A financial market is not a single, uniform market. It is divided into different segments based on the nature of financial instruments, maturity period, type of transaction, and purpose for which funds are raised or invested. Each segment performs a specific role in the financial system and together they ensure smooth flow of funds from savers to users of funds.
Broadly, financial markets are segmented into Money Market, Capital Market, Foreign Exchange Market, Derivatives Market, and Commodity Market.
1. Money Market
The money market is the segment of the financial market that deals with short-term funds and highly liquid instruments. The maturity period of instruments traded in the money market is up to one year. The main purpose of the money market is to meet the short-term funding requirements of banks, financial institutions, corporates, and the government.
The money market plays a crucial role in maintaining liquidity in the banking system. It also helps the Reserve Bank of India (RBI) in implementing monetary policy, as RBI uses money market instruments to regulate money supply and interest rates.
Important Features of Money Market
- Deals in short-term funds (≤ 1 year)
- Instruments are highly liquid and low risk
- Returns are generally lower compared to capital market
- Major participants include RBI, banks, financial institutions, mutual funds, and corporates
Major Instruments of Money Market
- Call / Notice Money: Very short-term funds (overnight to 14 days) used mainly by banks
- Treasury Bills (T-Bills): Short-term government securities issued by RBI on behalf of Government of India
- Commercial Bills: Bills arising out of genuine trade transactions
- Commercial Paper (CP): Unsecured short-term instruments issued by corporates
- Certificates of Deposit (CD): Time deposits issued by banks and financial institutions
Remember that the money market focuses on liquidity and stability, not long-term growth.
2. Capital Market
The capital market is the segment of the financial market that deals with medium-term and long-term funds, generally with maturity exceeding one year. It helps businesses and governments raise funds for investment, expansion, and development projects.
Unlike the money market, the capital market involves higher risk and higher returns. It plays a vital role in economic growth by channelising savings into productive investments.
The capital market is further divided into Primary Market and Secondary Market.
(a) Primary Market
The primary market is the market where new securities are issued for the first time. Funds raised in the primary market go directly to the issuer, such as a company or the government.
Companies raise capital through:
- Initial Public Offer (IPO)
- Further Public Offer (FPO)
- Rights Issue
- Private Placement
The primary market helps in capital formation and provides investors an opportunity to invest in new enterprises.
(b) Secondary Market
The secondary market is the market where existing securities are bought and sold. It does not provide funds to the issuing company, but it ensures liquidity and marketability of securities.
In India, the major secondary market platforms are:
- BSE (Bombay Stock Exchange)
- NSE (National Stock Exchange)
The secondary market helps in:
- Price discovery
- Providing liquidity to investors
- Encouraging investment by reducing risk
It is important to clearly differentiate between primary and secondary markets.
3. Foreign Exchange Market (Forex Market)
The foreign exchange market is the segment where currencies of different countries are bought and sold. It facilitates international trade, foreign investment, and cross-border transactions.
In this market, one currency is exchanged for another at an agreed exchange rate. For example, conversion of Indian Rupees (INR) into US Dollars (USD).
Functions of Foreign Exchange Market
- Facilitates import and export of goods and services
- Enables foreign investments
- Helps in hedging foreign exchange risk
- Determines exchange rates
Participants in Forex Market
- Banks (Authorised Dealers)
- Corporates
- Central banks (RBI)
- Foreign institutional investors
The foreign exchange market is very important for a country like India which is actively involved in global trade.
4. Derivatives Market
The derivatives market deals with financial instruments whose value is derived from an underlying asset. The underlying asset may be shares, bonds, commodities, interest rates, currencies, or market indices.
The main purpose of the derivatives market is risk management (hedging), though it is also used for speculation and arbitrage.
Major Types of Derivative Instruments
- Forwards: Customised contracts traded over the counter
- Futures: Standardised contracts traded on exchanges
- Options: Contracts giving the right but not the obligation to buy or sell
- Swaps: Contracts for exchange of cash flows
Derivatives help in price discovery and reducing uncertainty in financial markets. However, they involve high risk if used for speculation.
5. Commodity Market
The commodity market is the segment where physical commodities such as agricultural products, metals, and energy products are traded. It provides a platform for price discovery and risk management for producers and consumers of commodities.
In India, commodity trading is conducted through organised exchanges like:
- MCX (Multi Commodity Exchange)
- NCDEX (National Commodity & Derivatives Exchange)
Types of Commodities Traded
- Agricultural commodities (wheat, rice, cotton)
- Metals (gold, silver, copper)
- Energy commodities (crude oil, natural gas)
The commodity market helps farmers, traders, and industries to hedge against price fluctuations.
Conclusion
Financial markets are divided into various segments to efficiently serve different funding needs of the economy. The money market handles short-term liquidity, the capital market supports long-term investment, the foreign exchange market facilitates international transactions, the derivatives market manages financial risk, and the commodity market ensures stable prices for physical goods. A sound and well-regulated financial market structure is essential for economic stability and growth.