FINANCIAL INSTRUMENTS

Contract between the lender and borrower is termed as financial instrument. The financial instrument si
traded in financial market.

Traditional financial instruments

1. EQUITY

Equity is share ownership. It carries voting right. Equity gives company ownership to shareholder to
the amount of voting rights.

Equity may eb classified as

a). normal equity : 1 equity is 1 vote

b) differential equity: 1 equity more than 1 vote (upward differential/supernormal equity which is
owned by promoters only). 1 equity less than 1 vote (downward differential equity/DVR)

EQUITY is listed on stock exchange and can be traded.

2. DEBT
Debt is loan taken by corporates and can be termed as
a). term loans taken from banks
b) bonds /debentures issued to public

Term loans are OTC (over the counter) and highly customized and negotiable instruments. They carry
rate of interest and are tenured. They are not listed and cannot be traded.

Bonds and debentures are standardized debt instruments directly issued by company to the public. They
can eb listed and traded. For example 12% NCD 1000fv, 10 yrs ( this bond is carrying coupon or interest
rate of 12 % on 1000 fv unit of bond having maturity of 10 yrs).

Companies have to follow the Indian bankruptcy code so as to not qualify their loan as NPA by
commercial banks.

Commercial banks

Commercial banks are retail banks monitored by central bank (RBI) of that country. Commercial banks
do mass banking and manage their assets (loans) and liabilities (deposits) continuously. Commercial
banks along with central bank aide in managing the monetary and fiscal policy of the country. They
regulate the quantity and cost of money supply in the economy. Commercial banks are evaluated on
basis of CAMELS where C stands for capital adequacy ratio, A asset quality like net NPA to advances
ratio, M is managerial efficiency measured by non interest income, E is earnings like interest income, L is
liquidity and S is systematic risk.

A commercial bank is a kind of financial institution that carries all the operations related to deposit
and withdrawal of money for the general public, providing loans for investment, and other such
activities. These banks are profit-making institutions and do business only to make a profit. The two
primary characteristics of a commercial bank are lending and borrowing. The bank receives the
deposits and gives money to various projects to earn interest (profit). The rate of interest that a bank
offers to the depositors is known as the borrowing rate, while the rate at which a bank lends money
is known as the lending rate.

Function of Commercial Bank:

The functions of commercial banks are classified into two main divisions.

(a) Primary functions 

 Accepts deposit : The bank takes deposits in the form of saving, current, and fixed deposits. The
surplus balances collected from the firm and individuals are lent to the temporary requirements of
the commercial transactions.

Provides loan and advances : Another critical function of this bank is to offer loans and advances to
the entrepreneurs and business people, and collect interest. For every bank, it is the primary source
of making profits. In this process, a bank retains a small number of deposits as a reserve and offers
(lends) the remaining amount to the borrowers in demand loans, overdraft, cash credit, short-run
loans, and more such banks.

Credit cash: When a customer is provided with credit or loan, they are not provided with liquid cash.
First, a bank account is opened for the customer and then the money is transferred to the account.
This process allows the bank to create money.

(b) Secondary functions 

 Discounting bills of exchange: It is a written agreement acknowledging the amount of money to be

paid against the goods purchased at a given point of time in the future. The amount can also be
cleared before the quoted time through a discounting method of a commercial bank.

Overdraft facility: It is an advance given to a customer by keeping the current account to overdraw
up to the given limit.

 Purchasing and selling of the securities: The bank offers you with the facility of selling and buying
the securities.

Locker facilities: A bank provides locker facilities to the customers to keep their valuables or
documents safely. The banks charge a minimum of an annual fee for this service.

Paying and gathering the credit : It uses different instruments like a promissory note, cheques, and
bill of exchange.

Types of Commercial Banks:

There are three different types of commercial banks.

 Private bank –: It is a type of commercial banks where private individuals and businesses own a
majority of the share capital. All private banks are recorded as companies with limited liability. Such
as  Housing Development Finance Corporation (HDFC) Bank, Industrial Credit and Investment
Corporation of India (ICICI) Bank, Yes Bank, and more such banks.
 Public bank –: It is a type of bank that is nationalised, and the government holds a significant stake. 
For example, Bank of Baroda, State Bank of India (SBI), Dena Bank, Corporation Bank, and Punjab
National Bank.

Foreign bank –: These banks are established in foreign countries and have branches in other
countries. For instance, American Express Bank, Hong Kong and Shanghai Banking Corporation
(HSBC), Standard & Chartered Bank, Citibank, and more such banks.

Investment banks

Investment banking is the division of a bank or financial institution that serves governments,
corporations, and institutions by providing underwriting (capital raising) and mergers and acquisitions
(M&A) advisory services. Investment banks act as intermediaries between investors (who have money
to invest) and corporations (who require capital to grow and run their businesses). 

Investment bank function

 Underwriting – Capital raising and underwriting groups work between investors and companies
that want to raise money or go public via the IPO process. This function serves the primary
market or “new capital”.
 Mergers & Acquisitions (M&A) – Advisory roles for both buyers and sellers of businesses,
managing the M&A process start to finish.
 Sales & Trading – Matching up buyers and sellers of securities in the secondary market.  Sales
and trading groups in investment banking act as agents for clients and also can trade the firm’s
own capital.
 Equity Research – The equity research group research, or “coverage”, of securities helps
investors make investment decisions and supports trading of stocks.
 Asset Management – Managing investments for a wide range of investors
including institutions and individuals, across a wide range of investment styles.