There are mainly two ways through which funds are allocated
(b) Financial Market
Financial market is a market for the creation and exchange of financial assets.
Functions of financial market
1. Mobilization of saving and channellising them into most productive use: Financial market transfers saving of saver to most appropriate investment opportunities.
2. Facilitate price discovery: Price of anything depends upon the demand and supply factors. Demand and supply of financial assets and securities in financial market help in deciding the price of various financial securities.
3. Provide liquidity to financial assets: In financial markets financial securities can be bought and sold easily so financial market provide a platform to convert securities in cash.
4. Reduce the cost of transaction: Financial market provide complete information regarding price, availability and cost of various financial securities.
There are two types of financial markets:
(a) Capital market
(b) Money market
Money market is a short term funds meant for use for a period of upto one year. Generally money market is a source of finance for working capital. Transaction of money market include lending and borrowing of cash for a short period of time and also sale and purchase of securities having one year term.
Instruments of money market:
1. Call money: The money borrowed or lenmt on demand for a short period which is generally one day. Sundays and other holidays are excluded for this purpose. Mostly banks use call money. When one bank faces temporary shortage of cash then bank with surplus cash lends to bank in shortage for one or two days. Call money is called interbank call money market.
Most of the time banks require call money to meet the minimum requirement of Cash Reserve Ratio(CRR).
2. Treasury bills: They are issued by reserve bank of India on behalf of the government of India. These bills unable government to get short term borrowing. These bills are negotiable instrument and are freely transferable. these are issued at discount. The maturity period of these bills varies from 14 to 365 days.
These are also called Zero Coupon Bond. they are issued at lower price than their face value.
3. Commercial bills: Trade bills or accommodation bills are bills drawn by one business firm on another. These have short term maturity period generally 90 days and can be discounted with bank even before the maturity period. These are negotiable instruments and can easily be transferred.
4. Commercial paper: It is an unsecured promissory note issued by public or private sector companies with a fixed maturity period which varies from 3 to 12 months. Since commercial papers are unsecured so these can be issued by companies having good reputation and creditworthiness.
Funds raised through commercial paper are used to meet the the floatation cost. This is known as bridge financing.
5. Certificate of deposits(CD): It is time of deposit which can be sold in the secondary market. Only a bank can issue a C.D. It is a bearer certificate or document of title. It is also negotiable instrument and can be transferred easily. The time period of C.D. ranges from 91 days to 1 year. These are not allowed to discount these documents.
Capital market is a market for medium and long term funds. It includes all the organizations institutions and instruments that provide long term and medium term funds. It does not include the instruments or institutions which provide finance for short period. The common instruments used in capital market are shares, debentures, bonds, mutual funds, public deposits etc.
Features of capital market
1. Link between savers and investment opportunities: Capital market is a crucial link between saving and investment process. The capital market transfers money from savers to entrepreneurial borrower.
2. Deals in long term investment: Capital market provide funds for long term and medium term. It does not deal with channellising saving for less than one year.
3. Utilities intermediaries: Capital market makes use of different intermediaries such as brokers, underwriters, depositors etc. These intermediaries act as working organs of capital market and are very important elements of capital market.
4. Determinants of capital formation: The activities of capital market determine the rate of capital formation in an economy. capital market offers attractive opportunities to those who have surplus funds so that they invest more and more in capital market.
5. Government rules and regulations: The capital market operates freely but under the guidance of government policies. These market functions within the framework of government rules and regulations.
Types of capital market
The main components of capital market are:
(i) Primary market
(ii) Secondary market
Primary market is also known as new issue market. As in the market securities are sold for the first time i.e new securities are issued from the company. Primary market directly contributes in capital formation because in primary market company goes directly to investors and utilizes these funds for investment in building, plants, machinery etc.
Methods of Floatation
1. Public issue through prospectus: Under this method company issues a prospectus to inform and attract general public. In prospectus company provides detail about the purpose for which funds are being raised, past financial, performance of the company, background and future of company.
The information in the prospectus helps the public to know about the risk and earning potential of the company and accordingly they decide whether to invest or not in that company.
2. Offer for sale: Under this method new securities are offered to general public but not directly by the company but by an intermediary who buys whole lot of securities from the company. So sale of securities takes place in two steps: first when the company issues securities to the intermediary at face value and second when intermediaries issues securities to general public at higher price to earn profit.
3. Private placement: Under this method the securities are sold by the company to an intermediaries at a fixed price and in second step intermediaries sell these securities not to general public but to selected clients at higher price. The private placement method is a cost saving method as company is saved from the expenses of underwriters fees, manager fees, agents commission, listing of company's name in stock exchange etc.
4. Right issue: This is the issue of new shares to existing shareholders. It is called right issue because it is the pre-emptive right of shareholders that company must offer them the new issue before subscribing to outsiders. Each shareholder has he right to subscribe to the new shares in the proportion of shares he already holds.
5. E-IPO's: It is the new method of issuing securities through on line system of stock exchange. In this company has to appoint SEBI registered brokers for the purpose of accepting applications and placing orders. The manager coordinate the activities through various intermediaries connected with the issue.
The secondary market is the market for the sale and purchase of previously issued or second hand securities.
In secondary market securities are not directly issued by the company to investors. The securities are sold by existing investors to other investors. Sometimes the investors is in need of cash and another investors wants to buy the shares of the company as he could not get directly from company. Then both the investors can meet in secondary market and exchange securities for cash through intermediary called broker. In secondary market companies get no additional capital as securities are bought and sold between investors only so directly there is no capital formation but secondary market indirectly contributes in capital formation by providing liquidity to securities of the company.
The securities contract and regulation act defines a stock exchange as "An organization or body of individual, whether incorporated or not established for the purpose of assisting, regulating and controlling of business in buying, selling and dealing in securities.
Functions of stock exchange:
1. Economic barometer: A stock exchange is a reliable barometer to measure the economic condition of a country. Every major change in country and economy is reflected in the prices of shares.the rise in the share price indicates the boom or recession cycle of the economy. Stock exchange is also known as a pulse of economy.
2. Pricing of securities: The stock market helps to value the securities on the basis of demand and supply factor. The securities of profitable and growth oriented companies are valued higher as there is more demand for such securities. The valuation of securities is useful for investors, government and creditors.
3. Safety of transaction: In stock exchange only the listed securities are traded and stock exchange authorities include the companies names in the trade list only after verifying the soundness of company. The companies which are listed they also have to operate within the strict rules and regulations.
4. Contributes to economic growth: In stock exchange securities of various companies are bought and sold. This process of disinvestment and reinvestment helps to invest in most productive investment proposal and this leads to capital formation and economic growth.
5. Spreading of equity cult: Stock exchange encourages people to invest to ownership securities by regulating new issues, better trading practices and by educating public about investment.
6. Providing scope for speculation: To ensure liquidity and demand of supply of securities the stock exchange permits healthy speculation of securities.
Trading procedure on a stock exchange
1. Selection of broker: Investors intended to buy or sell securities start by selecting a broker to buy or sell securities for them through computer.
2. Placing order: After selecting the broker the investors specify the type and number of securities they want to buy or sell.
3. Execution of order: In online trading the trading takes place on the screen only. The broker buy or sell according to instructions of client. Client can see the rate at which buying or selling is taking place.
4. Settlement: Most of the time the settlement takes place in on line for cash and on the spot but forward settlement is also permitted. This carry over of settlement is called Badla in Indian stock exchange. The stock exchange year is divided into period called account.
There are mainly two ways through which funds are allocated