Financial Markets - Money and Capital for UPSC

Market Types

The Indian financial system channels household savings to productive investments through two main types of markets: the money market and the capital market. Both markets help allocate resources efficiently, but they differ in purpose, maturity and regulation.

Money Market in India

The money market is the market for shortterm funds instruments that have a maturity of up to one year. These instruments are close substitutes for cash, so they are highly liquid and low risk. The Reserve Bank of India (RBI) regulates the money market because it is central to liquidity management and implementation of monetary policy. Banks, mutual funds, nonbanking financial companies (NBFCs), insurance firms and large corporations are the major participants; retail investors seldom participate directly.

In practice, the money market serves several purposes. It allows banks with temporary surpluses to lend funds overnight or for a few weeks to banks facing shortfalls through the call and notice money market. The government raises shortterm funds by issuing treasury bills (Tbills) of 91, 182 and 364 days, while companies issue commercial paper (CP) and banks issue certificates of deposit (CD). Repurchase agreements (repos) and triparty repos (TREPS) allow participants to borrow funds by selling securities with a promise to repurchase them at a set date and rate. Other instruments include bill rediscounting, interbank participation certificates, forward rate agreements and interest rate swaps.

The money market helps the RBI transmit monetary policy. When inflationary pressures rise, the central bank can tighten liquidity by raising the policy repo rate or conducting open market operations, which push up shortterm interest rates. In 2025 the weighted average call money rate hovered between 5% and 6%, reflecting a slightly tight liquidity environment after the RBI raised the policy repo rate to keep inflation within the 4% 2% target band. Average daily turnover in the overnight call and triparty repo market exceeded 1trillion, indicating deep and efficient shortterm funding avenues.

Capital Market in India

The capital market is the market for longterm finance. It facilitates the issuance and trading of instruments with maturities greater than one year. Participants include companies seeking to raise equity or debt, governments issuing longdated securities, banks, financial institutions, insurance firms, mutual funds, pension funds, foreign portfolio investors (FPIs) and millions of small investors. The Securities and Exchange Board of India (SEBI), established as a statutory regulator in 1992, oversees the capital market to ensure fairness, efficiency and investor protection.

Indias capital market has grown rapidly in recent years. By June2025 the combined market capitalisation of listed companies on the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) crossed $5.3trillion, making India the fifthlargest equity market globally after the US, China, Japan and HongKong. This expansion reflects robust corporate earnings, rising domestic savings and increasing retail participation via demat accounts and lowcost trading platforms. The debt segment has also expanded: outstanding corporate bonds exceeded 42trillion in 2025, and the government securities market benefited from steady foreign portfolio investment after India was included in major global bond indices. Reforms such as the shift to a T+1 settlement cycle, the introduction of online eKYC and UPIsupported IPO applications, and platforms for online bond trading have made the capital market more accessible and resilient.

The capital market not only funds investment but also provides investors with opportunities to build wealth over the long run. Unlike the money market, it carries higher risk share prices and bond yields fluctuate with company performance, macroeconomic conditions and global factors. However, a diversified portfolio and proper regulatory safeguards help mitigate these risks.

Instruments

Different instruments are traded in the money and capital markets. UPSC aspirants should memorise the main instruments, their issuers, maturities and features.

