Price Discovery  

Liquidity 

Lower Transaction Costs 

Financial markets save a market player the cost of locating counterparty to his transactions. The counterparty can be readily found by going to the appropriate market.  We discuss one major way in which financial markets are classified.Primary  Market and Secondary Market

Primary Market: In the primary market, new financial securities are sold to the financial players.  This is also called the new issue market.  The Initial Public Offering (IPO) of equity shares of a company, and issue of new debentures are some examples of transactions that take place in the primary market. 

There are two major types of players who sell securities in the primary markets – the government and the corporate sector. These transactions mobilize savings and supply fresh capital to corporates and other entities. In India, central, state and local governments raise finance by selling debt paper in the primary market. Typically, the Reserve Bank of India manages these debt issues.

The corporate houses raise finance through issue of equity as well as debt. There are many ways in which funds can be raised from the primary markets.  In an Initial Public Offering (IPO), a company sells its securities to the public for the first time. This again may involve issue of fresh capital or public offering of existing capital.  If the same company again goes to the market to raise more funds, it is a further public offering. 

Sometimes companies directly place securities with the institutional investors such as insurance companies, pension funds, and venture capital funds on mutually acceptable terms and conditions. This is called Private Placement of securities. In a preferential issue, securities are sold to a select group of investors such as the promoters. This is a faster way to raise capital. SEBI has framed regulations to regulate such issues to ensure that just interests of the other investors are not sacrificed. A Rights Issue means selling securities to the existing investors in proportion to their existing holdings. This is particularly used for issue of equity shares. This method is meant to ensure that after a fresh issue of capital, the stake of the existing equity holders is not diluted. In case of a Bonus Issue, fresh shares are offered to the existing shareholders free of cost. This may be done when the company has a large amount of accumulated profits, which are utilized for the issue of bonus shares. In theory, the share price should adjust for the increase in the number of outstanding shares. 

Pricing of Capital Issues In a Fixed Price Issue, the issuer decides the price at which the securities will be sold, and the issue is open for a pre specified time period. During this time, prospective investors apply for purchase of securities, if they find the price acceptable. This may result in either under pricing (the issuer loses the benefit of a high price that the market would have been willing to pay), or overpricing (response to the issue is less than adequate). To overcome this difficulty, the concept of Book Building was introduced. In case of Book Building, the issue is again open for a specific period. During this time, the prospective investors submit their bids. Based on the bids received, the cut off price is determined, subject to the floor and cap price decided by the issuer in advance. The Bombay Stock Exchange as well as the National Stock Exchange conduct online public offerings through the Book Building process. This method facilitates price discovery through the mechanism of bidding. 

Financial Market Segments Primary Market : 

New Issue, Initial Public Offering (IPO):Companies, Public, Institutional Investors                   

Institutional InvestorsPreferential issue    :         Promoters, Existing Shareholders

Rights Issue                  :                                               Existing Shareholders       

Bonus Issue                         :                                          Existing Shareholders 

Secondary Market : 

Trading of Existing Securities :                       Companies, Public, Institutional Investors, Brokers 

 Secondary Market The secondary market is where existing financial securities are traded.  Trading of shares or debt instruments on the national stock exchange is one example.  An active secondary market imparts liquidity to the financial securities. An investor need not hold on the securities to maturity.  This also provides depth to the financial markets. People will be willing to buy financial securities if they are confident of being able to sell them in the secondary market.  

Stock Exchanges (SE)

 The stock exchanges provide a platform for the transaction of securities in the secondary markets. Trading on the SE helps investors get the best price for the deals. There is no counterparty risk as the clearing corporation assumes the role of the counterparty to both the buyer as well as the seller.  The Bombay Stock Exchange (BSE) is the oldest SE in India. The National Stock Exchange (NSE) was set up in 1992. Both SE have now migrated to online, screen based trading systems. Equities, corporate debt paper, and government securities are all traded through these systems. There are separate segments for trading in wholesale and retail debt. Brokers access these systems through computer terminals. Orders are directly entered through these systems. Once the broker specifies the quantity and price, the system automatically finds a matching buy / sell order.  E trading permits the investors web based access to trade directly on the exchange. Client orders are routed to the computers of designated brokers from where they enter the trading systems of the SE. Screen based trading offers the flexibility of trading from any place. This has created a sort of role crisis for the local stock exchanges, as the SE trading has now become truly national in character. The emergence of Depositories has obviated the need to keep the share certificates in paper form. Shares (and other securities) can now be held and transferred in electronic form. Two depositories – National Securities Depository Ltd (NSDL), and Central Securities Depository Ltd (CSDL) have been set up for electronic holding and transfer of securities. Investors can access their services through the Depository Participants. 

Settlement on the SE is now on a rolling (T+) basis. This means that the trades done on a particular day are settled after a given number of business days. (As of now, it is T+2 in India).