Indian Economy · Topic 9 of 20
Money and capital markets, stock exchanges, insurance, pensions and their regulators
The Basics
A financial system is a network that takes savings and gives them to borrowers. It has three parts: markets, institutions, and instruments. Markets are places where funds are bought and sold. Institutions mobilise savings and lend or invest them. Instruments are the financial products traded, such as shares, bonds, or derivatives.
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The money market is where people borrow money for a short time. Cash-rich groups, like banks or government, lend to cash-poor groups. Loans here last up to 364 days. Trading uses a 'discount rate'. This rate moves with the Reserve Bank of India's repo rate. The repo rate is the rate at which the Reserve Bank of India lends short-term money to banks. Banks give government securities as a guarantee for this loan.
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The capital market is the market for long-term funds. It deals in money raised for a period of more than 364 days, often for many years. A company or government may need funds to build a factory, a road, or a power plant. Such projects cannot be repaid quickly. So a market is needed where lenders are willing to commit funds for the long run. The capital market provides this platform.
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The primary market sells new shares or bonds for the first time. A company sells them directly to investors. The company gets this money as fresh capital. This differs from the secondary market. There, investors only trade shares among themselves. The company gets no new money there.
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A security market has two linked parts. The primary market is where a company sells new shares for the first time. The secondary market is where these shares are later bought and sold between investors. One investor buys from another, at the market price. This trading happens on stock exchanges.
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The Securities and Exchange Board of India (SEBI) regulates India's securities market.
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Market capitalisation means share price multiplied by total shares.
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A mutual fund pools money from many small investors. A professional manager invests this money for them. Managers buy shares, bonds, gold, or other assets. This spreading out is called diversification. Diversification lowers risk, but never removes it fully. Small savers often cannot study many companies by themselves. Buying many different shares alone also costs a lot in fees. Mutual funds solve this problem by pooling money and buying many shares together.
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An Alternative Investment Fund is a privately pooled investment fund. It collects money from Indian and foreign investors. It invests this money as per a set plan. It is not a mutual fund. Rules for mutual funds, banks, and insurers do not apply to it. Stocks and bonds are securities traded in the market. Alternative Investment Funds are not securities. They are funds that buy stakes in companies, projects, or other assets. These are often assets normal savers cannot easily buy.
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A derivative is a contract. Its value comes from another thing, called the underlying asset. The underlying can be a share, bond, currency, interest rate, or commodity like wheat or gold. In India, the Securities Contracts (Regulation) Act, 1956, treats derivatives as securities. So derivatives are regulated like shares. They can only trade on recognised stock exchanges.
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A depository holds securities in electronic form. For example, it holds shares and bonds, not paper certificates.
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Foreign Portfolio Investment (FPI) means foreign investors buy shares and bonds in India. They buy securities already listed on Indian stock exchanges. They do not take control of the company. For example, a foreign investor buys shares of an Indian company through the stock exchange. This differs from Foreign Direct Investment (FDI). In FDI, a foreign company builds a factory or buys a controlling stake. FPI investors can enter and exit quickly. So FPI money moves in and out of India faster than FDI money.
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A corporate bond is a debt instrument. A company borrows money from investors and promises to pay a fixed rate of interest, called the coupon. It also promises to repay the original amount, called the principal, on a fixed maturity date. Buying a bond makes you a lender, not an owner.
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A Real Estate Investment Trust (REIT) pools money from many investors. It invests this money in income-earning real estate, like a mutual fund invests in shares.
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An Inflation-Indexed Bond is a government bond. Its principal and interest change with an inflation index. This protects investors from inflation risk. Inflation risk means rising prices can reduce the real value of your money.
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Insurance is a way of sharing risk. Many people pay small amounts, called premiums, into a common pool. Whoever suffers a loss gets paid from this pool. Life insurance pays on death or on maturity of the policy. General insurance covers property, health, motor vehicles, crops, exports and other risks.
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A pension is money paid regularly to a person after retirement. It replaces income earned while working. In India, pensions were long seen as part of a government job. The government paid pensions out of its own funds every year.
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India does not have one super regulator for finance. Different regulators watch different products.
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Credit rating checks if a borrower can repay debt on time. A credit rating agency studies a borrower's past record and ability to pay. It gives a simple grade, like a report card for repayment. This grade is used for individuals, companies, and even countries. When a country is rated, this is called sovereign rating. For example, India's sovereign rating shows how safely it can repay foreign loans.
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