CM M1 Notes

INVESTMENT MANAGEMET
MODULE 1
INDIAN FINANCIAL SYSTEM
Financial System
A financial system refers to a set of activities, which facilitate the

transfer of resources from savers to borrowers. It is an institutional
framework existing in a country to enable financial transactions. It
comprises financial institutions, financial markets, financial
instruments, and financial services. This system provides for a regular,
smooth, efficient, and cost-effective linkage between depositors and
investors. Unorganized financial markets are also part of the financial
system. These are interdependent components. A financial system may
be defined as a set of institutions, instruments, and markets which
foster savings and channelize them to their most efficient use. The
financial system regulates dealings between various economic units
including individuals and institutions in money and monetary assets. It
also relates to the provision of money for the exchange of goods and
services and is concerned with safeguarding the value of money. It
provides in the form of cash,credit & assets in financial form necessary for\
Production. Thus, the growth of financial system means growth or savings in

the financial system that mobilises savings and allocates them to different
economic activities and it will greatly facilitated by an efficient investment
leading to economic development.
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Features of Financial System
A well developed financial system is characterised by the existence of an

integrated, organized and well regulated financial market s, innovative
financial instruments, services and dynamic institutions that meet the short term
and long term financial needs Or individual s, government and corporate
segments.
• Organised and unorganized financial markets are part of financial

system.
• It regulates transactions between various economic units (i.e., Govt.,
Industry and household
• Financial system provides a linkage between depositors and
investors.
• It promotes efficient allocation of financial resources.
• It promotes economic development.
• It facilitates expansion of financial markets.
A strong legal and regulatory environment, stable currency system,

dynamic central hank, sound banking system, well functioning securities
market, efficient management of public debt and finance are the basic
elements required for a well functioning financial system,
INDIAN FINANCIAL SYSTEM
The Indian financial system includes both organized and unorganised

financial sectors. The organized sector consists of well integrated and
regulated sub-systems of financial institutions, markets, services and
that faciiitate the effective flow of fund. The organized ; sector of
Indian financial systems comes under the purview of Ministry Fina nce
(Mon, Ministr y of Corporate Affairs (MCA), the Reserve Bank of India
(RBI) the Securities Exchange Board of India (SEBI), the I ns ur a nc e
Re g ul a t o r y a n d De v e l o pm e nt Aut ho r i t y ( I RD A) o t he r regulatory
bodies.
Components of Financial System
The Indian financial system consists of financial markets, financial

Instruments, financial systems &financial services.
1.Financial Markets
A financial market is an institutional arrangement that facilitate the

exchange of financial assets, including deposits and loans, stocks and
bonds, options and futures. The financial markets may be orgainsed or
unorganised. An organised financial market is a recognised and formal market
governed by rules and regulations and controlled by market
regulators.
Organised sector of financial market consists of two important

markets viz., money market and capital market. Money market comprises of
groups of connected sub-markets, which deal in money, and monetary
assets of short-term nature such as call money, treasury bills, bills of
exchange etc.
The capital market consists of a number of institutions that borrow and

lend in tor long term such as equity, debentures, bonds etc. The capital
market may be further it . divided into Industrial securities market and
Government securities market. Primary market and secondary markets are
the two major segments of the capital market. The primary market is the
market where securities are issued for the first time. Securities issued in
the primary market are traded in the secondary market i.e., stock
exchanges. A well-developed and well-functioning financial market is
necessary for the economic growth of any country.
An unorganized financial market is an informal arrangement for

financial intermediation by individuals or firms characterized by
exorbitant interest rates, exploitation, non-standardized procedures and is
out of the purview of market regulators.
2) Financial Institutions
Financial institutions, also called financial intermediaries, are those institutions

which facilitate the mobilisation and disbursement of savings of the public. They
are broadly classified into Regulatory Institutions, Banking Institutions and Non-
Banking Financial Institutions or Companies [NBFIs or NBFCs).
a) Regulatory Institutions
Financial institutions that regulate, supervise and monitor the financial system
are called 'regulatory (or promotional) institutions. The Reserve Bank of India
(RBI) and the Securities and Exchange Board of India [SEBI) are the major
regulatory financial institutions in India. While the RBI administers the financial
institutions in the country, the SEBI monitors and controls the securities market.
Insurance Regulatory and Development Authority (IRDA) is another major
regulatory institution in India which governs and controls the functioning of
insurance sector in the country.
b) Banking Institutions
Banking institutions constitute another major category of financial institutions.

The banking system in India consists of public sector banks, private sector banks,
co-operative banks and foreign banks.
Public sector banks are those banks which the government is the major
shareholder. The State Bank of India and its associates and the nineteen other
nationalised banks belong to this category.
Those banks which are included in the second schedule of the RBI are termed as
scheduled banks. Therefore scheduled banks include both public sector and
private sector banks.
Foreign banks are those banks which are incorporated and headquartered
abroad, but having branches in India.
Co-operative banks are those banks promoted by the members to serve the
banking requirements of small and medium income people of a locality and
registered under the Co-operative Societies Act of the respective State. There
are different kinds of co-operative banks like State co-operative banks, District
co-operative banks, Urban co-operative banks, Rural co-operative banks, etc.
Though registered under the Co- operative Societies Act of the State, the
banking activities of cooperative societies are subject to the control of RBI.
c) Non-Banking Financial Institution/Company (NBFI/NBFC]
A Non-Banking Financial Institution or Company is a body registered under the

Companies Act and is engaged in the business of providing financial services like
loans and advances, insurance, housing finance, hire purchasing, leasing, chit
fund, etc. For example, Kerala State Financial Enterprises Ltd. [KSFE) is a non-
banking financial institution. Investment funds, etc., belong to this category.
institutions like Unit Trust of India (UTI), public and private sector mutual funds
etc. belong this category.
A Non-Banking Financial Institution cannot accept savings deposit or issue

cheques to its customers, as in the case of a bank. Since they are not under the
direct monitoring of the RBI, deposits with the Non-Banking Financial Institution
are neither insured nor guaranteed by the RBI.
3) Financial Instruments
Financial instruments refer to the documentary proof of securities purchased by

the investors. In other words, financial instruments represent the money saved
by the people and entrusted with the financial instimtions to be deployed for
safe and profitable investment. The term 'Financial instrument' is used for a
variety of written legal claims on money that are transferable from one person
to another. Financial instruments are documentary evidence of a claim against
an individual/firm/state for payment of principal and/or interest or dividend on
a specified maturity date or on the spot. They are issued by financial
intermediaries in financial markets for channelizing funds from lenders to
borrowers.Financial instruments may be either primary instruments or
secondary instruments,
a) Primary or Direct Instruments
Financial instruments issued directly to the public are called primary or direct
instruments. For example, a company issues equity shares and collects capital.
Here share certificate issued to the subscriber is a primary instrument. Equity
shares, preference shares and debentures belong to the category of primary
financial instruments.
b) Secondary or Indirect Instruments
Unlike primary instruments, secondary instruments are issued by the financial

