Unit 3: Financial markets and instruments
Indian Financial System notes · PTU syllabus (MCOP201-18)
On this page
Unit summary
Financial markets are where funds and risks are traded. This unit covers the structure, role and functions of the money market, capital market, debt, equity, derivatives and forex markets, and instruments — treasury bills, commercial bills, certificates of deposit, gilt-edged securities, equity and preference shares, forwards, futures, options and swaps.
After this unit you can
- Explain the structure and instruments of the money market
- Explain the capital market — primary and secondary, debt and equity
- Explain derivatives — forwards, futures, options and swaps
- Explain the structure and functions of the forex market
PTU syllabus topics
- Structure
- role and functions of the Indian money market
- capital market
- debt
- equity
- derivatives and forex markets
- treasury bills
- commercial bills
- certificates of deposit
- gilt-edged securities
- equity/preference shares
- forwards
- futures
- options and swaps
Maturity
Up to one year
More than one year
Instruments
T-bills, CPs, CDs, call money
Shares, debentures, bonds
Purpose
Short-term liquidity
Long-term investment
Regulator
RBI
SEBI
Topic 1
Money market
The money market deals in short-term funds (maturity up to one year); regulated by RBI.
| Instrument | Features |
|---|---|
| Call/notice money | Overnight (call) or 2–14 days (notice) inter-bank lending |
| Treasury bills | Government short-term securities — 91, 182, 364 days; issued at a discount through RBI auctions |
| Commercial bills | Bills of exchange arising from trade, discounted by banks |
| Certificates of deposit (CDs) | Negotiable time deposits issued by banks (7 days–1 year) and FIs (1–3 years) |
| Commercial paper (CP) | Unsecured promissory notes by highly rated companies, 7 days–1 year |
| Repo and reverse repo | Short-term borrowing against government securities |
| TREPS | Tri-party repo dealing system (CCIL) |
- Functions: short-term liquidity management, monetary policy transmission (repo rate), investment of surplus funds, financing trade.
- Features of a developed money market: depth, breadth, resilience, integrated sub-markets, a central bank as lender of last resort.
Topic 2
Capital market: debt and equity
The capital market deals in long-term funds (more than one year) — regulated mainly by SEBI (and RBI for government securities).
Primary market
IPO, FPO, rights, private placement, QIP
Secondary market
Stock exchanges — NSE, BSE
Equity market
Equity and preference shares
Debt market
Government securities (gilt-edged), corporate bonds, debentures
Others
Mutual funds, REITs, InvITs
- Gilt-edged securities: government securities — "gilt" because there is no default risk; dated securities, state development loans, floating rate bonds, inflation-indexed bonds; traded on NDS-OM; retail access via RBI Retail Direct.
- Equity shares: ownership, residual claim, voting rights. Preference shares: fixed dividend, priority in repayment, limited voting; cumulative, redeemable, convertible, participating types.
- Corporate bond market is relatively shallow — dominated by private placements of highly rated issuers.
Maturity
Up to 1 year
Above 1 year
Instruments
T-bills, CPs, CDs, call money
Shares, bonds, debentures
Participants
Banks, FIs, RBI, corporates
Investors, companies, FPIs, mutual funds
Regulator
RBI
SEBI (and RBI for G-secs)
Purpose
Liquidity
Long-term investment
Topic 3
Derivatives market
A derivative is a contract whose value depends on an underlying asset — shares, indices, currencies, interest rates, commodities.
Forwards
Customised OTC agreement to buy/sell at a future date at a fixed price
Futures
Standardised, exchange-traded, daily mark-to-market, margins
Options
Right but not obligation — call (buy) or put (sell); buyer pays premium
Swaps
Exchange of cash flows — interest rate swaps (fixed for floating), currency swaps
- Participants: hedgers (reduce risk), speculators (take risk for profit), arbitrageurs (exploit price differences).
- India: index futures started on NSE in 2000; NSE is the world's largest derivatives exchange by contracts traded; SEBI tightened F&O rules for retail traders (2024).
Example
A wheat farmer sells futures at ₹2,400 per quintal; if the market price falls to ₹2,200 at harvest, the futures gain offsets the lower selling price — a hedge.
Topic 4
Forex market
The foreign exchange market is where currencies are bought and sold; regulated by RBI under FEMA, 1999.
- Structure: retail segment (tourists, exporters) and inter-bank market (authorised dealers); spot and forward markets; exchange-traded currency futures and options (NSE, BSE).
- Functions: transfer of purchasing power, credit (trade finance), hedging (forwards), price discovery of exchange rates.
- Exchange rate system: India follows a managed float — market-determined rupee with RBI intervention to curb volatility; current account convertibility (1994); partial capital account convertibility.
- Quotes: direct (₹ per US$) — the norm in India; FBIL publishes reference rates.
Key terms
- Money market
- Market for short-term funds up to one year
- Treasury bill
- Short-term government security issued at a discount
- Gilt-edged securities
- Government securities with no default risk
- Option
- Right without obligation to buy or sell at a set price
- Managed float
- Market-determined exchange rate with central bank intervention
Quick revision
- Money market instruments: call money, T-bills, CBs, CDs, CPs, repo, TREPS.
- Capital market: primary and secondary; equity and debt; gilts.
- Derivatives: forwards, futures, options, swaps; hedgers, speculators, arbitrageurs.
- Forex: RBI under FEMA; managed float; spot and forward.
- Money vs capital market differences.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.What is a treasury bill?
- Q2.Distinguish CP and CD.
- Q3.What are gilt-edged securities?
- Q4.Distinguish futures and forwards.
- Q5.What is a swap?
- Q6.What is a managed float?
Long-answer questions
- Q1.Explain the structure and instruments of the Indian money market.
- Q2.Explain the structure of the capital market and its debt and equity segments.
- Q3.Explain derivative instruments and the participants in derivatives markets.
- Q4.Explain the structure and functions of the foreign exchange market in India.
Stuck on this unit?
Message SBS on WhatsApp for help with Indian Financial System, or to ask about studying M.Com at Synetic.