FINANCIAL SYSYTEM

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S.T GONSALO GARCIA COLLEGE

CHAPTER 1: INTRODUCTION TO FINANCIAL SYSTEM

In finance, the financial system is the system that allows the transfer of

money between savers and borrowers. It comprises a set of complex and

closely interconnected financial institutions, markets, instruments, services,

practices, and transactions.

Financial systems are crucial to the allocation of resources in a modern

economy. They channel household savings to the corporate sector and

allocate investment funds among firms; they allow intertemporal smoothing

of consumption by households and expenditures by firms; and they enablehouseholds and firms to share risks. These functions are common to the

financial systems of most developed economies. Yet the form of these

financial systems varies widely.

Financial System of any country consists of financial markets, financial

intermediation and financial instruments or financial products. This paper

discusses the meaning of finance and Indian Financial System and focus onthe financial markets, financial intermediaries and financial instruments. The

brief review on various money market instruments are also covered in this

study.

In this respect providing or securing finance by itself is a distinct activity or

function, which results in Financial Management, Financial Services and

Financial Institutions. Finance therefore represents the resources by way

funds needed for a particular activity. We thus speak of 'finance' only in

relation to a proposed activity. Finance goes with commerce, business,

banking etc. Finance is also referred to as "Funds" or "Capital", when

FINANCIAL SYSTEM IN INDIA Page 1


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INDIAN FINANCIAL SYSTEM

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. A Financial System is a composition of various institutions,markets, regulations and laws, practices, money manager, analysts,

transactions and claims and liabilities.

Pre-reforms Phase:

Until the early 1990s, the role of the financial system in India was primarily

restricted to the function of channelling resources from the surplus to deficit

sectors. Whereas the financial system performed this role reasonably well,

its operations came to be marked by some serious deficiencies over the

years. The banking sector suffered from lack of competition, low capital

base, low productivity and high intermediation cost. After the nationalisation

of large banks in 1969 and 1980, the Government-owned banks dominated

the banking 3 sector. The role of technology was minimal and the quality of

service was not given adequate importance. Banks also did not follow proper risk management systems and the prudential standards were weak. All these

resulted in poor asset quality and low profitability. Among non-banking

financial intermediaries, development finance institutions (DFIs) operated in

an over-protected environment with most of the funding coming from



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assured sources at concessional terms. In the insurance sector, there was

little competition. The mutual fund industry also suffered from lack of

competition and was dominated for long by one institution, viz., the Unit

Trust of India. Non-banking financial companies (NBFCs) grew rapidly, butthere was no regulation of their asset side.

Financial markets were characterized by control over pricing of financial

assets, barriers to entry, high transaction costs and restrictions on movement

of funds / participants between the market segments. This apart from

inhibiting the development of the markets also affected their efficiency.

Financial Sector Reforms in India:

It was in this backdrop that wide-ranging financial sector reforms in India

were introduced as an integral part of the economic reforms initiated in the

early 1990s with a view to improving the macroeconomic performance of

the economy. The reforms in the financial sector focussed on creating

efficient and stable financial institutions and markets. The approach to

financial sector reforms in India was one of gradual and non-disruptive

progress through a consultative process. The Reserve Bank has been

consistently working towards setting an enabling regulatory framework with

prompt and effective supervision, development of technological and

institutional infrastructure, as well as changing the interface with the market

participants through a consultative process. Persistent efforts have been

made towards adoption of international benchmarks as appropriate to Indianconditions. While certain changes in the legal infrastructure are yet to be

effected, the developments so far have brought the Indian financial system

closer to global standards.



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The reform of the interest regime constitutes an integral part of the financial

sector reform. With the onset of financial sector reforms, the interest rate

regime has been largely deregulated with a view towards better price

discovery and efficient resource allocation. Initially, steps were taken todevelop the domestic money market and freeing of the money market rates.

The interest rates offered on Government securities were progressively

raised so that the Government borrowing could be carried out at market-

related rates. In respect of banks, a major effort was undertaken to simplify

the administered structure of interest rates. Banks now have sufficient

flexibility to decide their deposit and lending rate structures and manage

their assets and liabilities accordingly. At present, apart from savings

account and NRE deposit on the deposit side and export credit and small

loans on the lending side, all other interest rates are deregulated. Indian

banking system operated for a long time with high reserve requirements both

in the form of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio

(SLR). This was a consequence of the high fiscal deficit and a high degree of

monetisation of fiscal deficit. The efforts in the recent period have been to

lower both the CRR and SLR. The statutory minimum of 25 per cent for

SLR has already been reached, and while the Reserve Bank continues to

pursue its medium-term objective of reducing the CRR to the statutory

minimum level of 3.0 per cent, the CRR of SCBs is currently placed at 5.0

per cent of NDTL.



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Financial System: Current StatusThere has been a notable reduction in the ratio of non-performing assets

(NPAs) to advances in response to various initiatives, such as, improved risk

management practices and greater recovery efforts driven, inter alia, by the

recently enacted Securitisation and Reconstruction of Financial Assets and

Enforcement of Security Interest (SARFAESI) Act, 2002. The financial

performance of most of the PSBs has improved in recent times as reflected

in their comfortable capital adequacy ratios and declining NPL ratios. The

CRAR in respect of all categories of banks has improved. New private sector

banks have displayed impressive performance particularly in terms of

efficiency and customer service

Financial System

The word "system", in the term "financial system", implies a set of complex

and closely connected or interlined institutions, agents, practices, markets,

transactions, claims, and liabilities in the economy. The financial system is

concerned about money, credit and finance-the three terms are intimately

related yet are somewhat different from each other. Indian financial system

consists of financial market, financial instruments and financial

intermediation.



