Dr.

Neelam Tandon

a. b. c.

Financial System is a complex system comprising of sub-systems of: financing institutions, markets, instruments, and services which facilitates the transfer and allocation of funds, efficiently and effectively.

The economic development of a nation is reflected by the progress of the various economic units, broadly classified into corporate sector, government and household sector. While performing their activities these units will be placed in a surplus/deficit/balanced budgetary situations.

 There are areas or people with surplus funds and there are those with a deficit. A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. .

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markets.  The word "system". and liabilities in the economy. practices. . implies a set of complex and closely connected or interlined institutions. The financial system is concerned about money. agents. credit and finance-the three terms are intimately related yet are somewhat different from each other. claims. transactions. in the term "financial system".

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 Financial market is a market where financial instruments are exchanged or traded and helps in determining the prices of the assets that are traded in and is also called the price discovery process. .

NSE. bonds and warrants. MCX) facilitate the trade in stocks.g. For e. Organizations that facilitate the trade in financial products. . Stock exchanges (BSE.

 Coming together of buyer and sellers at a common platform to trade financial products is termed as financial markets.e. stocks and shares are traded between buyers and sellers in a number of ways including: the use of stock exchanges. . directly between buyers and sellers etc. i.

     Financial markets may be classified on the basis of Types of claims – debt and equity markets Maturity – money market and capital market Trade – spot market and delivery market Deals in financial claims – primary market and secondary market .

Secondary capital market Money Market Debt Market .    Indian Financial Market consists of the following markets: Capital Market/ Securities Market Primary capital market.

  Primary Market : Deals with new securities Provides additional capital to issuer companies Secondary Market: Is the market for existing securities. It Provides liquidity to existing stock. . which are already listed No additional capital is generated.

Bombay Stock Exchange Limited Oldest in Asia Presence in 417 cities and towns in India Trading in equity. debt instrument and derivatives  National Stock Exchange  New York Stock Exchange (NYSE)  NASDAQ  London Stock Exchange  Functions of Stock Exchanges  Liquidity and marketability of securities  Fair price determination  Source of long-tern funds  Helps in capital formation  Reflects general state of economy  .

Movements in the index represent the average returns obtained by the investors. Stock market index is sensitive to the news of: Company specific Country specific Thus the movement in the stock index is also the reflection of the expectation of the future performance of the companies listed on the exchange . It is a representative of the entire stock market.     A stock market index is the reflection of the market as a whole.

. The Clearing House acts like an intermediary in every transaction and acts as a seller to all buyers and buyer to all sellers.  Settlement is the process whereby the trader who has made purchases of scrip makes payment and the seller selling the scrip delivers the securities. This settlement process is carried out by Clearing Houses for the stock exchanges.

This market encompasses the trading and issuance of short term non equity debt instruments including treasury bills. commercial papers. . etc.  Money market is a market for debt securities that pay off in the short term usually less than one year. for example the market for 90-days treasury bills. bankers acceptance. certificates of deposits.

It is a short term (usually less than one year, typically three months) maturity promissory note issued by a national government as a primary instrument for regulating money supply and raising funds via open market operations. Issued through RBI , T-bills commonly pay no explicit interest but are sold at a discount their yield being the difference between the purchase price and the par-value (also called redemption value).

This yield is closely watched by financial markets and affects the yield on municipal and corporate bonds and bank interest rates. Although their yield is lower than on other securities with similar maturities, T-bills are very popular with institutional investors because, being backed by the government's full faith and credit, they come closest to a risk free investment.

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. CP, as a privately placed instrument, was introduced in India in 1990 with a view to enable highly rated corporate borrowers to diversify their sources of short-term borrowings and to provide an additional instrument to investors.

as amended from time to time.  Certificate of Deposit (CD) is a negotiable money market instrument and issued in dematerialised form against funds deposited at a bank or other eligible financial institution for a specified time period. . Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of India (RBI).

These instruments are similar to T-Bills and are frequently used in money market funds. They are traded at a discount from face value on the secondary market. Banker's acceptances are regularly used financial instruments in international trade.   It is a short-term debt instrument issued by a firm that is guaranteed by a commercial bank. . which can be an advantage because the banker's acceptance does not need to be held until maturity.

This also includes private placement sources of debt and equity as well as organized markets like stock exchanges. the capital funds comprising of both equity and debt are issued and traded.   Capital Market: Capital market is a market for long-term debt and equity shares. In this market. Capital market includes financial instruments with more than one year maturity .

in which securities are made available for sale on the open market. mutual funds. Private placement is the opposite of a public issue. insurance companies and pension funds. . Investors involved in private placements are usually large banks.   The sale of securities to a relatively small number of select investors as a way of raising capital.