Money Market Instruments

• Call and Notice Money: Unsecured shortterm loans between banks and primary dealers. Call money is overnight lending, while notice money ranges from 2 to 14 days. The call money rate, which varies daily based on liquidity, is a key indicator of shortterm interest rates.
• Treasury Bills (Tbills): Shortterm government securities issued by the Reserve Bank of India on behalf of the central government. They come in 91day, 182day and 364day maturities and are sold at a discount to face value. Tbills are riskfree and widely used by banks and mutual funds for parking surplus funds.
• Commercial Paper (CP): Unsecured promissory notes issued by financially sound companies and primary dealers to meet shortterm working capital needs. Maturities range from 7 days to one year. Investors include banks, mutual funds and insurance companies.
• Certificates of Deposit (CD): Negotiable receipts issued by scheduled commercial banks and select financial institutions for funds deposited with them. CDs have maturities between 7 days and one year and carry a fixed interest rate.
• Repurchase Agreements (Repo and Reverse Repo): Shortterm loans backed by government securities. In a repo, a borrower sells securities with an agreement to repurchase them at a specified date and price. A reverse repo is the mirror transaction. The RBI uses repo and reverse repo operations to manage liquidity and signal its policy stance.
• Triparty Repo (TREPS): A variation of the repo where a third party the clearing corporation manages the collateral and settlement. TREPS replaced the old collateralised borrowing and lending obligation (CBLO) system, providing a safer and more efficient way for participants to borrow and lend funds overnight.
• Commercial Bills: Trade bills drawn by sellers on buyers of goods and services. Banks discount these bills to provide immediate funds to the seller, and can rediscount them with other financial institutions. Maturities usually range from 90 to 180 days.
• InterBank Participation Certificates (IBPCs): Instruments through which banks share their advances with other banks for a short duration, helping to even out the demand and supply of funds within the banking system.
• Forward Rate Agreements (FRAs) and Interest Rate Swaps (IRS): Derivative instruments that allow participants to lock in future interest rates and manage interest rate risk. They are largely used by banks and corporate treasuries.

Capital Market Instruments

• Equity Shares: Represent ownership in a company. Equity shareholders have voting rights and share in profits through dividends and capital gains. Equity carries high risk but offers the potential for high returns.
• Preference Shares: A hybrid instrument offering a fixed dividend and priority over equity in the event of liquidation. Preference shareholders generally do not have voting rights.
• Debentures and Bonds: Longterm debt instruments issued by companies and governments. Debentures can be secured or unsecured; bonds are typically secured by assets. Investors receive periodic interest and return of principal at maturity.
• Government Securities (Gsecs): Longdated bonds issued by the central and state governments with maturities ranging from 5 to 40 years. Gsecs are considered near riskfree and form the benchmark for pricing other debt instruments.
• Corporate Bonds: Bonds issued by companies to raise longterm funds. These include nonconvertible debentures (NCDs), convertible bonds, perpetual bonds and green bonds. In 2025 the outstanding corporate bond market in India exceeded 42trillion.
• Mutual Fund Units: Pool savings from many investors to invest in diversified portfolios of equity, debt or hybrid instruments. Regulations require mutual funds to be registered with SEBI and follow strict disclosure norms.
• ExchangeTraded Funds (ETFs): Units listed and traded on stock exchanges that track an underlying index, commodity or basket of assets. ETFs combine the diversification of mutual funds with the liquidity of shares.
• Derivatives: Financial contracts whose value is derived from underlying assets. The two main types traded on Indian exchanges are futures and options on equities, indices, currencies and interest rates. Derivatives help investors hedge risk and speculate on price movements.
• Infrastructure Investment Trusts (InvITs) and Real Estate Investment Trusts (REITs): Truststructured vehicles that hold operational infrastructure or real estate assets and distribute income to unit holders. These instruments provide investors access to incomegenerating assets with lower ticket sizes.

Primary vs Secondary Market

The capital market has two segments: the primary (new issue) market and the secondary (stock exchange) market. Though they are interconnected, their functions and mechanisms differ.

Primary Market

The primary market is where new securities are issued and sold for the first time. Companies, governments or institutions raise fresh capital by offering shares or bonds to investors. Transactions are between the issuer and investors; the proceeds go directly to the issuer to finance projects, repay debt or expand operations. Primary issues take several forms:

• Initial Public Offering (IPO): A private company offers its shares to the public for the first time and lists on a stock exchange. In FY202425 more than fifty companies tapped the market through IPOs, raising over 60,000crore.
• Followon Public Offering (FPO): A listed company issues additional shares to raise more capital.
• Rights Issue: Existing shareholders are given the right to buy additional shares at a predetermined price in proportion to their holdings.
• Private Placement: Securities are sold to a select group of investors such as banks, mutual funds or wealthy individuals without a public issue. Qualified institutional placements (QIPs) are a popular route for listed companies to raise funds quickly.
• EIPO and UPI Applications: In recent years the process has become fully digital. Investors use the Application Supported by Blocked Amount (ASBA) facility and UPI payment option, making IPO participation seamless.

