Financial Markets and Instruments
What this domain tests
Financial Markets and Instruments tests money market versus capital market, primary versus secondary markets, debt pricing, equity, derivatives, foreign exchange and the roles of RBI and SEBI. Expect numerical bond questions and conceptual questions on risk and regulation.
Core rules
- The money market deals in short-term instruments such as treasury bills, commercial paper, certificates of deposit and call money. The capital market deals in long-term equity and debt.
- Primary markets raise new capital; secondary markets provide liquidity and price discovery.
- Bond prices move inversely to yields. Coupon rate determines cash interest; yield determines return; duration measures price sensitivity.
- Equity represents ownership and residual claim. Derivatives derive value from an underlying and carry leverage and counterparty risk.
- RBI regulates money market, forex and government securities; SEBI regulates securities markets. Credit risk, market risk, liquidity risk and operational risk must be distinguished.
Worked example
A bond has face value INR 1,000, 8% annual coupon and 2 years to maturity. At a 10% yield, price = 80/1.10 + 1,080/1.21 = 72.73 + 892.56 = INR 965.29. Because the yield exceeds the coupon, the bond trades at a discount. If the yield fell below 8%, the price would rise above face value.
Traps that cost marks
Do not confuse coupon with yield. Do not assume duration equals maturity; for a coupon bond, duration is shorter. Do not treat derivatives as low-risk because of low initial margin. Do not mix primary and secondary market functions. Bond price and yield move in opposite directions.