Savings mobilization and promotion of investment are functions of the stock and capital markets. These all are part of the organized Indian financial system. The objective of all economic activity is to promote the well being and standard of living of the people. This depends on the income and distribution of income in terms of real goods and services in the economy.
The production of output is vital to the growth process in the economy. It is a function of the many inputs which are necessary for productive process. These inputs are material inputs, human inputs and financial inputs. The easy availability of financial inputs promotes the growth process through proper coordination between human and material inputs.
The financial inputs emanate from the financial system, while real goods and services are part of the real system. The interaction between the real system and the financial system is necessary for production. Trading in money and monetary assets constitute the activity in the financial markets. This is known as Financial system.
Indian Financial System
The term “liquidity” refer to cash, money and nearness to cash. A financial system deals with trading of money and monetary assets. Thus, provision of liquidity and trading in liquidity are these major functions of the financial system. Cash creation is the function of the RBI. Banks do credit creation and financial institutions including RBI, banks and term-leading institutions deals in claims on money or monetary assets.
These institutions are all part of Indian financial system. Government and business sectors are the major borrowers whose investment is always greater than savings. On the other hand, in India household and foreign sectors are the net savers, with savings exceeding investment. The financial system acts as intermediary between investors and helps the process of specialization in the financial infrastructure. This leads to greater financial development that is prerequisite for faster economic development.
Functions of Financial Markets
The primary function of the financial markets is to facilitate the transfer of funds from surplus sectors to deficit sectors. In simple words from lenders to borrowers. Normally, households have excess of funds or savings, which they lend to borrowers in the corporate sectors. A financial market consists of buyers, ‘sellers, dealers and brokers. The most important thing to note is that it does not refer to a physical location.
Secondary market or stock exchange is a place where existing securities are traded is an auction market. It has a physical location such as Bombay Stock Exchange or the National Stock Exchange.
The Bombay Stock Exchange now introduces on-line trading. Other exchanges are in the process of introducing the same that is screen-based. Financial markets trade in money. Their price is the rate of return the buyer expects the financial asset to yield. The value of financial assets changes with the investors’ expectations on earning or interest rates.
The three important functions of financial markets are:
Financial Markets Facilitate Price Discovery
Financial markets help in establishing the prices of financial assets. Well organized financial markets seem to be remarkably in the rate of return and other incentives, funds flow from less efficient in price discovery. That is why financial economists productive to more productive activities. The efficient functioning say: “If you want to know what is the value of a financial asset simply look at its price in the financial market”
Financial Markets Provide Liquidity to Financial Assets
Investors can readily sell their financial assets through the mechanism of financial markets. In the absence of financial markets the motivation of investors to hold financial assets will diminish. Thanks to negotiability and transferability of securities through the financial markets, it is possible for companies (and other entities) to raise long-term funds from investors with short-term and medium term horizons.
Financial Markets Considerably Reduce the Cost of Transacting
The two major costs associated with transacting are search costs and information costs. Search costs comprise explicit costs such as the expenses incurred on advertising when one wants to buy or sell an asset and implicit costs such as the effort and time one has to put in to locate a customer. Information costs refer to costs incurred in evaluating the investment merits of financial assets.
Classification of Financial Markets
Financial markets can be classified in various types based on the different characteristics.
- One way is to classify financial markets by the type of financial claim. The debt market is the financial market for fixed claims. The equity market is the financial market for residual claims.
- A second way is to classify financial markets by the maturity of claims. The market for short-term financial claims is known as the money market. On the other hand, long term financial claim is known as capital market. Since short-term financial claims are almost invariably debt claims, the money market is the market for short-term debt instruments. The capital market is the market for long-term debt instruments and equity instruments.
- A third way to classify financial markets is whether the claims represent new issues or outstanding issues.
- A fourth way to classify financial markets is through the timing of delivery. A cash or spot market is one where the delivery occurs immediately. On contrary a forward or futures market is one where the delivery occurs at a pre-determined time in future.
- A fifth way to classify financial markets is by the nature of its organisational structure. An exchange-traded market is characterized by a centralized organisation with standardized procedures.
Efficiency of Indian Financial System
The real test of development of financial system is its efficiency in operations and functional roles. The operational efficiency reflects through costs of intermediation, quality of service and its width. Improvement in operational efficiency results through reforms in structure and technology in capital market.
The strengthening of the institutions evidences the Width of Services Structure. The reforms in general and increasing role of technology and competitive forces in particular have improved the quality of service. Following criteria reflects the financial efficiency of a financial system.
- Quantity of funds raised through saving for investment and pattern of allocation from less to more productive purposes.
- Its contribution to economic growth and its impact on real economic variables, reflected in market capitalization as a proportion of GDP and the usual ratios, such as Finance ratio- ratio of total issues to national income; Financial interrelations ratio -ratio of total issues to net domestic capital, formation; and financial intermediation ratio -ratio of secondary issues raised by banks and financial institutions to primary issues in the market
- Scrip prices should reflect the market
- Scrip prices should also reflect company valuation.