The primary market is regulated by SEBI. Every offer document must contain detailed disclosures about the companys finances, risk factors and use of proceeds. Merchant bankers, underwriters, registrars, credit rating agencies and stock exchanges play important roles in the issue process. SEBIs approval, though not a guarantee of profitability, ensures transparency and protects investors.

Secondary Market

The secondary market is the marketplace where existing securities are traded among investors. It provides liquidity to investors, enabling them to exit investments before maturity and discover fair prices. The main secondary market platforms in India are stock exchanges such as the BSE, NSE and Metropolitan Stock Exchange (MSE). Trading also occurs in the overthecounter (OTC) market for certain bonds and derivatives.

In the secondary market prices are determined by demand and supply. An investor selling shares receives payment from the buyer; the issuing company is not directly involved. Clearing corporations guarantee settlement of trades, ensuring that buyers receive securities and sellers receive funds on time. India moved to a T+1 (trade date plus one working day) settlement cycle in 2023, and regulators are now testing sameday settlement for select trades to enhance efficiency. Stock indices such as the BSE Sensex and NSE Nifty 50 track market performance and influence investor sentiment.

SEBI and Market Regulation

The Securities and Exchange Board of India (SEBI) is the watchdog of the Indian capital market. Established in 1988 and given statutory powers through the SEBI Act, 1992, its mandate is to protect the interests of investors, promote the development of the securities market and regulate its functioning.

Organization and Powers

SEBI is a quasilegislative, quasiexecutive and quasijudicial body. It drafts regulations, conducts investigations, passes rulings and imposes penalties. The board consists of a chairman nominated by the government and members representing the Ministry of Finance, the Reserve Bank of India and independent experts. SEBI has powers with respect to issuers, investors and intermediaries:

• Issuers: SEBI can call for information, conduct inspections, and audit issuers and stock exchanges. It scrutinises draft offer documents for accuracy, mandates disclosure of financials, risk factors and pricing rationale, and can restrain companies from accessing the market if they violate rules.
• Investors: SEBI prohibits fraudulent and unfair trade practices such as insider trading and price manipulation. It regulates substantial acquisitions and takeovers, prescribes rules for buybacks, and promotes investor education through campaigns and the Investor Education and Protection Fund. The SCORES portal provides an online mechanism for investors to lodge complaints and track their resolution.
• Intermediaries: SEBI registers and regulates the working of stock brokers, subbrokers, merchant bankers, registrars, portfolio managers, mutual funds, investment advisers, credit rating agencies, custodians and debenture trustees. It prescribes net worth requirements, codes of conduct and risk management norms. It also regulates alternative investment funds, collective investment schemes and selfregulatory organisations.

Market Development and Reforms

Beyond policing misconduct, SEBI plays a developmental role. It introduced screenbased electronic trading in the 1990s, mandated dematerialisation of securities to eliminate paper certificates, and established clearing corporations to ensure counterparty risk management. Recent reforms include:

• Shorter Settlement Cycles: India migrated from T+2 to T+1 settlement by January2023 and is testing T+0 settlement. Faster settlement reduces counterparty risk and frees up capital for redeployment.
• Regulatory Sandbox and Innovation: SEBI encourages fintech innovations through a regulatory sandbox that allows controlled testing of new products. Platforms using artificial intelligence for advisory, algorithmic trading and blockchainbased settlement are being explored.
• Strengthening Corporate Governance: SEBI tightened rules on disclosure of relatedparty transactions, independent director appointments and auditor rotation. It mandated separation of the roles of chairperson and managing director in the top 500 listed companies to improve accountability.
• Facilitating Startups and SMEs: The Innovators Growth Platform (IGP) provides a simplified listing framework for startups with relaxed profitability norms. SEBI also rolled out a special platform on BSE and NSE for small and medium enterprises (SMEs) to raise capital.
• Expanding the Bond Market: SEBI eased regulations for listing of municipal bonds, infrastructure debt funds and green bonds. It introduced a framework for fractional ownership platforms to democratise investment in real estate and infrastructure.

SEBI works alongside the Reserve Bank of India, Insurance Regulatory and Development Authority (IRDAI) and Pension Fund Regulatory and Development Authority (PFRDA). While SEBI oversees the capital market, the RBI regulates the money market and foreign exchange. Coordination among regulators is essential because financial products often straddle multiple segments.

