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Objectives of the Session
• Financial System And Its Function • Classification Of Financial Markets • Money Market Instruments • Capital Markets Instruments • Government Securities Market
It is an orderly mechanism and structure that is available in an economy to mobilize the monetary resources/capital from various surplus sectors of the economy and allocate and distribute the same to various needy sectors. The term financial system is a set of inter-related activities/services working together to achieve some predetermined purpose or goal. It includes different markets, the institutions, instruments, services and mechanisms which influence the generation of savings, investment capital formation and growth.
• Van Horne defined the financial system as the purpose of
financial markets to allocate savings efficiently in an economy to ultimate users either for investment in real assets or for consumption. • Christy has opined that the objective of the financial system is to "supply funds to various sectors and activities of the economy in ways that promote the fullest possible utilization of resources without the destabilizing consequence of price level changes or unnecessary interference with individual desires.“ • According to Robinson, the primary function of the system is "to provide a link between savings and investment for the creation of new wealth and to permit portfolio adjustment in the composition of the existing wealth."
Inter-relationship in the Financial System
FUNCTIONS OF FINANCIAL SYSTEM
Policy Financial System
CLASSIFICATION OF FINANCIAL MARKETS
• Financial Markets: Market in which financial
assets are created or transferred. • Financial Markets can be classified as:
1. Money Market: Deals with transactions related to short-term instruments with maturity period less than one year 2. Capital Market: Deals with transactions related to long-term instruments with maturity period greater than one year.
MONEY MARKET INSTRUMENTS
• Call money • Commercial Papers • Certificate of Deposits
CALL MONEY/NOTICE MONEY
• Call money : Money lent for 1 day • Notice money: Money lent for 2-14 days. • Purpose:
- To help commercial banks by discounting commercial bills. - To help the banks in meeting the CRR requirement - To meet the sudden demands for funds - To meet the temporary mismatches.
CALL MONEY/NOTICE MONEY cntd…
Can both lend and borrow: (e.g. Commercial banks, DFHI, STCI etc.) Can only lend (e.g. LIC, UTI, Mutual funds etc.)
– Short-term, unsecured promissory notes issued at a discount to face value by well known companies with a high credit- rating. – Commercial Paper (CP) is popular, among highly rated entities, as a tool for diversifying their sources of short term borrowings and for reducing the cost of such borrowings. – It was introduced in India in 1990. – Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP. – Maturity period: 15 days – 1 year. – Issued in multiples of Rs. 5 lakh ;the amount invested by a single investor should not be less than Rs. 5 lakh. – They usually have a buy-back facility. – Negotiable by endorsement and delivery – Highly flexible instruments.
CERTIFICATE OF DEPOSIT
• This scheme was introduced in July 1989, to enable the banking
system to mobilise bulk deposits from the market, which they can have at competitive rates of interest. • Issued by banks in the form of usance promissory notes. The major features are: • Who can issue: Scheduled commercial banks (except RRBs) and All India Financial Institutions within their `Umbrella limit’. • CRR/SLR: Applicable on the issue price in case of banks • Investors: Individuals (other than minors), corporations, companies, trusts, funds, associations etc • Maturity Min: 7 days Max : 12 Months (in case of FIs minimum 1 year and maximum 3 years). • Amount Min: Rs.1 lac, beyond which in multiple of Rs.1 lac
• Interest Rate: Market related. Fixed or floating • Loan Against collateral of CD not permitted • Pre-mature cancellation Not allowed • Transfer Endorsement & delivery. Any time • Nature Usance Promissory note. Can be issued in
Dematerialisation form only only wef June 30, 2002 Other conditions • If payment day is holiday, to be paid on next preceding business day • Issued at a discount to face value • Duplicate can be issued after giving a public notice & obtaining indemnity
Money Market Mutual Funds
• MMMFs were set up to make available the
benefits of investing in money markets to small investors. • MMMFs invest primarily in money market instruments of very high quality and of very short maturities. • MMMFs can be set up by commercial banks,RBI and public financial institutions either directly or through their existing mutual fund subsidiaries. • MMMfs are regulated and governed by SEBI. • Schemes offered can either be open- ended or close – ended.
• They deal with securities with
maturity period > 1 year.
CAPITAL MARKETS PRIMARY MARKETS SECONDARY MARKETS
• Helps companies in raising funds through issue of
securities like shares and debentures.
• Governed by SEBI (Securities and Exchange Board
of India). • Methods of issuing securities in Primary Market: - Public Issue - Rights Issue - Bonus Issue - Private Placement - Bought-out Deals
• Securities already issued in the primary market
are traded in the secondary market.
