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Financial System

Dr. Yamini Sharma
D.M.S.
• Financial system is a set of complex and
closely interconnected financial institutions,
markets, instruments, services, practices, and
transactions.“

• Financial System is
the system that
allows the transfer
of money between
savers (and
investors) and
borrowers.
Level of Operations
A financial system
can operate on a
• Global Level,
• Regional Level
• Firm specific
level.

Income Flow Model
Content of Financial Concept
• Financial assets
• Financial intermediaries
• Financial Markets
• Financial Rate of Return
• Financial Instruments
Financial Assets
• Financial assets is one which is used for
production or consumption or for further
creation of assets
• Financial assets vs. Physical assets.

Financial Assets
Marketable
Assets
Shares Bonds
Mutual
Fund
Non-
Marketable
Assets
Bank
Deposits
P.F.
LIC
Schemes
Financial Intermediaries
• Financial Intermediaries includes all kind of
organizations which intermediate and
facilitate financial transactions of both
individuals and corporate customers.
• Financial Intermediaries can be classified into:
– Capital Market Intermediaries
– Money Market Intermediaries
Financial Markets
• Financial Markets can be referred to as those
centers and arrangements which facilitate
buying and selling of financial assets, claims
and services.
• Classification of Financial Market:-
– Unorganized market
– Organized Market

• Financial
Market

Financial Market can be define as the market in
which financial assets are created or
transferred.
Define
Financial
Market
Organized
Market
Capital
Market
Money
Market
Unorganized
Market
Money
lender
Indigenous
bankers
Money Market includes the
entire machinery for
channeling a short term funds.
OR
Money Market concerned with
the exchange of all short-term
claim mediates by investment
bankers, security dealers and
other financial institutions and
can concerned with dealing
between individuals.
Money Market
• MM is define as the center for dealing mainly of a
short character, in monetary assets; it meets the
short-term requirement of borrowers and
provides liquidity or cash to the lenders,
according Reserve Bank of India.

• The Money Market is the collective name given to
the various firms and institutions that deal in the
various grades of near money. -Crowther
Definition of Money Market
• A well- organized Banking
System
• Presence of a Central
Bank
• Financial instrument
• Sub-market
• Prefect Mobility of funds
• Integrated structure

Characteristics of Money Market
• Existence of unorganized money
market
• Absence of integration
• Difference in interest rates
• Seasonal stringency of money
• Absence of Organized Bill Market
• Highly volatile call money market
• Lack of a well organized Banking
system
• Lack of Credit institutions
• Limited availability of credit
instruments

Features and defect of Indian Money
Market
• Help to trade & industry
• Outlets of commercial
Banks Funds
• Effective implication of
Monetary Policy
• Public Debt Policy
• Establishes Equilibrium
• Capital Formation

Functions of Money Market
On the Basis
of
Person
Debtors
Creditors
Organization
Organized
sector
Unorganized
sector
Co-operative
Markets
Sub-
Markets
Call Money
Market
Bill Market
Treasury bill
Market
Structure of Money Market
Unorganized Market
• In these market, there
are a number of
moneylenders,
indigenous bankers,
Traders etc., who lend
money to the public as
well as collect deposit
from public.
Organized Market
• In the organized
markets, there are
standardized rules and
regulations governing
their financial dealings.
These markets are
subject to strict
supervision and control
by RBI or other
regulatory bodies.
• Control over indigenous bankers
• Standardization of “Hundies”
• Establishment of Financial institution
• Development of bill Market
• Development of banking operations
• Establishment of clearing Houses
• Facility of money transfer
• Expansion of Money Market

Suggestions for Improving Indian
money Market
Money Market
• The market for dealing with financial assets
and sec. which have a maturity period of up to
one year.
• RBI defines the money market as “A market
for short term financial assets that are close
substitutes for money, facilitates the exchange
of money for new financial claims in primary
market as also for financial claims, already
issued, in the secondary market”

Money Market Instruments
• Money market instruments are those which
have maturity period of less than one year.
• The most active part of the money market is
the market for overnight call and term money
between banks and institutions and repo
transactions
• Call money/repo are very short-term money
market products
Money Market Instruments
• Certificates of Deposit
• Commercial Paper
• Inter-bank participation certificates
• Inter-bank term money
• Treasury Bills
• Bill rediscounting
• Call/notice/term money
Features of a money market
• Market purely for short –term funds or financial assets
• Its deals with financial assets having maturity period up
to one year.
• it deals with those assets which can be convert in to
cash readily without loss and mini transaction cost
• Transaction have to be conducted without the help of
brokers

Objectives of money market
• To provide a parking place to employ short-term
surplus
• To provide room for overcoming short-term
deficits.
• To enable the central bank to influence and
regulate liquidity in the economy through its
intervention in this market.
• To provide reasonable access to the users of
short-term funds to meet requirements.