3.     A well functioning stock market may help the development process in an economy through the following channels: 1. Growth of savings. Better utilization of the existing resources. Efficient allocation of investment resources. 2. .

financial market institutions provide the avenue by which long-term savings are mobilized and channelled into investments. In market economy like India. Confidence of the investors in the market is imperative for the growth and development of the market. .

Stock index is created to provide investors with the information regarding the average share price in the stock market. The ups and downs in the index represent the movement of the equity market. . the market Indices is the barometer of its performance and reflects the prevailing sentiments of the entire economy.  For any stock market.

the stock price of any company is vulnerable to three types of news: • Company specific • Industry specific • Economy specific . Generally.     These indices need to represent the return obtained by typical portfolios in the country.

. All diversified portfolios. use the common stock index as a yardstick for their returns.  The most important use of an equity market index is as a benchmark for a portfolio of stocks. belonging either to retail investors or mutual funds.

       Indices are useful in modern financial application of derivatives. Capital Market Instruments – some of the capital market instruments are: Equity Preference shares Debenture/ Bonds ADRs/ GDRs Derivatives .

  A contractual arrangement in which the issuer agrees to pay interest and repay the borrowed amount after a specified period of time is a debt instrument. Certain features common to all debt instruments are:  .

.   Maturity – the number of years over which the issuer agrees to meet the contractual obligations is the term to maturity. Debt instruments are classified on the basis of the time remaining to maturity Par value – the face value or principal value of the debt instrument is called the par value.

for instance zero coupon bonds. These bonds are issued on discount and redeemed at par. Some of the debt instruments may not have an explicit coupon rate. .    Coupon rate – agreed rate of interest that is paid periodically to the investor and is calculated as a percentage of the face value. Thus the difference between the investor’s investment and return is the interest earned. Coupon rates may be fixed for the term or may be variable.

and debenture holders are just creditors. whereas debentures are mere debt. The share holders are part proprietors of the company. whether the company makes profit or not. as agreed. Share holders get dividend only out of profits and in case of insufficient or no profits they get nothing and debenture holders being creditors get guaranteed interest. .  Share money forms a part of the capital of the company.

  Debentures are quite often secured. . There is no question of any security in case of shares. a security interest is created on some assets to back up debentures. that is. Share holders have a right to attend and vote at the meetings of the share holders whereas debenture holders have no such rights.

. Preference share holders have the following preferential rights (i) The right to get a fixed rate of dividend before the payment of dividend to the equity holders. (ii) The right to get back their capital before the equity holders in case of winding up of the company.     Preference shares Preference shares are different from ordinary equity shares.

 Provisions about investments by nonresidents. non resident Indians. . overseas bodies corporates and other foreign investors are made by the RBI in pursuance of FEMA provisions.

Under Foreign Direct Investments (FDI) Scheme. and • Government Route. .   Foreign investment is freely permitted in almost all sectors in India. • Automatic Route. investments can be made by non-residents in the shares / convertible debentures of an Indian Company under two routes.

market rate. A derivative picks a risk or volatility in a financial asset. and creates a product the value of which will change as per changes in the underlying risk or volatility. or contingency. The idea is that someone may either try to safeguard against such risk (hedging). or someone may take the risk. or may engage in a trade on the derivative. transaction. based on the view that they want to execute.  .

i. derivatives is a financial instrument that offers return based on the return of some other underlying asset.e the return is derived from another instrument. A derivative is a financial instrument. . In the sense. whose value depends on the values of basic underlying variable.  The risk that a derivative intends to trade is called underlying.

National Board of Trade (NBOT) and Multi Commodity Exchange (MCX) . However in the recent times the commodity trade has grown significantly and today there are 25 derivatives exchanges in India which include four national commodity exchanges. National Commodity and Derivatives Exchange (NCDEX). National Multi-Commodity Exchange of India (NCME). since then the market has suffered from liquidity problems and several regulatory dogmas.   Commodity derivatives in India were established by the Cotton Trade Association in 1875.

Financial intermediaries came into existence. Financial intermediation in the organized sector is conducted by a wide range of institutions functioning under the overall surveillance of the Reserve Bank of India.  To serve the purpose of transfer of funds from surplus to deficit sector. .

issuer and the security should be passed on to take place. Adequate information of the issue. mere issue of securities will not suffice. the issuer should then ensure that these financial assets reach the ultimate investor in order to garner the requisite amount. There should be a proper channel within the financial system to ensure such transfer. .   Having designed the instrument. When the borrower of funds approaches the financial market to raise funds.