intermediaries. Later the financial intermediaries transfer the fund to the
ultimate borrowers. For example, a bank receives fixed deposit and issues F.D.
receipt to the depositor. Later the amount is lent to the borrowers. Here the FD.
receipt is a secondary financial instrument. Units of mutual funds, insurance
policies, post office savings are also examples of secondary or indirect financial
instruments. Financial instruments are issued by companies, financial
institutions and governments. They differ in price, marketability, rate of return,
type of benefits, extent of risk involved and transaction costs. Financial
instruments may be transferable or non-transferable. Financial instruments help
the financial intermediaries to collect funds from the public and channelise them
to companies, investment firms, etc.
4) Financial Services
Financial services can be defined as "all those services available in the financial
market which either do or assist the mobilisation of savings and their conversion
into investment". securitisation, portfolio managenie counselling and

consultancy are the important financial services currently available in the
market.
All the four components of a financial system viz., financial markets, financial
institutions, financial instruments and financial services function in close
relationship with each other. They are inter-dependent and mutually
supplement the functions of others. Their relationship is that the financial
institutions offer different types of financial instruments in the financial markets
for the mobilisation and transfer of capital or funds. Financial services extend
direct or indirect support to this process. At the same time, different financial
institutions strongly compete among themselves to increase their role and
market share.
Role and Functions of Financial System
In a market economy, the financial system performs a number of important

functions influencing the efficiency of the economy as a whole. A dynamic
financial system encourages savings to flow into money and monetary assets
which promotes investment and capital formation and facilitates economic
development. A good financial system ensures that savings are allocated in an
efficient manner so that scarce financial resources are effectively utilized.
Important functions can be listed as follows:
1) Mobilisation of savings and allocating them to projects.
2)Reallocation of accumulated old savings to projects and firms
3) Organisation of the payment and settlement system to ensure safe and quick
movement of funds.
4) Provision of liquidity of financial claims and securities.5) Provision of a good

corporate governance system.6 Generation of information for
economic/financial decision-making.
7) Creation of innovative schemes and features to make financial instruments

attractive to investors i.e., financial innovation.
8) Management of uncertainty and risk associated with mobilization of savings

and allocation of credit
9)Encourage investments by lowering the cost of transactions and offering an

increased rate of return to investors.
10) Facilitate judicious allocation of financial resources for the economic

development of the nation.
11) Facilitate financial engineering (development of new and improved financial

products or repack existing ones) in financial instruments, markets, services etc.
to ensure better performance of the system.
12) Promoting capital formation by channelizing the flow of savings into

productive investments.
13) Facilitate the integration of the domestic economy with that of other
foreign economies i.e., globalization of the economy.
Classification of Financial Markets
Financial Market is the market where financial securities like stocks, bonds etc
are exchanged at efficient market prices. The trading of financial instruments in
the financial market can take place directly between buyers (lenders) and sellers
(borrowers) or by the medium of stock exchanges. There are various segments
or sub-markets like equity markets, debt markets, derivative markets, foreign
exchange markets etc with the respective primary and secondary
wings/segments. The main organized financial markets in India are the money
market and the capital market.
I. The Money Market - It is a market for short-term debt instruments.
II. The Capital Market -lt is a market for long-term equity and debt
instruments
Borrowers of funds, suppliers of funds and the institutions serving as

intermediaries in the process of circulation of funds are collectively called
‘Financial Market'. Financial markets may be broadly classified into two as
Money Market and Capital Market.
Money market can be defined as a "market for short-term funds with maturity
period ranging upto one year and includes financial instruments that are
considered to be close substitutes of money".
As the definition highlights, money market refers to a market for short term debt
instruments having maturity period of less than one year, Money market is a
wholesale market of short term debt instruments where securities are
transacted in large denominations. It is not a single market but a collection of
markets for several instruments. Large financial institutions and governments
frequently depend on money market to manage their short-term fund
requirements and also to deploy surplus money for short-term periods.
Central and State Governments, Reserve Bank of India, mutual funds,

commercial banks, public sector undertakings, public and private companies,
foreign institutional investors [FIIS), domestic institutional investors (DIIS),
Discount houses and Non-banking financial companies are the major players in
money market.
Role and Functions of Money market
Money market plays a crucial role in the economy in three different ways.
Primarily it provides a mechanism for evening out short-term deficits and
surpluses of funds of business houses. Secondly, the central bank controls
liquidity in the economy through money market interventions. Thirdly, money

market helps to bring the short term lending rates to
optimum levels as a result of stiff competition among the players. Money market
is a need based market where the demand for and supply of money are the
major factors determining the terms and conditions of operations. Money
market provides a platform for the players to meet the short term fund
requirements. It also helps the participants to keep an optimum balance
between liquidity and profitability.
Benefits of Money Market
Money market facilitates efficient transfer of short term funds in the economy.
For the lenders it provides good return on their investment. For the borrowers
it provides speedy and relatively inexpensive source of money to meet short
term obligations. Money market enables the government as well as the central
bank to intervene in the financial system to check inflation or deflation by
increasing or decreasing interest rates. It also helps RBI in regulating supply of
money and maintaining liquidity in the economy. The various advantages of
money market can be briefed as follows.
1) Financing Trade
Money Market has a significant role in financing domestic and international

trade. Business houses quite often discount their commercial bills in large
volumes to meet the immediate fund requirements. Thus discount houses and
banks help in financing domestic and international trade.
2) Assisting Industrial Growth
Money market contributes to the growth of industries in two ways.
1) They help industries in securing short-term loans to meet the working capital
requirements through different types of money market instruments like call
money, commercial papers, etc.
ii) Industries require long-term funds, which are obtained from capital market.
However, the functioning of capital market is considerably depended on the
nature and conditions of money market. For example, the short-term interest
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rates in money market can influence the long- term interest rates of capital
market. Thus, money market indirectly helps to ensure competitive interest
rates in capital market.
3) Profitable Investment
Money market enables banks and other financial institutions to deploy their
short term surplus funds into most profitable investment avenues. The excess
reserves of the commercial banks are normally invested in money market
instruments since they can be easily converted into cash. Thus commercial
banks and financial institutions earn profits from money market without
sacrificing liquidity.
4) Self-Sufficiency for Financial Institutions
In the absence of a good money market, commercial banks and financial