Characteristics of a Developed
Money Market
• Highly organized banking system
• Presence of a central bank
• Availability of proper credit instrument
• Existence of sub-brokers
• Sufficient resources
• Existence of secondary markets
• Demand and supply of funds


Importance of Money Market
• Development of money market
• Development of capital market
• Smooth functioning of commercial banks
• Effective central bank control
• Formulation of suitable monetary policy
• Non-inflation source of finance to
government

Capital market refers to “ an organized
mechanism concerned with transfer of money,
capital or financial resources from investor to
entrepreneurs engaged in industry or
commerce”
Definition of capital market
Capital Market
The capital market is a market for
financial assets which have a long or
indefinite maturity. Generally it deals
with long-term securities which have a
maturity period of above one year.
Capital market further divided into three
market:
• Industrial Securities market
• Government Securities Market
• Long-term loans Market

Industrial Securities market
• It is Market for industrial
securities i.e. Equity
shares, Preference Share,
Debentures or bond.
• It can be subdivide into
two segments
– Primary Market or New
Issue Market
– Secondary Market or
Stock Exchange
Government Securities Market
• Government Securities Market or
gilt-edged market is market which
where Government securities are
traded.
• Securities issued by the central
Government, State Government,
Semi-Government authorities like
city corporations, Port trust, State
electricity board, all India and state
level financial institutions and public
sector enterprises are dealt in this
market.
Long-term loans Market
• Development banks and commercial banks
play a significant role in this market by
supplying long-term loans to corporate
customers.
• Deals in long term securities
• Deals in Marketable and non- Marketable securities
• Deals individual and institutional investor
• Comprises of primary and secondary market
• Conduct through intermediaries
Features of Capital Market
• Basis for industrialization
• Faces business risk
• Accelerating the pace of growth
• Building sound financial structure
• Promoting organized stock market
• Generating liquidity
• Availability of foreign Capital

Importance of Capital Market
Capital market mechanism
•Individuals
•Institutions
•Government
Capital Market
•Stock exchange
•New issue market
•Finance and
investment corp.
•Individuals
•Institutions
•Government
Supply of
funds
•Investors
•Lenders
•Sellers of money
capital
• Entrepreneurs
•Borrowers
•Clearing house for
long term or
permanent finance
• Buyers of money
capital
Middlemen
Demand for
funds
Capital Market Structure
Marketable Securities
Non-Marketable Securities
Govt.
securities
Corporate
securities
PSUs Bonds
UTI Mutual
Funds
Bank
Deposits
Deposits
with
Companies
Loans and
advances of
banks and
FIs.
POC and
deposits
New Issues
Market
players –
original
Stock market
intermediaries
New Issues
Market
players –for
Issues
Capital market instruments
• Equity shares
• Preference shares
• Non-voting equity shares
• Cumulative convertible preference shares
• Company fixed deposits
• Debentures/ bonds
• Global depository receipts

Structure of Capital Markets
Primary Markets Secondary Markets
When companies need financial resources for
its expansion, they borrow money from
investors through issue of securities.
The place where such securities are traded by
these investors is known as the secondary
market.
Securities issued
a) Preference Shares
b) Equity Shares
c) Debentures
Securities like Preference Shares and
Debentures cannot be traded in the secondary
market.
Equity shares is issued by the under writers
and merchant bankers on behalf of the
company.
Equity shares are tradable through a private
broker or a brokerage house.
People who apply for these securities are:
a) High networth individual
b) Retail investors
c) Employees
d) Financial Institutions
e) Mutual Fund Houses
f) Banks
Securities that are traded are traded by the
retail investors.
One time activity by the company. Helps in mobilizing the funds for the investors
in the short run.
What is Commodity market
Commodity markets are markets where raw or
primary products are exchanged.

It covers physical product (food, metals,
electricity)markets but not the ways that
services, including those of governments, nor
investment nor debt, can be seen as a
commodity.

History of Commodity Market
Modern Commodity Market have their roots in the
trading of agricultural products.
Wheat and corn, cattle and pigs, were widely traded
using standard instruments in the 19th century in the
United States.
Historically, in ancient times Sumerian use of sheep
or goats, or other peoples using pigs, rare seashells, or
other items as commodity money, have traded
contracts in the delivery of such items, to render trade
itself more smooth and predictable.