Quick Facts

• The money market deals with instruments of maturity up to one year such as Tbills, CP, CD and call/notice money; it is regulated by the RBI to manage liquidity and shortterm interest rates.
• The capital market handles longterm instruments like shares, debentures, bonds and mutual fund units; the SEBI regulates it to ensure transparency and investor protection.
• Indias equity market capitalisation surpassed $5.3trillion in June2025, ranking fifth globally and reflecting robust domestic savings and retail participation.
• Average daily turnover in the call and triparty repo segments of the money market exceeded 1trillion in 2025, with call rates hovering between 5% and 6% as the RBI balanced growth and inflation.
• Over 50IPOs were launched in FY202425, raising more than 60,000crore; digital platforms like ASBA and UPI simplified retail participation.
• The corporate bond market outstanding crossed 42trillion in 2025; reforms such as centralised clearing and repo in corporate bonds aim to deepen this market.
• India introduced the T+1 settlement cycle for equity trades in 2023 and is piloting T+0 settlements for sameday transfers in select securities.
• SEBIs Investor Education and Protection Fund (IEPF) and SCORES portal provide mechanisms for investor awareness and grievance redressal.

For UPSC Prelims vs Mains

Prelims Pointers

• Remember the definitions of the money market and capital market and the maturity horizon for each.
• Know the main money market instruments call money, Tbills, CP, CD, repo/TREPS and commercial bills and who issues them.
• Know the main capital market instruments equity, preference shares, debentures/bonds, mutual funds, ETFs, derivatives, InvITs and REITs.
• Distinguish between primary and secondary markets: who issues, who trades, how prices are set, and examples like IPOs and stock exchanges.
• Identify the regulators RBI for money market, SEBI for capital market and recall key SEBI functions (investor protection, market development, regulation of intermediaries).
• Be aware of recent reforms such as dematerialisation, T+1 settlement, UPIbased IPO applications and platforms for startups.

Mains Notes

• Discuss the importance of deep and efficient capital markets in mobilising longterm finance for infrastructure and innovation. Evaluate measures needed to develop the corporate bond market and attract longterm investors.
• Analyse the challenges facing the money market, such as limited participation beyond banks, the need for a wellfunctioning repo market in corporate bonds and integration with the government securities market.
• Explain how SEBIs regulatory interventions have modernised Indias securities market dematerialisation, electronic trading, risk management frameworks and how further reforms can improve transparency and accountability.
• Critically assess the overlap between regulatory jurisdictions (RBI, SEBI, IRDAI, PFRDA) and suggest ways to enhance coordination, perhaps through a unified financial regulatory architecture.
• Discuss the role of technology in democratizing investing eKYC, account aggregation, roboadvisory and the risks of algorithmic trading and data privacy. Suggest regulatory approaches to balance innovation with investor protection.
• Use examples from recent IPOs, bond issuances and SEBI orders to support arguments. Remember to highlight the human angle: how retail investors benefit from easier access but also face risks from market volatility.

UPSC Previous Year Questions (Selected)

The following paraphrased questions illustrate how the Union Public Service Commission has tested candidates on financial markets:

1. Prelims 2017: Which of the following are capital market instruments? 1. Equity shares 2. Treasury bills 3. Debentures. Select the correct answer using the code below.
   Answer: Capital market instruments include equity shares and debentures. Treasury bills are money market instruments. Therefore the correct answer is 1 and 3 only.
2. Prelims 2020: With reference to the Indian money market, consider the following statements: (a) Commercial paper is an unsecured instrument issued by companies for shortterm financing. (b) Certificates of deposit can be issued by commercial banks. (c) Equity shares are money market instruments. Which statements are correct?
   Answer: Statements (a) and (b) are correct. Equity shares are capital market instruments. Hence the correct answer is (a) and (b) only.
3. Mains 2015 (General StudiesIII): Distinguish between the primary and secondary capital markets. Discuss the role of SEBI in regulating these markets.
   Answer: The primary market is the market for issuing new securities such as IPOs, FPOs and rights issues, where companies raise fresh capital from investors. The secondary market is the market for trading existing securities on stock exchanges, providing liquidity and price discovery. SEBI regulates both segments through disclosure requirements, registration of intermediaries, surveillance of trading, prevention of insider trading and investor protection measures. It has introduced electronic trading platforms, dematerialisation, risk management and grievance redress mechanisms to ensure orderly functioning.
4. Prelims 2022: Which of the following statements about SEBI are correct? (1) It is a statutory body under the Union Ministry of Finance. (2) It regulates mutual funds and alternative investment funds. (3) It supervises the call money market. Select the correct answer using the code below.
   Answer: Statements (1) and (2) are correct; SEBI regulates the capital market, mutual funds and alternative investment funds. Statement (3) is incorrect because the call money market is regulated by the RBI. Therefore the correct answer is 1 and 2 only.

