non-recourse factoring
Recourse factoring is a type of factoring where the factor (the financing entity)
has the right to seek repayment from the client (the business selling the
invoices) if the customer (the debtor) fails to pay the invoice. In other words, if
the customer doesn't pay the invoice, the responsibility and financial risk
ultimately fall back on the client. On the other hand, in non-recourse factoring,
the factor assumes the credit risk for the invoices it purchases from the client.
If the customer fails to pay the invoice, the factor absorbs the loss, and the
client is not responsible for repaying the factor. This type of factoring provides
greater protection to the client against the risk of non-payment by customers
non-recourse factoring typically comes at a higher cost to the client due to the
increased risk taken on by the factor.
The financing provided by the factor remains off the balance sheet as a
contingent liability in case of recourse factoring. In non-recourse factoring, it
doesn't appear in the borrower's financial statements. Factoring proceeds can
be used to settle bank borrowings, reducing current liabilities including trade
creditors. This positively impacts the company's current ratio and enhances the
client's credit standing. on the other hand, in Non-recourse factoring, e the
factor assumes the credit risk for the invoices it purchases from the client. If
the customer fails to pay the invoice, the factor absorbs the loss, and the client
is not responsible for repaying the factor. This type of factoring provides
greater protection to the client against the risk of non-payment by customers.

The capital market provides a platform for businesses and governments to

secure the necessary funds for growth and development over the long term
A company needs to explore avenues to fund its investments, which primarily
come from equity and debt. Equity and debt are the two main sources of
finance for businesses. In the case of business firms, equity is often referred to
as shareholders' funds comprising equity capital and retained earnings. Debt,
on the other hand, includes term loans, debentures. The sources of funds
exhibit distinct features and characteristics. The primary difference between
these two sources lies in the obligation created by borrowed funds to repay
both interest and the principal amount. Borrowed funds always come with
repayment requirements and entail committed costs in the form of interest
payments. Although borrowed funds are relatively cost-effective as the interest
amount is tax deductible, they also carry inherent risks, known as financial risk,
which may potentially result in the company facing insolvency if there are
failures to make interest or principal payments. Equity investors, being the true
owners of the company, bear the highest level of risk. Their entitlement to
residual income comes after all obligations to creditors have been fulfilled. Due
to this higher risk, they anticipate a correspondingly higher rate of return,
making equity a relatively expensive source of finance. Debt comes with a
specific maturity date, while equity typically has no set end date. Equity
investors have the advantage of controlling the company's affairs, whereas
debt investors generally adopt a more passive role. Let us understand each
source of finance in details lets first discuss about DEBENTURES: A debenture is
a form of creditorship security, serving as a document that acknowledges or
creates a debt. Essentially, the company borrows money from the investors by
issuing debentures. Debenture holders act as creditors to the corporation The
holder of a debenture is entitled to receive a fixed rate of interest. While they
earn this fixed interest rate, they do not share in the company's profits.
Debenture holders do not possess voting rights in the company's general
meetings. They are not involved in electing directors or making decisions in the
company. However, in the event of the company's liquidation, debenture
holders have priority over shareholders, and if their debts remain unpaid, they
may gain some level of control over the company. There are many types of
debentures like SECURED DEBENTURES and UNSECURED DEBENTURES::
Debentures secured against specific assets are referred to as secured
debentures or mortgage debentures. While Debentures without any asset-
based security, relying solely on the general solvency of the company, are
known as unsecured debentures
REDEEMABLE DEBENTURES and IRREDEEMABLE DEBENTURES Debentures that
can be repaid after a specific period are known as redeemable debentures.
