- Introduction to Financial Markets
- Objectives of Financial Markets
- Classification of Financial Markets
- Financial Instruments - Quick Reference
- Financial Market Regulators in India
- Role in Economic Development
- Financial Markets & Monetary Policy
- Financial Market Reforms in India
- Financial Market vs Financial System
- Key Facts for UPSC Prelims
- Mains Answer Framework
- Current Affairs Linkages
- Important Terms & Definitions
A financial market is a system or platform where financial assets (money, securities, derivatives) are created, bought, sold, and exchanged, enabling the flow of funds from surplus units (savers) to deficit units (borrowers).
Acts as a bridge between savings and investment, crucial for economic growth.
- Channelizes savings into productive investments
- Facilitates price discovery
- Provides liquidity to investors
- Enables risk transfer and management
-
Mobilization of Savings
- Converts idle savings into productive capital
- Provides investment avenues to savers
-
Efficient Allocation of Capital
- Directs funds to most productive uses
- Market-driven resource allocation
-
Price Discovery
- Determines fair value of financial assets
- Based on demand and supply
-
Providing Liquidity
- Easy conversion of assets to cash
- Secondary market trading
-
Risk Management
- Through derivatives and hedging instruments
- Portfolio diversification
-
Promoting Economic Growth & Financial Stability
- Capital formation for businesses
- Employment generation
- GDP growth
Definition: Deals in short-term funds and instruments for meeting immediate liquidity needs.
Key Instruments:
-
Treasury Bills (T-Bills)
- Maturity: 91, 182, 364 days
- Issued by: Government of India (GoI)
- Zero coupon securities (issued at discount)
- No default risk
- Prelims Fact: Auction conducted by RBI
-
Commercial Paper (CP)
- Maturity: 7 days to 1 year
- Issued by: Highly rated corporates
- Unsecured promissory note
- Minimum amount: ₹5 lakhs (multiples thereof)
- Prelims Fact: Introduced in India in 1990
-
Certificate of Deposit (CD)
- Issued by: Commercial banks and financial institutions
- Maturity: 7 days to 1 year (banks), 1-3 years (FIs)
- Negotiable instrument
- Cannot be withdrawn before maturity
-
Call Money / Notice Money
- Call Money: 1 day maturity
- Notice Money: 2-14 days
- Interbank lending
- Used for meeting CRR/SLR requirements
- Prelims Fact: Only banks can participate
-
Repo & Reverse Repo
- Repo (Repurchase Agreement): Borrowing by selling securities with agreement to repurchase
- Reverse Repo: Lending by buying securities
- Key monetary policy tools
- Current Repo Rate: (check latest RBI policy)
Participants in Money Market:
- Reserve Bank of India (RBI)
- Commercial Banks
- Non-Banking Financial Companies (NBFCs)
- Mutual Funds
- Primary Dealers (PDs)
- Insurance Companies
- Corporates
Importance:
- Liquidity management for banks
- Monetary policy transmission channel
- Short-term interest rate control
- Working capital financing
Definition: Market for long-term securities, facilitating capital formation and investment.
Components:
- Ownership securities
- Shares/stocks of companies
- High risk, high return
- Dividends not fixed
- Voting rights for shareholders
- Main exchanges: NSE, BSE
- Fixed income securities
- Bonds, Debentures, Government Securities
- Lower risk than equity
- Fixed interest payments
- No voting rights
- Includes Government Securities (G-Secs) market
Types of Bonds:
- Government Bonds (Sovereign guarantee)
- Corporate Bonds
- Municipal Bonds
- Infrastructure Bonds
- Tax-free Bonds
Definition: Market where new securities are issued for the first time.