Practice MCQs

1. Which of the following is not a money market instrument?
   A. Treasury bill
   B. Commercial paper
   C. Debenture
   D. Certificate of deposit
2. The primary market is also known as the:
   A. Secondary market
   B. New issue market
   C. Derivatives market
   D. Commodities market
3. Who regulates the call money market in India?
   A. Securities and Exchange Board of India
   B. Reserve Bank of India
   C. Insurance Regulatory and Development Authority of India
   D. Pension Fund Regulatory and Development Authority
4. Which of the following statements about SEBI is correct?
   A. It issues currency notes and conducts monetary policy.
   B. It regulates mutual funds and protects investors in securities.
   C. It provides agricultural credit to farmers.
   D. It manages the countrys foreign exchange reserves.
5. In the capital market, longterm funds are raised for a period of:
   A. Less than one year
   B. Between one and three months
   C. More than one year
   D. Daily settlement only

Answer key: 1C; 2B; 3B; 4B; 5C.

Frequently Asked Questions

What is the money market and how does it differ from the capital market?

The money market is a market for shortterm funds with maturities up to one year. It includes instruments like treasury bills, commercial paper, certificates of deposit and repos. The capital market mobilises longterm funds through instruments like shares, debentures and bonds. The RBI regulates the money market, whereas SEBI regulates the capital market.

Why do central banks like the RBI monitor the money market closely?

Because the money market determines shortterm interest rates and liquidity in the banking system. By conducting repos, reverse repos and open market operations, the RBI influences money supply, inflation and credit availability. A wellfunctioning money market helps transmit monetary policy effectively.

What are the advantages of investing in the capital market?

The capital market offers opportunities for wealth creation through dividends, interest and capital gains. Instruments like shares and bonds allow investors to participate in the growth of companies and the economy. Longterm investments also help beat inflation. However, investors should diversify and understand the risks involved.

How are primary market issues allotted to investors?

In bookbuilt issues, investors bid within a price band. After the bidding closes, the issue price is determined based on demand. Eligible investors receive allotment on a proportionate basis. Excess application money is refunded. Smaller issues may be priced through fixedprice offerings. The entire process is overseen by merchant bankers and monitored by SEBI.

Can individuals participate in the money market?

Retail participation in the money market is limited because many instruments have high minimum ticket sizes and are geared towards institutional investors. However, individuals can indirectly access the money market by investing in liquid mutual funds or money market mutual funds, which in turn invest in Tbills, CPs and repos.

What is dematerialisation and why is it important?

Dematerialisation is the process of converting physical share and bond certificates into electronic form held in demat accounts. It eliminates the risk of loss, theft and forgery associated with physical certificates, enables faster transfer and settlement of securities and reduces paperwork. All new issues today are in demat form.

What reforms are being considered to deepen Indias bond market?

The government and regulators are exploring measures such as encouraging retail participation through RBI Retail Direct, introducing repo markets in corporate bonds, enhancing credit rating disclosures, enabling trading of municipal bonds and tax incentives for longterm bond investors. Inclusion of Indian government bonds in global indices is also expected to bring more foreign investment and liquidity.

How does SEBI protect small investors?

SEBI enforces disclosure norms so investors can make informed decisions, monitors market trading to detect manipulation and insider trading, mandates fair pricing and allotment in primary issues and takes action against fraudulent entities. It also runs investor education campaigns, offers the SCORES platform for grievance redressal and compensates investors through the Investor Protection Fund where applicable.