institutions have to depend heavily on central bank to overcome scarcity of
funds. Money market assists them to avoid overdependence on RBI because
they can easily mobilise funds from money market without much legal
constraints restrictions as insisted by the central bank.
5) Assists the RBI
The central bank, through frequent money market interventions, can effectively
influence the banking system, money circulation, interest rates, market
competition etc. In other words, the RBI considers money market as a good
platform for healthy market competition beneficial for the economy as a whole.
Money market helps the central bank in the following ways also.
i) The short-run interest rates of the money market serves as an indicator of the
monetary and banking conditions in the country and guides the central bank to
adopt suitable banking policy;
ii) Since money market is highly sensitive on interest rates and financial
measures, the central bank can ensure quick and widespread steps for the
effective implementation of its policies. nogle
Money Market Instruments [Sub-Markets]
Different types of instruments are used in the money market. The major ones
among them are listed below.
I. Call Money
II. Treasury Bills (T-bills]
III. Commercial Papers (CPs]
IV. Certificate of Deposits [CDs]
V. Commercial Bills [CBS]
VI. Repo/Reverse Repo
VII. Collateralized Borrowing and Lending Obligations (CBLO]
VIII. Inter Corporate Deposits (ICDs]
IX. Banker's Acceptance [BA]
X. Money Market Mutual Funds (MMMFs]
i) Call Money Market -
Call money market is a very short term market in which funds are borrowed or
lent for a short period of 1 to 14 days. Call money market consists of two types
of transactions :
a) Call money or Money at call and
b) Money at short notice or Notice money
Call money is a loan given for a period of one day [24 hours) and repayable on
call, i.e., immediately on demand. Call money is next to cash in liquidity. When
the money is borrowed or lent for a period of more than a day and upto a
fortnight (2 to 14 days) it is called 'Money at Short Notice' or 'Notice Money'.
Money lent for 15 days or more in the inter-bank market [between banks] is
known as Term Money.
Features of Call Money Market
Call money market is basically an inter-bank money market. Prior to 2005

financial institutions other than banks were also permitted to operate in this
market. With effect from August 2005 only commercial banks, foreign banks, co-
operative banks and primary dealers are allowed to borrow and lend in this
market. Commercial banks borrow money from other banks either to maintain
the statutory requirements such as Cash Reserve Ratio (CRR) and Statutory
Liquidity Ratio (SLR) as stipulated by RBI or to meet any sudden demand for
funds rising out of large cash outflows. They frequently depend on call money
market for the purpose. Thus the call money market enables banks to even out
their day-to-day deficits and surpluses of money. Transactions in call money
market are not backed by any collateral securities. Call money market is highly
liquid as money lent can be called back at any time.
Call Rate or Call Money Rate
The interest rate charged on call loan is called 'call rate' or 'call money rate'. The
call rate is market determined and is very sensitive to the changes in the demand
for and supply of call loans. The call rate is highly volatile and may vary from day-
to-day, hour-to-hour or even minute-to- minute. Therefore too much
dependence on call money market is a risky exercise for the participants.
ii) Treasury Bills (T-Bills)
At times the Central Government may face shortage of funds due to the
temporary Trismatch between its receipts and expenditure. Treasury bills or T-
bills are the money market instruments used by the Central Government to raise
funds to fill the deficit between the receipts and expenditure. T-bills play an
important role in the cash management system of the government Treasury bills
market is the most important segment of the money market of any country, In
India T-bills are issued by the Reserve Bank on behalf of the Central Government.
The central bank uses T-bill as a tool to regulate the liquidity position and short
term interest rate in the country. T-bills are issued at discount to the face value.
The difference between issue price and maturity value is the return of the
investor. Treasury bills are negotiable securities. Earlier they were issued in the
form of promissory notes, in physical form. At present T-bills are not issued in
the scrip form but purchases and sales are made in dematerialised form. T- bills
are available in multiples 25,000 only.
All the entities registered in India including banks, financial institutions, primary
dealers, partnership firms, companies, mutual funds, FIIs, state governments,
provident funds and even individuals are eligible to purchase Treasury bills.
Presently, T-bills of different maturity periods like 91 days, 182 days and 364
days are available.
Sale of T-bills
T-bills are sold mainly through auction system. Auctions are conducted by the
Reserve Bank of India, in Mumbai. Competitive bids are submitted by the
participants in terms of price per 100. For example, one institution gives a bid
for the 91 day T-bill at 96.50. The auction committee of the RBI decides the cut
off price. Bids above the cut off price receive full allotment, bids at cut off price
may receive full or partial allotment and bids below the cut off price are
rejected.
Advantages of T-bills
Investment in Treasury bills is advantageous in different ways. The following are

the prominent ones among them.
• Treasury bills offer assured yield with low transaction cost.

• T- bills are eligible for inclusion in the securities for SLR purposes.
[Statutory Liquidity Ratio is insisted by the RBI for banks]
• There is no default risk as T-bills are government instruments,
• There is an active secondary market for T-bills. Therefore T-bills are highly
liquid and are easily tradeable.
• The procedure of issue and settlement of T-bills is simple and transparent.
• T-bills offer different sorts of tax incentives also. No tax is deducted at
source for these bills.
The Call money market and Treasury bills market form the most important
segments of the Indian money market.
Primary Dealer
The fund requirements of the government are quite often met by borrowings
from the market. In order to mobilise the required funds cheaply and efficiently,
the government appoints financial institutions and banks who are specialists in
the government security market. They act as market intermediaries for the
government. Such entities are generally called as Primary Dealers [PDs). In other
words, a Primary Dealer is a selected financial institution that has got the
privilege to deal directly with the central bank and the government for financial
market transactions.
iii) Certificate of Deposits [CDs]
Certificates of Deposits (CDs) are short term deposit instruments issued by

commercial banks and development financial institutions. Certificates of
Deposits are negotiable and quite often unsecured. A Certificate of Deposit can
be described as a savings certificate issued at a discount entitling the bearer to
receive interest.
A Certificate of Deposit bears a maturity date and a specified rate of interest.