• Provides liquidity to the securities held by the
• Operates through stock exchanges that regulate
the trading activities in this market.
• They are auction markets for securities. • Transaction at stock exchange occur by
placing an order. • Types of Orders: – Limit Orders – Best Rate Order – Immediate or cancel order – Limited Discretionary Order – Stop Loss Order – Open Order • Delivery of share certificate after execution of order may be spot, specified or hand delivery
GOVERNMENT SECURITIES MARKET
• Securities that are issued by the
Central government, state governments and entities that are wholly owned by the government.
• Fully secured in nature.
GOVERNMENT SECURITIES MARKET
Forms in which government securities can be held: - Stock Certificate - Promissory Notes - Bearer Bonds Examples of Government Securities: -Treasury Bills -Public Sector Bonds
• Short-term promissory notes issued by the government to meet their short-term obligations. • They are useful in managing short-term liquidity. • At present, the Government of India issues three types of
treasury bills through auctions, namely, 91-day, 182-day and 364-day. • There are no treasury bills issued by State Governments. • The RBI acts as an agent for issuing T-Bills. primary financial institutions, • Subscribers: Banks, providentdealers, NBFCs, FIIs and state insurance companies, funds, governments. • Treasury bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000. • Treasury bills are issued at a discount and are redeemed at par.
TREASURY BILLS cntd… Issued for a minimum amount of Rs. 25,000 and in multiples of 25,000 thereof. Maturity Period: 91 days and 364 days
PUBLIC SECTOR BONDS
• Bonds issued by public sector companies • Secured in nature. • Maturity Period: 5 to 7 years. • Investors: Banks, Insurance Companies, Corporate,
Provident Funds, Mutual Funds, Individuals. • Interest income eligible for deduction under Section 80L of I.T. Act.
Financial System And Its Function Classification Of Financial Markets Money Market Instruments Capital Markets Instruments Government Securities Market
Section II: Indian Financial System
Objectives of the Session: To understand
• • • • • INTERNATIONAL CAPITAL MARKETS FINANCIAL INSTITUTIONS BANKING SYSTEM INSURANCE NON-BANKING FINANCIAL COMPANIES
INTERNATIONAL CAPITAL MARKETS
• INSTRUMENTS IN INTERNATIONAL MARKETS
Equity Instruments -Global Depository Receipts -American Depository Receipts Debt Instruments -Euro Bonds -Foreign Bonds -Euro Notes
GLOBAL DEPOSITORY RECEIPTS & AMERICAN DEPOSITORY RECEIPTS • A GDR or ADR means any instrument in the form of a Depository receipt or certificate, created by the Overseas Depository Bank (ODB) outside India and issued to nonresident investors against the issue of ordinary shares or foreign currency convertible bonds of issuing company. • These are negotiable instruments denominated in US $ representing a non-US company’s publicly traded, local currency equity shares. • The issue of such instruments involves the delivery of ordinary shares of an Indian company to a domestic custodian bank in India, which in turn instructs an overseas depository bank to issue GDR/ADR on a predetermined ratio.
• The GDR/ADR can be sold outside India in their existing form. • The underlying shares (arising after redemption of GDR/ADR) can also be sold in India. • While ADRs are listed on the US stock exchanges, the GDRs are usually listed on a European stock exchange. • A GDR/ADR may evidence one or more GDS/ADS. • Each GDS/ADS represent underlying share of Issuing company.
• Eurobonds are bonds that are issued for sale outside the issuer’s home country. • They can be issued in the currency of the foreign country, or another currency. • Interest payments and principal are to be returned to the holder in the currency in which the bond was issued. • In most cases, the interest is paid annually. • The Eurobond marketis extremely liquid. While the majority of the trading is centralized around London’s trading hours. • Eurobond trading takes place 24 hours a day worldwide. • Eurobonds are named after the currency they are denominated in. For example, Euroyen and Eurodollar bonds are denominated in Japanese yen and American dollars respectively. • A Eurobond is normally a bearer bond, payable to the bearer.