Companies commonly issue this type of debenture. Debentures that are not
repayable during the company's lifetime are referred to as irredeemable
debentures. The company may repay the money upon liquidation, or the
occurrence of a specific event . CONVERTIBLE DEBENTURES and NON-
CONVERTIBLE DEBENTURE: Convertible debentures are those debentures that
can be converted into shares or securities at the discretion of the holders after
a specified period. There are two types of convertible debentures: fully
convertible debentures and partly convertible debentures. Non-convertible
debentures are debentures that cannot be converted into shares or other
securities of the company. Debentures are usually issued with a specified rate
of interest .This specified rate is called Coupon rate On the basis of coupon rate
we may have Coupon rate bond or zero bond. Coupon rate bond may be either
fixed or floating. The floating interest is usually linked with the bank rate and
yields on treasury bond plus a reward for risk while ZERO COUPON is one
which does not carry a specified rate of interest. In order to compensate the
investors such bonds are issued at a substantial discount and repaid at par.
Next very important source of finance is equity share. A share represents a unit
of ownership in a corporation. Unlike debt, there is no fixed commitment for
equity shareholders in terms of returns or capital repayment. Equity
shareholders have a residual claim on the company's income, meaning they are
entitled to the remaining profits after all external claims have been satisfied.
The payment of dividends is at the discretion of the management, and
shareholders have no legal right to demand dividends. Shareholders exercise
control through voting, following the majority rule voting system in India,
where each share carries one vote. They have indirect control over the
company's operations through the election of the board of directors and voting
in various company meetings. They enjoy pre-emptive rights, allowing them
the first opportunity to purchase additional shares in proportion to their
existing ownership. Equity capital has no maturity date, freeing companies
from any obligation to redeem it. This enhances the company's
creditworthiness. The cost of equity is relatively higher than any other source
of finance because shareholders demand higher returns in response to the
increased risk they bear. Furthermore, equity dividends are paid out of post-tax
profits, while interest payments are tax-deductible for the company In general,
equity shares offer companies a reliable and adaptable source of finance.
However, this comes with a trade-off as it involves relinquishing some control
for existing equity shareholders and incurring higher costs compared to debt
financing. Another important source of finance is
Preference Shares they are hybrid form of financing, having combine features
of both equity and debenture. Preference shares are entitled to a fixed
dividend and have their capital returned upon redemption. Having a priority
status over equity capital, preference shares receive income and assets before
equity shareholders, and preference dividends are paid before any equity
dividends. Equity shares do not have a claim to the company's assets upon
winding up until the preference shareholders are paid. Preference shares
generally do not carry voting rights, except in specific circumstances like non-
payment of cumulative preference dividends. While the company is not legally
obligated to pay preference dividends, skipping them can negatively impact the
firm's image in the capital market. Preferred shares have a specific maturity,
but the breach of redemption stipulations does not typically incur severe
penalties like bankruptcy. Just like debentures Preference share are also of
various types. Lets discuss them one by one Participating Preference Shares
and Non-Participating Preference Shares: Participating Preference shares
guarantee a fixed rate of dividend and also entitle shareholders to share in the
surplus profits of the company. While in non-participating preference shares,
shareholders do not have a share in the surplus profits. Redeemable and
Irredeemable Preference Shares : These shares can be repaid by the company
after a specific period or earlier, as stated in the terms of issuance. while
Irredeemable Preference Shares do not have a provision for redemption. They
are only repayable during winding up of the company. Next comes Cumulative
Preference Shares and Non Cumulative Preference shares: These shares assure
a predetermined dividend rate and provide shareholders with the ability to
accumulate unpaid dividends during years of insufficient profits. The
accumulated arrears will be paid in the following profitable year while Non-
Cumulative Preference shareholders do not receive any arrears in years of
inadequate profits. Convertible Preference Shares and Non-convertible
Preference Shares. Convertible preference shares can be converted into equity
shares within a designated timeframe. On the other hand, non-convertible
preference shares cannot be transformed into equity shares and retain their
preference status throughout their existence. Another very important source of
finance is retained earnings. Retained earnings refer to the accumulated profits
held back by a company instead of being distributed as dividends to
shareholders. These earnings are kept for future growth or unforeseen
contingencies. Utilizing retained earnings internally, as opposed to raising
external equity, eliminates floatation costs related to issuing new shares.
Additionally, there is no dilution of control when a firm relies on retained
earnings for financing. However, the amount that can be raised through
retained earnings might be limited, and the opportunity cost is relatively high
as it essentially represents dividends foregone by equity shareholders.