Methods of Issue:
-
Initial Public Offering (IPO)
- First time public offering
- Company goes from private to public
- SEBI regulations apply
- Red Herring Prospectus mandatory
-
Follow-on Public Offer (FPO)
- Additional securities by listed company
- Already traded on stock exchange
-
Rights Issue
- Offered to existing shareholders
- Proportional to existing holdings
- Usually at discount to market price
-
Private Placement
- Direct sale to select investors
- No public offering
- Faster and cheaper
-
Bonus Issue
- Free shares to existing shareholders
- Capitalization of reserves
Role of Primary Market:
- Capital formation for companies
- Funds directly go to issuers
- Economic growth through investment
- Entrepreneurship promotion
Key Intermediaries:
- Merchant Bankers
- Underwriters
- Registrars
- Depositories (NSDL, CDSL)
Definition: Market where existing securities are bought and sold among investors.
Major Stock Exchanges in India:
-
National Stock Exchange (NSE)
- Established: 1992
- Largest stock exchange by volume
- Benchmark Index: NIFTY 50
- Screen-based electronic trading
-
Bombay Stock Exchange (BSE)
- Established: 1875 (oldest in Asia)
- Benchmark Index: SENSEX (30 stocks)
- Located at Dalal Street, Mumbai
Role of Secondary Market:
- Provides liquidity to investors
- Continuous price discovery
- Builds investor confidence
- No direct fund flow to companies
- Exit mechanism for investors
Trading Mechanism:
- T+1 Settlement Cycle (from 2023)
- Dematerialized (Demat) form
- Online trading platforms
- Circuit breakers for volatility control
- Claim Type: Ownership/Residual claim
- Risk: High
- Return: Variable (potentially high)
- Income: Dividends (not guaranteed)
- Maturity: Perpetual (no fixed maturity)
- Rights: Voting rights in company decisions
- Claim Type: Creditor claim (fixed)
- Risk: Lower than equity
- Return: Fixed interest
- Income: Coupon payments
- Maturity: Fixed tenure
- Rights: No voting rights, priority in liquidation
Definition: Market for financial instruments whose value is derived from underlying assets.
Types of Derivatives:
-
Futures
- Standardized contracts
- Traded on exchanges
- Daily settlement (mark-to-market)
- Obligation to buy/sell
-
Options
- Call Option: Right to buy
- Put Option: Right to sell
- Premium payment
- No obligation (only right)
-
Swaps
- Exchange of cash flows
- Interest rate swaps
- Currency swaps
- Over-the-counter (OTC)
-
Forwards
- Customized contracts
- OTC market
- Settlement at maturity
Purpose of Derivatives:
- Hedging: Risk protection
- Speculation: Profit from price movements
- Arbitrage: Exploiting price differences
- Price discovery
Underlying Assets:
- Stocks/Indices
- Commodities
- Currencies
- Interest rates
Prelims Fact: SEBI regulates securities derivatives; FMC (now merged with SEBI) regulated commodity derivatives.
| Instrument | Market Type | Issuer | Maturity | Risk Level |
|---|---|---|---|---|
| Treasury Bills | Money Market | Government of India | 91, 182, 364 days | Nil (Risk-free) |
| Commercial Paper | Money Market | High-rated Corporates | 7 days - 1 year | Low |
| Certificate of Deposit | Money Market | Banks/FIs | 7 days - 3 years | Low |
| Call/Notice Money | Money Market | Banks (interbank) | 1-14 days | Low |
| Repo/Reverse Repo | Money Market | RBI/Banks | Short-term | Minimal |
| Government Bonds | Capital Market | Central/State Govt | Long-term | Nil (Sovereign) |
| Corporate Bonds | Capital Market | Companies | Long-term | Varies with rating |
| Equity Shares | Capital Market | Companies | Perpetual | High |
| Debentures | Capital Market | Companies | Medium to Long | Moderate to High |
| Mutual Fund Units | Capital Market | AMCs | Open/Close ended | Varies |
| Derivatives | Derivatives Market | Various | As per contract | High |
- Established: 1935
- Headquarters: Mumbai
Functions:
- Regulates money market
- Controls liquidity and interest rates
- Banker to Government
- Banker to banks
- Issues currency
- Manages foreign exchange reserves
- Implements monetary policy
- Regulates banking sector
Key Powers:
- Repo Rate, Reverse Repo, CRR, SLR
- Open Market Operations (OMOs)
- Liquidity Adjustment Facility (LAF)
- Banking licenses
Prelims Fact: RBI was nationalized in 1949.