Bonds issued by foreign entities for raising medium to long-term financing from domestic money centers in their domestic currencies. A bond issued in a particular country by a foreign borrower (or) a bond sold by a foreign • borrower, denominated in the currency of country in which it is sold and is underwritten & syndicated by national underwriting syndicate in the lending country . Foreign bonds are floated in the domestic capital markets (and are in the domestic currency of • those markets) by nonresident entities. These bonds are different from Euro bonds in the sense that they are governed by the • regulations of the country in which they are issued whereas Euro bonds are not. The bonds are generally named on the basis of the capital markets in which they are floated. • •
Types of Foreign Bonds
• Yankee Bonds: Yankee bond is a dollar denominated bond issued in U.S by a non-U.S. borrower in the U.S. market. • Samurai bond: Samurai bonds are yen denominated bonds issued in Japan by a non-Japanese borrower. • Bulldog bonds: Bulldog bonds are pound denominated bonds issued in U.K. domestic market by a non U.K. borrower.
• Foreign Exchange Market: Deals with transactions in currencies other than one’s own currency. • Exchange rate: The rate at which one currency can be converted into another currency
Participants: Exporters Importers Commercial Banks Central Banks Authorized Dealers and Money Changers Brokers
• Financial derivative is a product derived from the market of an underlying asset. Participants: - Hedgers: Hedgers wish to eliminate or reduce the price risk to which they are already exposed - Speculators: Speculators are those class of investors who willingly take price risks to profit from price changes in the underlying. - Arbitrators : Arbitrageurs profit from price differential existing in two markets by simultaneously operating in two different markets. Types of Derivatives: - Futures - Options
• • • • • • •
Industrial Development Bank of India Industrial Finance Corporation of India Industrial Credit and Investment Corporation of India Industrial Investment Bank of India Export and Import Bank of India State Financial Corporations Investment Institutions
ORGANIZATION OF BANKING SYSTEM
Reserve Bank of India Scheduled Banks Commercial Banks Foreign Private Sector banks
State Co-op Bank Indian Public Sector Banks
Central Co-operative Banks and Primary Credit Societies
RESERVE BANK OF INDIA
• It is the central bank of India. • Established to guide, monitor, regulate, promote and guide the Indian financial system.
FUNCTIONS OF RBI
• • • • • Currency issuing authority Acts as banker the central and state governments Serves as banker’s bank Foreign exchange control authority Exercises monetary control through: -Bank Rate -Reserve requirements: CLR and SLR -Open market operations • Undertakes developmental activities
COMMERCIAL BANKS • Most important depositors and disbursers of finance. • They are expected to hold a part of the deposits in the form of ready cash, known as cash reserves as prescribed by RBI. SCHEDULED BANKS • Scheduled banks are those that are included in the second schedule of Banking Regulation Act, 1949; the others are non-scheduled banks.
SCHEDULED BANKS cntd… Requirements that should be fulfilled to be a Scheduled bank: A bank must have a paid-up capital and reserve of not less than Rs. 5 lakh, It must ensure that its affairs are not conducted in a manner detrimental to the interests of its depositors.
LIABILITIES AND ASSETS OF A BANK
LIABILITIES 1. Demand deposits a. Current deposits b. Savings deposits c. Call deposits 2. Time deposits 3. Other liabilities (e.g. borrowings form RBI, refinance form IDBI, NABARD etc.) ASSETS 1. Cash in hand 2. Balances with RBI 3. Assets with the banking system 4. Investments in Government and other approved securities 5. Bank Credit a. Demand and Term loans b. Cash Credit/Overdraft arrangement c. Bill financing
From an individual’s point of view, insurance is an economic device whereby the individual can substitute a small definite cost (premium) for a large uncertain financial loss [the contingency insured against] that would have to be borne if insurance was not available.
CLASSIFICATION OF INSURANCE BUSINESS
1.Life Insurance: A life policy covers risk of death due to natural causes as also due to accidents. 2.General Insurance: Insurance other than the life insurance fall under the category of general insurance. a.Fire Insurance b.Marine Insurance c.Miscellaneous Insurance Insurance Regulatory and Development Authority: Regulates, promotes and ensures orderly growth of the insurance business and reinsurance business.
NON BANKING FINANCIAL COMPANIES
• • • • • • • • Investment Trusts and Investment Companies Mutual Benefit Funds Merchant Banks Hire Purchase Finance Companies Lease Finance Companies Housing Finance Companies Non-Housing Bank Venture Capital Funding Companies
FINANCIAL SYSTEM AND ITS FUNCTION CLASSIFICATION OF FINANCIAL MARKETS MONEY MARKET INSTRUMENTS CAPITAL MARKETS INSTRUMENTS GOVERNMENT SECURITIES MARKET INTERNATIONAL CAPITAL MARKETS FINANCIAL INSTITUTIONS BANKING SYSTEM INSURANCE NON-BANKING FINANCIAL COMPANIES