However. and dealers. the role of the intermediary was mostly related to ensure transfer of funds from the lender to the borrower. . the scope of its operations also widened.  In the initial stages. This service was offered by banks. FIs. as the financial system widened along with the developments taking place in the financial markets. brokers.

underwriters. depositories. investment bankers. . satellite dealers. registrars. stock exchanges. primary dealers. custodians. portfolio managers. financial consultants. etc. self regulatory organizations. Some of the important intermediaries operating in the financial markets include. mutual funds.

underwriter. . the services offered by them vary from one market to another.  Though the markets are different. However.g. there may be a few intermediaries offering their services in more than one market e.

the securities and exchange board of India. . the credit rating agencies. insurance companies and the specialized financial institutions in India. The Financial Institutions in India mainly comprises of the Central Bank which is better known as the Reserve Bank of India. the commercial banks.

The bank formulates different rates and policies for the overall improvement of the banking sector. .  The Reserve Bank of India was established in the year 1935 with a view to organize the financial frame work and facilitate fiscal stability in India. The bank acts as the regulatory authority with regard to the functioning of the various commercial bank and the other financial institutions in India. It issue currency notes and offers aids to the central and institutions governments.

. acting as trustees. offering loans for the different purposes and are even allowed to collect taxes on behalf of the institutions and central government.  The commercial banks in India are categorized into foreign banks. The commercial banks indulge in varied activities such as acceptance of deposits. private banks and the public sector banks.

The credit rating agencies offer various services as: Operation Up gradation Training to Employees Scrutinize New Projects and find out the weak sections in it Rate different sectors The two most important credit rating agencies in India are: CRISIL ICRA .        The credit rating agencies in India were mainly formed to assess the condition of the financial sector and to find out avenues for more improvement.

register institutions and indulge in risk management. The securities and exchange board of India. They supervise market conditions. . also referred to as SEBI was founded in the year 1992 in order to protect the interests of the investors and to facilitate the functioning of the market intermediaries.

marine insurance. The insurance companies are collaborating with different foreign insurance companies after the liberalization process. They deal in life insurance. vehicle insurance and so on.  The insurance companies offer protection against losses. . This step has been incorporated to expand the Indian Insurance market and make it competitive. The insurance companies collect the little saving of the investors and then reinvest those savings in the market.

      The specialized financial institutions in India are government undertakings that were set up to provide assistance to the different sectors and thereby cause overall development of the Indian economy. The significant institutions falling under this category includes: Board for Industrial & Financial Reconstruction Export-Import Bank Of India Small Industries Development Bank of India National Housing Bank .

the Reserve bank of India. Examples are friends. Formal institution is institutionalized. Partnership consisting of local brokers. and Securities and exchange board of India. association. unorganized and non-regulated system caters to the need of traditional and rural economy. and relatives. . It comes under the preview of Ministry of Finance. investment. organized and regulated system caters to the need of modern economy. chit fund companies.Financial Dualism . Informal Institution . and finance companies. groups of persons operating as funds or association under their own rules and use name as fixed fund.Is non-institutionalized.Is co-existence of formal and informal financial sectors.

. Non-banking institutions –purveyors of credit. IIBI(industrial investment bank of India). Housing finance companies (HFCs).IFCI(industrial financial corporation of India). Example: (Development financial institutions DFI). ICICI(industrial credit and investment corporation of India) .Financial institutions: 1. 3. Term finance institutions : IDBI(industrial development bank of India). SIDBI(small industrial development bank of India). 2. Banking Institutions are creators and purveyors of credit. non-banking financial companies (NBFCs).

UTI. public sector and private sector mutual funds and insurance activity of Life Insurance Corporation (LIC). Tourism finance corporation of India (TFCI). 6. (GIC) General Insurance Corporation and its subsidiaries are classified as financial institutions.4. National Housing Bank (NHB). State level financial institutions: State financial corporation (SFCs). Specialized finance institutions: Export Import Bank of India (EXIM) . Investment Institutions in the business of mutual funds. National Bank for Agriculture and Rural Development (NABARD). and State Industrial development corporation (SIDCs) which are owned and managed by the state governments. . ICICI venture. 5. the Infrastructure Development Finance Company(IDFC).