- Established: 1988 (statutory status: 1992)
- Headquarters: Mumbai
Functions:
- Regulates capital market
- Protects investor interests
- Develops and regulates securities market
- Prevents fraudulent practices
- Regulates stock exchanges, brokers, merchant bankers
Key Powers:
- Registration of market intermediaries
- Insider trading regulations
- Takeover code
- Disclosure norms
- Delisting procedures
Prelims Fact: SEBI came into existence through SEBI Act, 1992.
- Established: 1999
- Headquarters: Hyderabad
Functions:
- Regulates insurance sector
- Protects policyholders
- Issues licenses to insurers
- Sets prudential norms
- Established: 2003 (statutory: 2013)
- Headquarters: New Delhi
Functions:
- Regulates pension sector
- Manages National Pension System (NPS)
- Protects subscribers
a) Forward Markets Commission (FMC)
- Now merged with SEBI (2015)
- Earlier regulated commodity derivatives
b) Competition Commission of India (CCI)
- Prevents monopolies
- Ensures fair competition
- Reviews mergers and acquisitions
-
Encourages Savings & Investment
- Multiple investment options
- Better returns than traditional savings
- Financial inclusion
-
Promotes Entrepreneurship
- Easy access to capital for startups
- IPO route for growth
- Venture capital and private equity
-
Facilitates Industrial Growth
- Long-term capital for industries
- Infrastructure financing
- Technology adoption
-
Government Borrowing
- G-Secs for fiscal deficit
- Infrastructure bonds
- Non-inflationary financing
-
Efficient Resource Allocation
- Market-driven capital allocation
- Funds flow to profitable sectors
- Reduces wastage
- Employment generation
- GDP growth
- Wealth creation
- Financial deepening
- Foreign investment (FDI, FPI)
- Economic stability
Financial markets are the primary transmission channel of RBI's monetary policy to the real economy.
Policy Tools Used by RBI:
-
Repo Rate
- Rate at which RBI lends to banks
- Lower repo → cheaper loans → more borrowing
- Primary tool for inflation control
-
Reverse Repo Rate
- Rate at which RBI borrows from banks
- Absorbs excess liquidity
-
Open Market Operations (OMOs)
- Buying/selling of G-Secs
- Permanent liquidity adjustment
-
Cash Reserve Ratio (CRR)
- Portion of deposits banks must keep with RBI
- Currently: (check latest rate)
- No interest paid
-
Statutory Liquidity Ratio (SLR)
- Liquid assets banks must maintain
- Currently: (check latest rate)
- G-Secs, gold, cash
-
Marginal Standing Facility (MSF)
- Emergency lending by RBI
- Rate higher than repo
-
Bank Rate
- Long-term lending rate
- Currently aligned with MSF
RBI Policy Change → Money Market Rates → Bank Lending Rates → Investment & Consumption → GDP & Inflation
Prelims Fact: Efficient financial markets ensure effective monetary policy transmission.