List of Traded Commodity
Agricultural (Grains, and Food and Fiber)
•Livestock & Meat
•Energy
•Precious metals
•Industrial metals
• Precious Metal:- Gold, Platinum, Palladium, Silver.
•Industrial Metals:- Copper, Lead, Zinc, Tin,
Aluminium, Aluminium alloy, Nickel, Aluminium
alloy, Recycled steel.

Commodity Exchanges
• Indian Commodity Exchange Limited ICEX
• Multi Commodity Exchange MCX
• National Commodity and Derivatives Exchange
NCDEX
• National Multi-Commodity Exchange of India Ltd
NMCE
• Ace Derivatives & Commodity Exchange Ltd. ACE
• Bhatinda Om & Oil Exchange Ltd. BOOE
• Universal Commodity Exchange UCE
Composition of Money Market
The money market consist of following sub market.

• Call money market
• Commercial bills market
• Acceptance market
• Treasury bill market

Call money market
The call money market refers to the market
for extremely short period loans, say one day
to fourteen days.
These loans are repayable on demand at
the option of either the lender or the
borrower.


Advantages of call money market
• High liquidity
• High profitability
• Maintenance of statutory reserve ration
(SRR)
• Safe and cheap
• Assistance to central bank operation

Drawbacks of call money market
• Uneven development

• Lack of integration

• Volatility in call money rates


Commercial bills market or discount
Market
• Definition
“An instrument in writing containing
an unconditional order, signed by the maker,
directing a certain person to pay a certain sum
of money only to ,or the order of certain
person or to the bearer of the instrument”.

Types of bills
Many types of bills are in circulation in a
bill market
• Demand bills are also called sight bills. these bills are
payable immediately as soon as they are presented
to the drawer no time of payment is specified and
hence they are payable at sight.
• Documentary bill
when bills have to be accompanied by
document of title to goods like railway receipt, lorry
receipt, bill of lading etc. The bills are called doc.bills.

• Inland and foreign bills
inland bills are those drawn upon a person
resident in India and are payable in India. foreign bills are
drawn outside India and they may be payable either in
India or outside India.
• Export bills and import bills
export bills are those drawn by Indian exporters on
imports outside India and importer bills are drawn on
Indian importers in India by exporters outside India.
• Indigenous bills
indigenous bills are those drawn and accepted
according to native custom or usage of trade.


Advantages of Commercial bills market
• Liquidity
• Self-liquidating and negotiable asset
• Certainty of payment
• Ideal investment
• Simple legal remedy
• High and quick yield
• Easy central bank control
Drawbacks of Commercial bills market
• Absence of bill culture
• Absence of rediscounting among banks
• Stamps duty
• Absence of secondary market
• Difficulty in ascertaining genuine trade bills
• Limited foreign trade
• Absence of acceptance service
• Attitude of banks


Treasury bill market
A treasury bill nothing but a promissory
note issued by the Govt. under discount for a specified
period stated therein. The govt. promises to pay the
specified amount mentioned therein to the bearer of
the instrument on the due date.

T.B are issued only by the RBI on behalf of the
govt. TB are issued for meeting temporary govt.
deficits.

Types of Treasury bill
• There are two types of TB
ordinary treasury bills are issued to the
public and other financial institution for
meeting the short term financial requirements
of the central govt.
ad hocs treasury are always issued in favor
of the RBI only.

Importance of Treasury bill
• Safety
• Liquidity
• Ideal short-term investment
• Ideal fund management
• Statutory liquidity
• Source of sort term funds
• Non-inflationary monetary tool
• Hedging facility
Defects of TB
 poor yield
 absence of competitive bids
 absence of active trading







Commercial papers (CP)
• A Cp Is an unsecured promissory note issued with a fixed
maturity by a company approved by RBI, negotiable by
endorsement and delivery, issued in bearer form and issued at
such discount on the face value as may be determined by the
issuing co.
• Short-term borrowings by corporate, financial institutions,
primary dealers from the money market
• Can be issued in the physical form (Usance Promissory Note) or
demat form
• Introduced in 1990
• When issued in physical form are negotiable by endorsement
and delivery and hence, highly flexible
• Issued subject to minimum of Rs. 5 lacs and in the multiple of
Rs. 5 lacs after that
• Maturity is 7 days to 1 year
• Unsecured and backed by credit rating of the issuing company
• Issued at discount to the face value