Krishna Niraula

Chartered Accountant

Financial System
A 'financial system' is a system that allows the exchange of funds between lenders, investors, and
borrowers. Financial systems operate at national and global levels. They consist of complex,
closely related services, markets, and institutions intended to provide an efficient and regular
linkage between investors and depositors.

Money, credit, and finance are used as medium of exchange in financial systems. They serve as a
medium of known value for which goods and services can be exchanged as an alternative to
bartering. A modern financial system may include banks (public sector or private sector),
financial markets, financial instruments, and financial services. Financial systems allow funds to
be allocated, invested, or moved between economic sectors. They enable individuals and
companies to share the associated risks.

As an alternative to bartering, a modern financial systems may include banks, financial markets,
financial instruments and financial services.

Features of financial system

 It is a set of interrelated activities or services.
 Services are working together to achieve predetermined goals.
 The system allows transfer of money between savers and borrowers.
 It is applicable at global, regional, and firm level.
 It includes Financial Institutions, markets, instruments, services, practices and
transactions.

The main objective is to formulate capital, investment and profit generation, financial
services for members and clients. It is also termed as financial intermediaries because they act as
middlemen between the savers and borrowers
 It bridges the gap between savings and investment through efficient mobilisation and
allocation of surplus funds.
 It helps a business in capital formation
 It helps in minimising risk and allocating risk efficiently .
 It helps business to liquidate tied up funds.
 It facilitates financial transactions through provision of various financial instruments
 It facilitate trading of financial assets/ instruments by developing and regulating financial
markets.
 It helps in economic development and raising the standard of living of people.
 It provides effective financial as well as advisory services.
 It protects investors through regulatory bodies like NRB, SEBON etc.,
Krishna Niraula
Chartered Accountant

Role
Economic Development

1. Mobilising savings
2. Promoting Investments
3. Encouraging investments in financial assets
4. Allocating savings on the basis of national priorities.
5. Creating credit
6. Providing a spectrum of financial assets.
7. Financing trade, Industry and agriculture.
8. Encouraging Entrepreneurial talents.
9. Providing financial services.
10. Developing backward areas.
11. Helping in financial deepening and broadcasting.

Financial Market

Definition: Financial Market refers to a marketplace, where creation and trading of financial
assets, such as shares, debentures, bonds, derivatives, currencies, etc. take place. It plays a
crucial role in allocating limited resources, in the country’s economy. It acts as an intermediary
between the savers and investors by mobilising funds between them.

The financial market provides a platform to the buyers and sellers, to meet, for trading assets at a
price determined by the demand and supply forces.

Functions of Financial Market

1. It facilitates mobilisation of savings and puts it to the most productive uses.

2. It helps in determining the price of the securities. The frequent interaction between investors
helps in fixing the price of securities, on the basis of their demand and supply in the market.
3. It provides liquidity to tradable assets, by facilitating the exchange, as the investors can readily
sell their securities and convert assets into cash.
4. It saves the time, money and efforts of the parties, as they don’t have to waste resources to
find probable buyers or sellers of securities. Further, it reduces cost by providing valuable
information, regarding the securities traded in the financial market.

The financial market may or may not have a physical location, i.e. the exchange of asset
between the parties can also take place over the internet or phone also.

Classification of Financial Market

o By Nature of Claim
 Debt Market: The market where fixed claims or debt instruments, such as
debentures or bonds are bought and sold between investors.
Krishna Niraula
Chartered Accountant

 Equity Market: Equity market is a market wherein the investors deal in equity
instruments. It is the market for residual claims.
o By Maturity of Claim
 Money Market: The market where monetary assets such as commercial paper,
certificate of deposits, treasury bills, etc. which mature within a year, are traded
is called money market. It is the market for short-term funds. No such market
exist physically; the transactions are performed over a virtual network, i.e. fax,
internet or phone.
 Capital Market: The market where medium and long term financial assets are
traded is a capital market. It is divided into two types:
 Primary Market: A financial market, wherein the company listed on an
exchange, for the first time, issues new security or already listed
company brings the fresh issue.
 Secondary Market: Alternately known as Stock market, a secondary
market is an organised marketplace, wherein already issued securities
are traded between investors, such as individuals, merchant bankers,
stock brokers and mutual funds.
o By Timing of Delivery
 Cash Market: The market where the transaction between buyers and sellers are
settled in real time.
 Futures Market: Futures market is one where the delivery or settlement of
commodities takes place at a future specified date.
o By Organizational Structure
 Exchange Traded Market: A financial market, which has a centralised
organisation with the standardised procedure.
 Over-the-Counter Market: An OTC is characterised by a decentralised
organisation, having customised procedures.

Since last few year, the role of financial market has taken a drastic change, due toa number of factors
which are low cost of transactions, high liquidity, investor protection, transparency in pricing
information, adequate legal procedures for settling disputes, etc.

Differences between Money Market and Capital market

Basis Money Market Capital Market

Money market is part of the financial Capital market is part of the

market where lending and borrowing financial market where lending and
takes place for short-term up to one borrowing takes place for the
Definition year medium term and long-term

Money markets generally deal in

promissory notes, bills of exchange, Capital market deals in equity
Types of instruments commercial paper, T bills, call money shares, debentures, bonds,
involved etc. preference shares etc.
Krishna Niraula
Chartered Accountant

Capital market involves

Money market contains financial stockbrokers, mutual funds,
Institutions banks, the central bank, commercial underwriters, individual investors,
involved/types of banks, financial Companies, chit funds commercial banks, stock exchanges,
investors etc. Insurance Companies
Nature of Market Money markets are informal Capital markets are more formal
Liquidity of the Capital Markets are comparatively
market Money markets are liquid less liquid
The maturity of capital markets
The maturity of financial instruments instruments is longer and they do
Maturity period is generally up to 1 year not have stipulated time frame
Since the market is liquid and the Due to less liquid nature and long
maturity is less than one year, Risk maturity, the risk is comparatively
Risk factor involved is low high
The market fulfills short-term credit The capital market fulfills long-term
Purpose needs of the business credit needs of the business
The money markets increase the The capital market stabilises the
Functional merit liquidity of funds in the economy economy due to long-term savings
Return on The return in money markets are The returns in capital markets are
investment usually low high because of higher duration