- Controlled interest rates
- Limited financial instruments
- Physical share certificates
- Government dominance
- SEBI Act, 1992 - Statutory regulator
- NSE established (1992) - Screen-based trading
- Dematerialization - NSDL (1996), CDSL (1999)
- Derivatives introduced - 2000
- FII investments allowed
- SARFAESI Act, 2002 - Asset reconstruction
- Introduction of T+2 settlement
- Commodity derivatives
- Credit derivatives
- Insolvency and Bankruptcy Code (IBC), 2016
- RERA, 2016 - Real estate regulation
- GST, 2017 - Unified tax
- Merger of FMC with SEBI (2015)
- T+1 Settlement Cycle (2023)
- GIFT City - International Financial Services Centre
- FinTech revolution - UPI, digital payments
- Account Aggregator framework
- Central Bank Digital Currency (CBDC) - Digital Rupee pilot
A. SEBI Strengthening:
- Investor protection measures
- Listing norms
- Corporate governance
- Disclosure requirements
B. Technology Integration:
- Online trading
- Mobile apps
- Algorithmic trading
- Blockchain experiments
C. Financial Inclusion:
- Jan Dhan accounts
- Mudra loans
- Payment banks
- Small finance banks
D. International Integration:
- FDI liberalization
- P-Notes regulations
- FATCA compliance
- Masala Bonds
| Aspect | Financial Market | Financial System |
|---|---|---|
| Definition | Platform for trading financial assets | Broader framework encompassing institutions, markets, instruments, services |
| Scope | Markets only | Markets + Institutions + Regulators + Infrastructure |
| Components | Money market, Capital market, Forex market | Banks, NBFCs, Insurance, Markets, Regulators, Payment systems |
| Example | Stock Market, Bond Market | Banking system + Capital markets + Insurance |
| Function | Trading and price discovery | Complete financial intermediation |
Analogy:
- Financial Market = Marketplace
- Financial System = Entire economy's financial infrastructure
- NIFTY 50: NSE's benchmark index (50 stocks)
- SENSEX: BSE's benchmark index (30 stocks)
- Market Cap: BSE has more listed companies (~5000+), NSE higher turnover
- T+1: India moved to T+1 settlement in January 2023
- GIFT City: Gujarat International Finance Tec-City (Gandhinagar)
- SEBI Headquarters: Mumbai (established 1992)
- RBI Headquarters: Mumbai (established 1935)
- IRDAI Headquarters: Hyderabad (established 1999)
- PFRDA Headquarters: New Delhi (established 2013 as statutory body)
- Commercial Paper: ₹5 lakhs
- Certificate of Deposit: ₹1 lakh
- IPO minimum application: As per company (usually ₹10,000-15,000)
- 1875: BSE established
- 1935: RBI established
- 1988: SEBI established (statutory: 1992)
- 1992: NSE established
- 1996: NSDL (first depository)
- 1999: CDSL, IRDAI established
- 2015: FMC merged with SEBI
- 2016: Insolvency and Bankruptcy Code
- 2023: T+1 settlement
"9-1-8-2-3-6-4" → 91, 182, 364 days
"T-C-C-C-R"
- Treasury Bills
- Commercial Paper
- Certificate of Deposit
- Call Money
- Repo
"Explain the structure and role of financial markets in promoting economic development in India." (150 words / 10 marks)
Introduction (2-3 lines): Financial markets facilitate the flow of funds from savers to investors, acting as the backbone of economic growth by enabling efficient capital allocation.
Body:
Structure of Financial Markets:
- Money Market (short-term liquidity)
- Capital Market (long-term capital)
- Primary Market (capital formation)
- Secondary Market (liquidity)
- Derivatives Market (risk management)
Role in Economic Development:
- Mobilizes savings and channels them into productive investments
- Facilitates capital formation for industries and infrastructure
- Enables government borrowing for development projects
- Promotes entrepreneurship through IPOs and venture capital
- Provides risk management tools through derivatives
- Attracts foreign investment (FDI, FPI)
- Ensures efficient resource allocation based on market signals
Conclusion: With reforms like T+1 settlement, GIFT City, and digital innovations, Indian financial markets are becoming more efficient and inclusive, contributing significantly to India's goal of becoming a $5 trillion economy.
- "Financial deepening and inclusion"
- "Monetary policy transmission mechanism"
- "Capital formation and resource allocation"
- "Risk diversification and hedging"
- "Financial stability and systemic risk"
- "Regulatory framework and investor protection"
- "Technology-driven transformation"
- "Integration with global markets"
-
Union Budget 2024-25:
- Capital gains tax changes
- Market infrastructure development
- IFSC incentives
-
RBI Monetary Policy:
- Interest rate decisions
- Liquidity management
- Inflation targeting
-
SEBI Regulations:
- New listing norms
- ESG disclosures
- F&O trading regulations
-
Digital Innovations:
- CBDC (Digital Rupee) pilot
- UPI internationalization
- Account Aggregator framework
-
Global Integration:
- FATF compliance
- Gift Nifty (earlier SGX Nifty)
- Cross-border payments
- Jan Dhan Yojana → Financial inclusion
- Mudra Yojana → SME financing
- Startup India → Venture capital ecosystem
- Make in India → Capital market role
Arbitrage: Simultaneous buying and selling in different markets to profit from price differences.
