Financial Markets and Stock Exchange
The exam tests the money market and capital market split, the functions of a stock exchange, and the language of settlement and speculation.
Structure
- Money market: instruments of one year or less - call money, treasury bills, commercial paper, certificates of deposit; regulated by the RBI.
- Capital market: long-term funds, split into the primary market (new issues) and the secondary market (stock exchanges); regulated by SEBI under the SEBI Act 1992.
- Stock exchanges are recognised under the Securities Contracts (Regulation) Act 1956. Their functions are liquidity, price discovery, safety of transactions and mobilisation of savings.
Trading and settlement
- BSE's Sensex tracks 30 scrips (base 1978-79 = 100); NSE's Nifty 50 has base 1995 = 1000.
- India moved to T+1 settlement in January 2023: trades settle on the next working day.
- Speculators: bull expects a rise and buys; bear expects a fall and sells; stag applies for new issues hoping for a listing premium; lame duck fails to meet obligations.
Worked example
A bull buys 1,000 shares at ₹100 with a 50% margin, so own funds are ₹50,000. If the price rises to ₹120, profit is ₹20,000, a 40% return on own funds. If it falls to ₹90, the loss is ₹10,000, a 20% loss. Margin trading magnifies return and risk equally, which is why exchanges impose margins.
Traps
- Saying SEBI regulates the money market; the RBI does.
- Mixing up the Sensex and Nifty constituents.
- Treating the primary market as a place where investors trade with each other.