Certificates of Deposit are the next lowest risk category money market
instrument after treasury bills. The denomination of a CD is minimum one lakh
and multiples thereof. Certificates of Deposits Were introduced in 1989 and they
are similar to fixed deposits [FDs) of banks. The major difference between CDs
and FDs is that CDs are transferable and tradable while FDs are not. Certificates
of Deposits can be issued to companies, trusts, funds and individuals.
Since CDs are issued during times of tight liquidity they carry relatively high rate
of interest. The maturity period of CDs issued by banks shall vary between one
week to one year. However, financial institutions can issue CDs of more
durations ranging between one to three years. CDs are issued in the
dematerialised form. However the investor has the option to get CD in physical
form, if needed. Dematerialised CDs can be transferred as in the case of any
other de-mat securities and physical CDs are freely transferable by endorsement
and delivery. CDs are negotiable instruments and hence tradable in the
secondary
money market.
iv) Commercial Papers (CPs)
Commercial Papers (CPs) are unsecured, short-term debt instruments issued by

ereditworthy companies for meeting their short term liabilities, CPs were
introduced in India in 1990 with a view to enable highly rated corporate

borrowers to diversify their sources of short term funds, Commercial paper is a
promissory note with a fixed maturity period. It is a certificate evidencing an
unsecured corporate debt of short term matunty period. They are negotiable
and transferable by endorsement and delivery, Corporate entities issue
commercial papers normally to meet their working capital requirements,
Maturity period of CPs mange between 7 days to one year, Commercial papers
are issued at discount and the discount offered reflects the prevailing market
interest rates. The denomination of a CP is minimum five lakh and multiples
thereof
Banks are the major subscribers of commercial papers, though they can be
issued to companies and individuals also. Commonly, CPs are privately placed
with the investors through a merchant bankers.
For issuing a commercial paper the company must get them rated by a
recognised credit rating agency and obtain adequately high rating, CPs are
available in dematerialised form or as promissory note in the physical form. Prior
approval of the RBI is not needed for the issue of CPs, but is not permitted in the
case of CPs,but every issue has to be reported to the Reserve Bank of India.
Advantages of CPs
The following are the important advantages of commercial papers,
✓ Simplicity is the prime advantage of CPs. It involves much less

documentation between the issuer and investor,
✓ CPs of different maturity periods can be issued so as to match the cash
flow of the issuer,
✓ Commercial papers provide investors with higher returns than they could
get from banks,
v) Commercial Bills [CBs]
A trade bill [bill of exchange) is a short term, negotiable instrument drawn by a

seller on the buyer for the value of goods delivered in a credit transaction.
Normally the maturity period of bills shall be 30, 60 or 90 days. The drawer
(seller of the goods] or holder of the bill has different options before him. He
can keep the bill upto maturity date and present it to the drawee [buyer of
goods] for payment or can transfer the bill to some of his creditors to whom he
owes money. There are various types of commercial bills based on the maturity
period, accompanying documents, title of the bill, etc. If the drawer is in need of
money before maturity, he has the option of getting the bill discounted by a
commercial bank. When a trade bill is accepted and discounted by a commercial
bank, it becomes a commercial bill. Business men make use of this method
extensively to meet their working capital requirements. When the commercial
banks are in need of short term funds they get such bills rediscounted with the
RBI or other financial institutions.
vi) Repo and Reverse Repo
Repo is the short form for repurchase offer. It is basically a contract entered into
between RBI and other banks A repo is an agreement for sale of a security with
a commitment to repurchase the same at a specified price on a specified date in
future. For example, commercial bills with Canara Bank, discounted by traders,
may be sold by the bank to the RBI, to meet the short term fund requirements,
but with an undertaking to purchase the bills back on a future date. In other
words, Canara bank enters into an agreement with the RBI to sell the securities
to the latter, with an agreement to repurchase them back on a pre-determined
rate. This is a Repo for the Canara Bank.
Repo Rate
The repurchase price will be grenier than the original sale price, the difference
effectively representing interest, which is called as the repo rate. The party who
buys the securities elfectively acts as a lender the given example RBI, The original
seller (Canara Bank) is effectively acting as a borrower, using their security as
collateral for a secuered cash loan .Thus, Repo rate is the rate at which banks
borrow funds from the RBI to meet their short term financial requirements.
Reverse Repo
The term reverse repo is commonly used to describe the transaction in a debt
instrument where the buyer in the repo agreement immediately the security
provided by the seller to another buyer in the open market on the condition that
the security will be purchased back on a sperates future date, Forexample, RBI
may sell the serurity in another comment bank or banks with the offer to buy
the same back, on the settlement date on the settlement date of the repo, RBI
acquires the relevant security from the buyer and delivers it to the original seller
of the security.
Reverse Repo Rale rate
Reverse Repo Rate is the rate at which Reserve Bank of India borrow money
from banks, Banks are always happy to lend money to RBI since their money is
in safe hands with a reasonably good rate of interest.
An increase in Reverse Repe Rate will prompt the banks to transfer more funds
to RBI due to this attractive interest rates. Thus reverse reporate can be used to
draw money out of the banking system Reverse repo mute represents the rate
at which the central bank absorbs liquidity from the banks, while repo signifies
the rate at which liquidity is injected
vii) Collateralized Borrowing and Lending Obligations (CBLO}
Collateralized Borrowing and Lending Obligation (CBLO is a money market

instrument developed by the Clearing Corporation of India Ltd. CBLO is a
mechanism which enables the financial institutions to lend or borrow money on
the support of documents vested with the CCIL who acts as a depository of such
documents. In other words, CBLO is a money market instrument that enbales
financial institutions to lend and borrow on similar lines with call money market.
CBLO is an RBT approved money market instrument which can be issued for a
maximum tenor of one year. The following are the features of CBLO.
• CBLO is an instrument backed by Gilt edged securities;

[Gilt edged securities refers to high-grade bonds that are issued by a
government or company. Earlier the term was used to represent
government securities. Now agilt-edged security denotes a stock or bond
issued by a company too that has a strong record of consistent earnings
and can be relied on to cover dividends and interest. Gilt-edged securities
are a high-grade investment with very low risk.]
• It creates an obligation on the borrower to repay the money along with

interest on a predetermined future date;
• The lender has the right to receive money along with interest on a
predetermined future date;
• The lender has an option to transfer his right to receive the money, to any
other person;
• It creates a charge on the collaterals deposited by the borrower with CCIL
for the purpose;
viii) Inter Corporate Deposits (ICDs]
Inter Corporate Deposit represents unsecured loan given by a corporate entity

to another corporate entity, facing shortage of funds. Therefore in the case of
an ICD, both the lender and buyer are corporates. ICD is helpful to high rated
companies to make benefit by lending funds to low rated companies, because
the high rated companies can avail funds from the banking system at
comparatively lower rate and then lend the amount to small companies at a
higher rate.
The rate of interest in ICD market is relatively higher due to the higher risk
involved in advancing to the lower rated corporates. Moreover, the deposits in
this market are unsecured.
ix) Banker's Acceptance (BA)
Banker's acceptance or BA, is a money market instrument that usually arises in

the course of international trade. It is a negotiable instrument drawn by a
customer on his bank and accepted by the bank to finance import from foreign
countries.
Banker's Acceptance can be described as a short term credit instrument created