Asset Allocation: Distribution of investments across asset classes (equity, debt, gold, etc.).
Bear Market: Declining market (prices falling 20%+ from peak).
Bull Market: Rising market (sustained upward trend).
Call Option: Right to buy an asset at predetermined price.
Capital Adequacy Ratio (CAR): Bank's capital as percentage of risk-weighted assets.
Circuit Breaker: Trading halt mechanism during extreme volatility.
Debenture: Long-term debt instrument issued by companies.
Dematerialization: Conversion of physical shares to electronic form.
Derivative: Financial instrument derived from underlying asset value.
Face Value: Nominal value of security (printed on certificate).
Free Float Market Cap: Market cap of publicly tradeable shares (excluding promoter holding).
Futures: Obligation to buy/sell asset at future date and predetermined price.
GIFT City: Gujarat International Finance Tec-City (India's IFSC).
Hedging: Risk reduction strategy using derivatives.
IPO (Initial Public Offering): First public sale of company's shares.
Liquidity: Ease of converting asset to cash without price impact.
Market Capitalization: Total value of company's outstanding shares (Share Price × Total Shares).
Mutual Fund: Pooled investment vehicle managed by AMC.
NSDL/CDSL: Depositories holding securities in dematerialized form.
P/E Ratio (Price-to-Earnings): Share price divided by earnings per share (valuation metric).
Portfolio: Collection of financial investments.
Primary Dealer: Authorized to deal in government securities directly with RBI.
Put Option: Right to sell an asset at predetermined price.
Red Herring Prospectus: Draft prospectus for IPO (price band not finalized).
Securities: Tradable financial instruments (shares, bonds, derivatives).
Settlement: Process of transferring securities and funds between buyer and seller.
Short Selling: Selling borrowed securities expecting price decline.
Sovereign Gold Bond: Government securities denominated in grams of gold.
Swap: Exchange of cash flows or instruments between parties.
Underwriting: Guarantee by intermediary to buy unsold shares in IPO.
Volatility: Degree of price fluctuation (higher volatility = higher risk).
Yield: Return on investment expressed as percentage.
- [ ] T-Bill tenures (91, 182, 364 days)
- [ ] SEBI establishment year (1992 statutory)
- [ ] NSE established (1992)
- [ ] BSE oldest exchange in Asia (1875)
- [ ] T+1 settlement (2023)
- [ ] Money market instruments (5 main types)
- [ ] All regulators and their headquarters
- [ ] Primary vs Secondary market differences
- [ ] CRR, SLR, Repo Rate concepts
- [ ] FMC merged with SEBI (2015)
- [ ] Structure of financial markets (3 classifications)
- [ ] Role in economic development (5-6 points)
- [ ] Monetary policy transmission
- [ ] Financial market reforms timeline
- [ ] Difference: Financial Market vs Financial System
- [ ] Current affairs integration
- [ ] Regulatory framework importance
- RBI Annual Reports
- SEBI Annual Reports
- Economic Survey (Financial Sector chapter)
- Union Budget (Financial Markets section)
- NITI Aayog reports on financial inclusion
- Compare and contrast money market and capital market.
- Evaluate the role of SEBI in protecting investor interests.
- How does financial market development contribute to economic growth?
- Discuss recent reforms in Indian financial markets.
- Explain the transmission mechanism of monetary policy through financial markets.
Last Updated: January 2026 Prepared for: UPSC CSE (Prelims + Mains GS-III)
Note: Update current rates, recent policy changes, and current affairs regularly before exam.