Financial assets comprises of loans. etc. etc. Just Like corporate. equities. mutual fund units. etc. Treasury bills. etc. Also there are instruments for borrowers such as loans. overdrafts. governments too raise funds through issuing of bonds. are available to savers who wish to lend money to the government . equities. KissanVikas Patra (KVP). etc. bonds. – It Enable channelizing funds from surplus units to deficit units.Financial assets/instruments. deposits. There are instruments for savers such as deposits. The Instruments like Public Provident Fund (PPF).

etc. 3.1. Over the counter (OTC) –the government securities market is an OTC market. . Financial Markets facilitates the process of raising funds. chit funds. Spot trades are negotiated and traded for immediate delivery.for long-term funds (maturity period one year or more than that) Primary Market deals with new issues Secondary market deals in trading in outstanding or existing securities. 4. 2.) Capital Market. Derivatives (derived from underlying assets) market is exchange traded.for short-term funds (less than a year) Organized (Banks) Unorganized (money lenders. Financial Markets are : Money Market. Exchange traded market – trading takes place over a trading cycle in stock exchanges.

Commercial Paper 4. Trade Bill . Treasury Bill 3. Some of the important money market instruments are: 1.Call Money 2.Money market instruments are those which have maturity period of less than one year. Certificate of Deposit 5.

The loans are of short-term duration (1 to 14 days). Organized money market comprises RBI.   . Money lent for one day is called ‘call money’. Money lent for more than 15 days is ‘term money’. if it exceeds 1 day but is less than 15 days it is called ‘notice money’. banks (commercial and co-operative) . which include: Call money market Is an integral part of the Indian money market where dayto-day surplus funds (of banks) are traded? It is mainly used by the banks to meet their temporary requirement of cash. Organized Money Market is meant for short term securities.

The rate of interest paid on call money is known as call rate.   The borrowing is exclusively limited to banks.i. The call market helps banks economize their cash and yet improve their liquidity. It acts as a good indicator of the liquidity position . It is a highly competitive and sensitive market. no collateral is required.e. which are temporarily short of funds. Call loans are generally made on a clean basis. The main function of the call money market is to redistribute the pool of day-to-day surplus funds of banks among other banks in temporary deficit of funds .

The Banks can borrow in the money market to: 1. To meet the CRR and SLR mandatory requirements as stipulated by the central bank. Call money market serves the role of equilibrating the short-term liquidity position of the banks . 2. 3. To meet sudden demand for funds arising out of large outflows (like advance tax payments) 4. To fill the gaps or temporary mismatch of funds.

182-day and 364-day) of the Government of India It is an IOU of the government.Also called the T-Bill market      These bills are short-term liabilities (91-day.Treasury bill market. a promise to pay the stated amount after expiry of the stated period from the date of issue They are issued at discount to the face value and at the end of maturity the face value is paid The rate of discount and the corresponding issue price are determined at each auction RBI auctions 91-day T-Bills on a weekly basis.Bill Market . 182-day T-Bills and 364day T-Bills on a fortnightly basis on behalf of the central government .

These bills are normally issued at a price less than their face value . so the difference between the issue price and the face value of the treasury bill represents the interest on investment. that means. . financial institutions and corporations normally play major role in the Treasury Market.   Treasury bills are highly liquid instruments . Banks . at any time the holder of treasury bills can transfer of or get it discounted from RBI.

The CP is an unsecured instrument issued in the form of promissory note. This instrument was introduced in 1990 to enable the corporate borrowers to raise short term funds. .    It is a popular instrument for financing working capital requirements of companies. It can be raised from period ranging from 15 days to one year.

cooperatives and companies. These can be issued to individuals. CDs are transferable from one party to another.    CDs are short term instruments issued by Commercial Banks and Special Financial Institution(SFIs). . The maturity period of CDs ranges from 91 days to one year.

But if any seller does not want to wait or is in immediate need of money he /she can draw a bill of exchange in favour of the buyer. .  Normally the traders buy goods from the wholesaler or manufacturers on credit. The sellers get payment after the end of the credit period. When buyer accepts the bill it becomes negotiable instrument and is termed as bill of exchange or trade bill.

On maturity the bank gets the payment from the buyer of goods. which enables the drawer of the bill to get funds for short period to meet the working capital needs. When trade bills are accepted by commercial banks it is known as Commercial Bills. . Trade bill can now be discounted with a bank before its maturity. So trade bill is an instrument.

Depositories. Issue of securities Subscribe to unsubscribed portion of securities Issue securities to the Investment Bankers Capital Market. Credit Market Capital Market. Custodians Capital Market investors on behalf of the company and handle share transfer activity Primary Dealers Satellite Dealers Forex Dealers Money Market Market making in government securities Ensure exchange ink currencies Forex Market . Money Market Underwriters Registrars.Intermediary Stock Exchange Market Capital Market Role Secondary Market to securities Corporate advisory services.

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