by a commercial firm and guaranteed by a bank. Before acceptance, the
document is not an obligation of the bank, it is merely an order by the drawer
to the bank to pay a specified sum of money to the person named in it or the
bearer. But upon acceptance by the bank, it becomes a primary and
unconditional liability of the bank. Banker's Acceptance originates as an order
to a bank by a customer to pay a sum of money at a future date, normally within
six months. At this stage it is like a post dated cheque. When the bank endorses
the order for payment as 'accepted the bank assumes the responsibility for
ultimate payment to the holder of the instrument. Thereafter the acceptance
becomes eligible for being traded in the secondary market just like any other
claim on the bank.
x) Money Market Mutual Funds [MMMFs]
Money Market Mutual Funds (MMMFs)pool funds from retail investors and
invest them in various short term money market securities. It enables the
investors to deploy their surplus funds in money market instruments which offer
comparatively higher rate of return. They are more liquid compared to other
investment alternatives. From safety point of view also, investment in MMMFs
is more attractive because the funds are invested in highly rated securities of
governments and banks.
MMFS enable small and medium investors to indirectly participate in the money
market which is basically a field of big players. In short MMMFs operate just like
other mutual funds with the only difference that the funds are invested in
money market secunities.
Capital Market
Capital market refers to the market in which corporate equity and long- term
debt securities (with maturity period of more than one year) are issued and
traded. Therefore it is the market for long term funds where securities like
equity shares preference shares and bonds are bought and sold. Both the
primary market for new issues and the secondary market for existing securities
constitute the capital market.
Availability of long term funds for investment is extremely important for the
development of any economy. Capital market is the major source of medium
and long term funds. The funds in this market are raised either through
ownership securities like equity and preference shares or creditorship securities
like debentures and bonds.
Functions of Capital Market
Capital market performs a number of important functions in the financial system

of a country. Such functions can be summarised as follows
1. Motivates the different economic units to generate surplus and save it for
long term
2. Mobilises the savings and redirects them to long term investment projects
in the productive sectors.
3. Supplies long term capital to the entrepreneurs through equity
instruments
4. Provides medium term capital through debt instruments,
5. Ensures liquidity to the suppliers of funds by arranging secondary market
facility so that they can sell their securities at any time.
6. Improves the efficiency of allocating the available capital, which is scarce,
through a competitive pricing mechanism.
7. Continuously accumulates and disseminates quality information
regarding the developments in the market so that participants are
enabled to take wise and timely decisions.
8. Facilitates effective investment, reinvestment, disinvestment of financial
assets.
9. Enables the investors to know the current valuation of their investment
in securities at any time,
10. Extends the coverage of the securities market by reaching out to more
and more individuals and institutions through advanced information
networks,
11. Ensures efficiency in performance through simplified procedures, speedy
settlement of accounts and low cost for transactions.
12. Enables proper integration and equilibrium among the long term and
short term interest rates, equity and debt instruments, private and
government sectorsm, etc.
Sub-division of Indian Capital Market
Both the industrial sector and the government sector borrow funds from capital
market. Therefore the Indian capital market can be categorised into two as:
i) Industrial securities market and
ii) Government securities market
The industrial securities market can be again sub-divided as primary market and
secondary market.
I) Industrial Securities Market
The segment of the capital market through which the corporate entities raise
funds for their long term requirements, is known as the industrial securities
market. Corporate entities raise funds mainly through two types of securities
viz., Ownership securities and Creditorship securities.
A) Ownership Securities
The holders of the ownership securities are the real owners of the company
because they contribute towards the share capital of the company. A share
represents the smallest unit of ownership instruments. The persons who
subscribe to the shares are the shareholders of the company. Ownership
securities of a company consist of two types of instruments as a) equity shares
and b) preference shares.
a) Equity Shares
Equity shares are also known as ordinary shares. Equity shareholders are the
real owners of the company. They have voting right at the shareholder's annual
general meeting in proportion to their share in the paid up equity capital of the
company. It is through the voting right that they exercise their power and
control over the management of the company. Equity shareholders are entitled
for the entire balance of profit available after paying dividend to the preference
shareholders. Equity shareholders are also entitled to the accumulated free
reserves of the company. However, investment in equily shares bears some risks
too. The equity shareholders get return for their investment only if the company
makes sufficient profit. Similarly at the time of winding-up of the company the
equity share capital is repayable only after settling all other claims due to the
trade creditors, debenture holders, preference Shareholders, etc. Therefore the
equity share capital is also called 'risk capital'.
Bonus Shares
Bonus shares are issued by the company to the existing shareholders free of
cost. In fact bonus share is nothing but dividend paid in the form of shares.
Therefore bonus shares are issued to the shareholders in proportion to their
existing shareholdings. Bonus shares can be issued only when the existing shares
are fully paid up. They are issued out of accumulated profits or reserves of the
company subject to the following conditions insisted by the Companies Act.
• There must be sufficient amount of accumulated profits or reserves

available for bonus issue.
• The articles of association must contain a provision for the issue of bonus
shares.
• The board of directors must pass a suitable resolution and
• The shareholders must approve the proposal in the annual general
meeting
Sweat Equity Shares
The Companies Act defines sweat equity shares as "equity shares issued by the
company to its directors or employees at a discount or for consideration other
than cash for providing know-how or making available rights in the nature of
intellectual property rights or value additions".
In simple words, sweat equity shares mean the equity shares given to the
company's directors or employees on favourable terms in recognition of their
special contributions or extra efforts for the company.
Eligible employees are given an option to buy equity shares and become owners
of the company and participate in profits apart from earning salary. Therefore
the scheme is called Employee Stock Option Plan or Employee Share Ownership
Plan (ESOP). Many companies adopt ESOP as a good tool to retain talented
human resources, their Intellectual Property Right (IPR), know-how, skill and
expertise. Moreover ESOP also helps to improve the employer-employee

relationship in the company to a great extent.
Equity Shares with Detachable Warrants
A warrant is a security issued by a company granting its holder the right [but no
obligation] to purchase a specified number of additional shares at a specified
price within a given time. Warrants are issued with shares as well as debentures.
Such warrants are detachable and can be sold independently and the warrant
holder is entitled to apply for the shares whenever there is public issue within
the time specified
Non-Voting Shares
Equity shares which are eligible for dividend, but the holders of which are not
entitled for voting rights at any meeting are called non voting shares. This type
of shares are issued to individuals who want to invest in the company but not
interested to enjoy the voting rights. Non voting shares enable a company to
prevent dilution of control. Moreover such shares also help to avoid the
commitment of a fixed rate of dividend as in the case of preference shares.
b) Preference Shares
Shares which carry preferential rights over the equity shares are called
Preference shares. There are two sorts of preferential rights, first being the right
to receive the payment of dividend before any thing is paid to the equity holders.
The second is the preferential right with regard to the repayment of capital at
the time of winding up of the company. There are different types of preference
shares. They are briefly listed below.
i) Cumulative and Non-Cumulative
The cumulative preference shareholders have the right to claim the entire
unpaid dividend of the past years, subsequently, when sufficient profits are
available. In other words, in the case of cumulative preference shares the unpaid
dividends get accumulated and are paid out when there is enough profits. But
the non cumulative preference shares do not have any right to claim the arrears
of dividend of past years. In other words, in the case of cumulative preference
shares the unpaid dividends get accumulated and are paid out when there is
enough profits. On the other hand the non cumulative preference shares do not
have any right to claim the arrears of dividend of past years.
ii) Redeemable and Irredeemable
Those shares which are to be repaid or redeemed by the company within a

predetermined term are called redeemable preference shares. On the other
hand, irredeemable preference share are not repayable during the life time of
the company. In other words, irredeemable preference shares are redeemed
only at the time of winding up of the company. The companies Act insists that a
company must redeem its preference shares within a period of ten years of
issue. Therefore irredeemable preference shares can not be issued in India.
A company can issue redeemable preference shares only if the articles of

association contains a provision for that. The shares will be redeemable only if
they are fully paid up. They are redeemed out of the profits of the company or
out of proceeds of a new issue of shares made for that purpose.
iii) Participating Preference Shares
Participating preference shares have a right to participate further in the profits

of the company over and above the fixed rate of dividend.
iv) Convertible Preference Shares
Preference shares having an option to convert them into equity shares after a
specified period of time are called convertible shares.
B) Creditorship Securities
The holders of creditorship securities or debt instruments are the creditors of a

company. They enjoy fixed rate of interest on their investments, Debentures and
bonds are the prominent creditorship securities.
i) Debentures
A debenture is defined as a certificate given under the company's seal which

acknowledges its medium or long term indebtedness. Debertures are debt
instruments carrying a fixed rate of interest issued by companies to borrow
money from the capital market. Debenture holders supply loan capital to the
company.
Types of Debentures
There are different types of debentures. The following are the impor ones
among them.
a) Bearer Debentures
In the case of bearer debentures, the borrowed amount is payable to the bearer
of the security. Bearer debentures are transferable and megotiable by
endorsement and delivery.
b) Registered Debentures
In the case of registered debentures, the amount is payable only to the

registered debentureholders of the company. Such debentures are transferable
but only by entering the name of the transferee in de register of the company.
c) Unsecured Debentures
When debentures are issued without any charge on the assess of the company
or any other security, they are called unsecured or naked debentures.
d) Secured Debentures
These are debentures backed by security through charge on the assets of the
company. The charge can be either fined charge or floating charge.
e) Redeemable Debentures
Such debentures are redeemable or repayable at par or premium cler after the
expiry of particular period or a decaded by the company
f) Perpetual Debentures
Debentures may be made irredeemable or perpetual by not specifying any time

frame for its redemption. Such debentures are redeemable only when the
company decides to do so or when the company is dissolved
g) Convertible Debentures
Debentures may be convertible into equity or preference shares after a specified

period of time or as per certain agreed terms and conditions, When the full
amount of debentures is convertible into shares of the company, they are called
fully convertible debentures (FCD). When only a part of the amount of
debentures is convertible into shares, they are called partly convertible
debentures (PCD). The remaining part of such debentures is redeemable based
on the previously agreed terms.
Debentures which are not convertible into equity or preference shares are called
non-convertible debentures. There is another category of debentures called
'Interest Fully Convertible Debentures', in which case the interest on debenture
is not paid periodically, but get accumulated and is automatically converted into
equity shares.
ii) Bonds
A bond is an instrument under seal whereby one person binds himself to

another for payment of a specified sum of money at a specified date. In fact
there is no significant difference between bond and debenture. In India,
traditionally the term bond is used to indicate the instruments issued by the
government, semi government bodies and public corporations and
the term debenture is used to denote instruments issued by the corporate

sector. Now a days companies also started issuing different types of bonds with
varying privileges to the holder.
In practice, there exists some minor differences between bonds and debentures.
Bonds issued by a company are considered to be more secure than their
debentures. Bonds bear comparatively lower rate of interest. In case of winding
up of the company the amount due to the bond holders are paid prior to that of
the debenture holders.
Types of Corporate Bonds
The following are the major types of bonds issued by the corporates.
a) Bearer Bonds
These are bonds whose amount is payable to the holder of the instrument.
b) Registered Bonds
In this case the amount is payable to the person whose name is mentioned in
the register of the company.
c) Zero Coupon Bonds or Deep Discount Bonds
This is a new type of bond which has no periodic interest payment. They are
issued at a substantial discount to its face value. The difference between the
purchase price and the face value is the gain to the holder.
d) Sinking Fund Bonds
In the case of sinking fund bonds, the issuing company redeems a fraction of the
issue every year. Finally, only a small portion of the principal amount remains to
be repaid, on maturity.
e) Junk Bonds
Junk bonds are high risk and high yield bonds developed in USA. They are
normally issued in connection with mergers, acquisitions etc.
f) Privately Placed Bonds
Such bonds are sold directly to a limited number of institutional investors or in

other words they are 'privately placed'. They are not negotiable.
g) Bunny Bonds
Bunny bonds permit the bond holder to invest the interest income into the
bonds with the same terms and conditions of the host bond.
h) Secured Premium Notes (SPN)
These instruments are issued with detachable warrants and are redeemable
after a notified period, normally 4 to 7 years. The warrants enable the holders
to get equity shares when the SPNs are fully paid. The conversion of detachable
warrants into equity shares will have to be done within the time limit notified
by the company.
New Financial Instruments
Along with the unprecedented growth of industrial and service sectors globally,
the competition for the available funds also intensified Investors are becoming
increasingly selective. They differ in the perceptions regarding risk bearing,
expectation of returns and period for which funds can be spared. Hence to
satisfy the investors and attract their funds it became necessary for the issuers
to innovate new financial instruments. A new financial instrument is one which
has some new or additional features over the existing instruments. The
following are some of the recently issued financial instruments in global financial
market.
1) Floating Rate Bonds
Floating rate bonds are bonds whose interest rate is not fixed, but related to the
market rate. The interest rate of this type of bonds will fluctuate according to
the interest movements in the economy. Floating rate bonds ensure that neither
the borrower Dorthe lender suffers due to change in the interest rates. These
bonds usually specify a minimum and maximum range within which the interest
rate may fluctuate, depending on the market situations,
ii) Zero Coupon Bonds or Deep Discount Bonds
As already seen, Zero Coupon Bonds have no periodic interest payment. Instead
they are issued at a substantial discount to its face value. The difference
between the purchase price and the face value is the return to the investor. Zero
coupon bonds are more suitable for companies which have projects with long
gestation period as there is no immediate payment of interest on the funds
raised. Since these bonds do not have periodic interest payment, the investors
get some tax benefits as well.
1) Depository Receipts (DRS)
A depository receipt (DR) is a negotiable instrument, in the form of a certificate,

denominated in US dollars issued by an overseas depository against certain
underlying stocks or shares. The shares are deposited by the issuer company
with the depository and the depository in turn gives DRS to the investors. The
depository receipt represents a particular group of shares on which the receipt
holder has the right to receive dividend, other payments and benefits which the
company announces from time to time. DRs facilitate cross border trading and
settlement, minimise transaction costs and broaden the shareholders' base.
However DR holders do not have voting rights. Indian companies are permitted
to raise funds from foreign markets through two types of DRs, viz.,
a) American Depository Receipts and
b) Global Depository Receipts.
a) American Depository Receipts [ADRs]
American Depository Receipt (ADR), is a negotiable US certificate representing

ownership of shares in a non-US company. ADR is a receipt given by a Depository
based in US, representing the worth of shares of a company whose share
certificates are deposited with it. Any non-US company seeking to raise capital
from the US market or to increase its US investor base, can issue ADR. For
example X Ltd., an Indian company cannot directly issue its shares in USA, but
can deposit its shares with a depository in USA and can have equivalent worth
of ADR, denominated in US dollars. X Ltd. can sell these ADRs in the US market
and raise funds. Indian companies make use of ADRs to raise foreign currency
resources from investors in USA. ADRs are quoted and traded in US dollars in
the US securities market. They are designed to facilitate the purchase, holding
and sale of non-US securities by US investors, without worrying about the
complexities of cross border transactions. They offer to the US investor the same
economic benefits enjoyed by the domestic shareholders of the non-US
company. ADRs are listed in US stock exchanges so that they can be traded or
transferred like ordinary shares.
b) Global Depository Receipts [GDRs]
When the concept of ADR is extended to other geographical markets it is termed

as Global Depository Receipt (GDR). GDR may be defined as a financial
instrument that allows the issuer to raise capital from international markets
other than US. ADR and GDR are identical in legal and operational aspects. But
the word "global' denotes that the receipts are issued on a globał basis, i.e., to
investors not restricted to US.
Indian Depository Receipts [IDRs]
An indian Depository Receipt [IDR] is an instrument enominated in Indian upees

in the form of a domestic depository receipt against the underlying equity of
issuing company, to enable the forign companies to raise funds from the indian
securities market.
II) Government Securities [G-Sec] Market
A government security [G-Sec] is a tradable instrument issued by the Central

Government or State Governments. G-Sec means a document created and
issued by the government for the week of raising public loan. It may be in the
fom of a promissory note or bearer bond. It is an acknowledgement of the
Governments debt obligation. Such securities can be either short term securities
like Treasury bills or long term instruments refered to as ‘Dated
secuities’.Government securities carry practically no risk of default and hence
they are refered to as risk free securities. They are also known as ‘Gilt edged’
securities because the repayments of principal and interest are totally secured
by soveign gurantee. Government securities often carry some additional
attractions like tax exemptions or rebates.
Dated Government Securities [ Bonds]
Dated government secuities or Bonds are long term securities carriying fixed or
floating coupn rates(interest rates). The interest is payable by fixed time periods,
usually half yearly.
Types of Government Bonds
The following are the different types of bonds issued by the government in the
securities market.
i) Fixed Rate Bonds
These are bonds on which the coupon rate is fixed for the entire life of the bond.
Most of the government bonds are issued as fixed rate bonds.
ii) Floating Rate Bonds
These are securities which do not have a fixed coupon rate. The coupon rate is
reset at regular intervals, based on interest rate fluctuations.
iii) Zero Coupon Bonds
These are bonds with no coupon payments. Like Treasury bills they are issued at
a discount to the face value. The Government of India issued Zero coupon bonds
for the first time in the early nineties and has not issued such bonds thereafter.
iv) Capital Indexed Bonds
These are bonds whose principal is linked to an accepted index of inflation with
a view to protect the holder from the impact of inflation. The Government is
currently working on an improved version called Inflation Indexed Bonds in
which the payment of both the principal and coupon will be linked to an inflation
index.
v) Bonds with Call or Put Options
Bonds can also be issued with features of options where the issuer reserves an
option to buy-back (call option] them or the investor shall have the option to sell
put option to the issuer, during the currency of the bond
STRIPS
The government has devised some new types of instruments like Separate
Trading of Registered Interest and Principal of Securities [STRIPS]. STRIPS are
instruments where interest due on a fixed coupon security is converted into a
separate tradable Zero Coupon Bond.
Advantages of Government Securities
• Besides interest, Government securities offer maximum safety since they

carry the Sovereign's commitment for the payment of interest as well as
principal.
• Government securities are available in a wide range of maturity periods
ranging from 91 days to as long as 30 years, so as to suit to the
requirements of different types of investors.
• They can be sold easily in the secondary market ensuring liquidity.
• They can be held in demat form and thus avoid the hassles of keeping
hard copies
• G-secs can be used as collaterals to borrow funds whenever required,
• Information regarding the market prices of government securities are
available at any time due to the active secondary market and transparent
price dissemination mechanism
Differences between money market and capital market
Money Market Capital market
Dealings are for a period of less than Dealings are for a period of one year
one year. or more.
Securities are of high denominations. Securities are of small face values.

Hence each transaction is for a large Hence individual transactions are for
volume. small amounts.
Basically, institutional market. FIs buy Institutions are the issuers,

and sell at their own. Institutions and individuals buy and
sell. Individuals transact through
brokers.
There is no particular trading floor. Transactions are done through

Transactions are made over phone or organised exchanges
other electronic media.
Call Money, T-bills, CPs, CDs Equity and preference shares,

Commercial bills, Repos, CBLOs, etc., Debentures, Bonds, Futures, Options
are traded. and Swaps are traded
Return on investment is assured and High risk and high return.

the risk is low.
Speculative transactions are Speculations are more since the

comparatively less. maturity periods of instruments are
longer.
INDIAN MONEY MARKET
The Indian money market is a monetary system that facilitates the lending and
borrowing of short-term funds. Though it is not a developed money market, it is
a leading money market among developing countries. Reserve Bank of India
(RBI) plays a major role in regulating and controlling the Indian money market.
An important function of the Indian market is to facilitate the interventions of
the RBI. Thus, RBI influences the liquidity in the financial system and implements
other monetary policy measures through the money market. The structure of
Indian money market can be broadly classified into two; Organised (formal) and
Unorganized (Informal). Both these consist of different players and
components.RBI 1s at the head of the organized Indian money market. The
control extends to all those operating in the money market including
financialinsituions, banks, mutual funds, individuals and companies.
Capital MarketThe main constituents in a money market are the lenders who
supply the money and the borrowers who demand short-term credit. The
players in money market include; Government, Central Bank (i.e., RBI), Banks,
Discount and acceptance houses, Financial institutions, Corporate houses,
Mutual Funds, Flls etc. RBI, SBI and its subsidiaries, high rated corporations,
financial institutions etc., supply short-term fund. Central government, State
Government, local bodies, companies, mutual funds, insurance companies and
commercial banks are the main borrowers.
Unorganized Money MarketThe unorganized money market in India is not

under the direct control of RBI. The unorganized sector consisting of numerous
indigenous bankers and village money lenders also supply funds. The financing
gap (i.e., the requirements of unsatisfied borrowers in the organized market)is
met by the unorganized market. The interest rate in this segment is generally
higher than that in the organized market.
Characteristics of Indian money market-
1Dichotomic Structure –
It has a simultaneous existence of both the .organized money market as well as

unorganized money markets.
1. Seasonality - The demand for money in the Indian money market is of a

seasonal nature.
2. The multiplicity of interest rates differ from bank to bank, from period to
period, in organised and unorganized markets
3. Lack of organized bill market In the Indian money market, the organized
bill market is not prevalent.
4. .Absence of integration - There is a lack of coordination among different

components of the money market. RBI has full control over the
components in the organized segment but it cannot control the

component in the unorganized segment.
5. Limited instruments - It is n fact a defect of the Indian money market. .In

order to meet the varied requirements of borrowers and lenders,it is
necessary to develop numerous instruments.
Components /Sub-Markets of the Indian money market
A]call money market: It refers to the market for extremely short period
loans (1 to 14 days). It an important submarket of the Indian money
market.
B]Commercial bills market: It is a market for commercial bills arising)out

of trade transactions. Demand and usance bills, clean bills and
documentary bills, inland and foreign bills etc are the different types of
bills circulating in this market, It has two segments viz., Discount market
and Acceptance market Discount market refers to the market where short
term trade bills are discounted by financial intermediaries like banks,
Acceptance market is the market where short term trade bills are
accepted by financial intermediaries.
C]Treasury bill market: A market where treasury bills are bought and sold.
Treasury bill constituted the main instrument for short term borrowing by
the Government.market
D] Certificate of Deposits (CDs): It is again an important segment of the

Indian money market. The certificate of deposits is issued by the
commercial banks. E)Market for Commercial Papers (CPs): It is the market
where the commercial papers are traded.)
F]Short Term Loan Market: It is a market where the short-term loan

requirements of corporates are met by the Commercial banks. Banks
provide short-term loans to corporates in the form of cash credit or in the
form of overdraft.)
F]Repo Market: It is the market for repurchase agreements (repos).
Limitations
1. No Active Secondary Market: There is no active secondary market for

many instruments like Treasury Bills, Commercial Bills, CPs and CDs, etc in
India. Recently, the RBI has initiated schemes for the development of the
secondary market in commercial paper and for trading in certificates of
deposits and participation certificate.
2. Seasonality: An important aspect of the Indian money market is the

seasonality in the demand for funds following operations. The busy
season for funds extends from November to April and the slack season
from May to October.
3. No Foreign Players: Besides, the Indian money market 1s also

characterized by insulation from the foreign money markets due to the
operation of exchange controls in the economy, despite some
liberalization recently and freeing of the rupee. Another important aspect
of the money market is the dichotomy between the organised and
unorganized markets.
4. Lack of Integration: Unlike developed money markets, the Indian

market is not characterized by a high degree of integration and cohesion.
Multiple interest rates, shortage of investment instruments, less number

of dealers, etc are also defects of the Indian money .

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INVESTMENT MANAGEMET

INDIAN FINANCIAL SYSTEM

A financial system refers to a set of activities, which facilitate the

Production. Thus, the growth of financial system means growth or savings in

Features of Financial System

A well developed financial system is characterised by the existence of an

• Organised and unorganized financial markets are part of financial

A strong legal and regulatory environment, stable currency system,

INDIAN FINANCIAL SYSTEM

The Indian financial system includes both organized and unorganised

Components of Financial System

The Indian financial system consists of financial markets, financial

A financial market is an institutional arrangement that facilitate the

Organised sector of financial market consists of two important

The capital market consists of a number of institutions that borrow and

An unorganized financial market is an informal arrangement for

Financial institutions, also called financial intermediaries, are those institutions

Banking institutions constitute another major category of financial institutions.

c) Non-Banking Financial Institution/Company (NBFI/NBFC]

A Non-Banking Financial Institution or Company is a body registered under the

A Non-Banking Financial Institution cannot accept savings deposit or issue

Financial instruments refer to the documentary proof of securities purchased by

a) Primary or Direct Instruments

b) Secondary or Indirect Instruments

Unlike primary instruments, secondary instruments are issued by the financial

into investment". securitisation, portfolio managenie counselling and

Role and Functions of Financial System

In a market economy, the financial system performs a number of important

1) Mobilisation of savings and allocating them to projects.

2)Reallocation of accumulated old savings to projects and firms

4) Provision of liquidity of financial claims and securities.5) Provision of a good

7) Creation of innovative schemes and features to make financial instruments

8) Management of uncertainty and risk associated with mobilization of savings

9)Encourage investments by lowering the cost of transactions and offering an

10) Facilitate judicious allocation of financial resources for the economic

11) Facilitate financial engineering (development of new and improved financial

12) Promoting capital formation by channelizing the flow of savings into

Classification of Financial Markets

I. The Money Market - It is a market for short-term debt instruments.

Borrowers of funds, suppliers of funds and the institutions serving as

Central and State Governments, Reserve Bank of India, mutual funds,

Role and Functions of Money market

liquidity in the economy through money market interventions. Thirdly, money

Benefits of Money Market

Money Market has a significant role in financing domestic and international

2) Assisting Industrial Growth

Money market contributes to the growth of industries in two ways.

4) Self-Sufficiency for Financial Institutions

In the absence of a good money market, commercial banks and financial

5) Assists the RBI

Money Market Instruments [Sub-Markets]

a) Call money or Money at call and

b) Money at short notice or Notice money

Features of Call Money Market

Call money market is basically an inter-bank money market. Prior to 2005

Call Rate or Call Money Rate

ii) Treasury Bills (T-Bills)

Investment in Treasury bills is advantageous in different ways. The following are

• Treasury bills offer assured yield with low transaction cost.

iii) Certificate of Deposits [CDs]

Certificates of Deposits (CDs) are short term deposit instruments issued by

A Certificate of Deposit bears a maturity date and a specified rate of interest.

iv) Commercial Papers (CPs)