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Brokers: A broker is a party that mediates between a buyer and

a seller . A broker who also acts as a seller or as a buyer becomes

a principal party to the deal.

Underwriters: Underwriting refers to the process that a largefinancial service provider (bank, insurer, investment house) uses to

assess the eligibility of a customer to receive their products (equity

capital, insurance, mortgage , or credit). Mutual funds: A mutual fund is a professionally managed type

of collective investment scheme that pools money from many

investors and invests typically in investment securities (stocks , bonds ,

short-term money market instruments, other mutual funds, other

securities, and/or commodities such as precious metals )

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CHAPTER 3: FINANCIAL MARKETS

In economics , a financial market is a mechanism that allows people to buy

and sell ( trade ) financial securities (such as stocks and bonds), commodities

(such as precious metals or agricultural goods), and other fungible items of

value at low transaction costs and at prices that reflect the efficient-market

hypothesis .

Both general markets (where many commodities are traded) and specialized

markets (where only one commodity is traded) exist. Markets work by

placing many interested buyers and sellers in one "place", thus making iteasier for them to find each other. An economy which relies primarily on

interactions between buyers and sellers to allocate resources is known as a

market economy in contrast either to a command economy or to a non-

market economy such as a gift economy .

In finance , financial markets facilitate:

The raising of capital (in the capital markets ) The transfer of risk (in the derivatives markets ) International trade (in the currency markets )

and are used to match those who want capital to those who have it.

Typically a borrower issues a receipt to the lender promising to pay back the

capital. These receipts are securities which may be freely bought or sold. In

return for lending money to the borrower, the lender will expect some

compensation in the form of interest or dividends .

http://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Trade_(financial_instrument)http://en.wikipedia.org/wiki/Securitieshttp://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/Fungiblehttp://en.wikipedia.org/wiki/Transaction_costhttp://en.wikipedia.org/wiki/Efficient-market_hypothesishttp://en.wikipedia.org/wiki/Efficient-market_hypothesishttp://en.wikipedia.org/wiki/Market_economyhttp://en.wikipedia.org/wiki/Command_economyhttp://en.wikipedia.org/wiki/Market_economicshttp://en.wikipedia.org/wiki/Market_economicshttp://en.wikipedia.org/wiki/Gift_economyhttp://en.wikipedia.org/wiki/Financehttp://en.wikipedia.org/wiki/Capital_(economics)http://en.wikipedia.org/wiki/Capital_markethttp://en.wikipedia.org/wiki/Risk#Risk_in_financehttp://en.wikipedia.org/wiki/Derivatives_markethttp://en.wikipedia.org/wiki/International_tradehttp://en.wikipedia.org/wiki/Currency_markethttp://en.wikipedia.org/wiki/Receipthttp://en.wikipedia.org/wiki/Security_(finance)http://en.wikipedia.org/wiki/Interesthttp://en.wikipedia.org/wiki/Dividendshttp://en.wikipedia.org/wiki/Economicshttp://en.wikipedia.org/wiki/Trade_(financial_instrument)http://en.wikipedia.org/wiki/Securitieshttp://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/Fungiblehttp://en.wikipedia.org/wiki/Transaction_costhttp://en.wikipedia.org/wiki/Efficient-market_hypothesishttp://en.wikipedia.org/wiki/Efficient-market_hypothesishttp://en.wikipedia.org/wiki/Market_economyhttp://en.wikipedia.org/wiki/Command_economyhttp://en.wikipedia.org/wiki/Market_economicshttp://en.wikipedia.org/wiki/Market_economicshttp://en.wikipedia.org/wiki/Gift_economyhttp://en.wikipedia.org/wiki/Financehttp://en.wikipedia.org/wiki/Capital_(economics)http://en.wikipedia.org/wiki/Capital_markethttp://en.wikipedia.org/wiki/Risk#Risk_in_financehttp://en.wikipedia.org/wiki/Derivatives_markethttp://en.wikipedia.org/wiki/International_tradehttp://en.wikipedia.org/wiki/Currency_markethttp://en.wikipedia.org/wiki/Receipthttp://en.wikipedia.org/wiki/Security_(finance)http://en.wikipedia.org/wiki/Interesthttp://en.wikipedia.org/wiki/Dividends


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Money Market - The money market ifs a wholesale debt market for

low-risk, highly-liquid, short-term instrument. Funds are available in

this market for periods ranging from a single day up to a year. This

market is dominated mostly by government, banks and financialinstitutions.

Capital Market - The capital market is designed to finance the long-

term investments. The transactions taking place in this market will be

for periods over a year. Forex Market - The Forex market deals with the multicurrency

requirements, which are met by the exchange of currencies.

Depending on the exchange rate that is applicable, the transfer of

funds takes place in this market. This is one of the most developed

and integrated market across the globe. Credit Market - Credit market is a place where banks, FIs and

NBFCs purvey short, medium and long-term loans to corporate and

individuals.



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FINANCIAL MARKETS IN INDIA:

Generally the world Market denotes a specific place or location where

transactions take place. But this is not true in case of financial markets.

Wherever financial transactions take place, it is deemed to have taken place in

financial market.

Financial markets in India are classified in major two categories:

1. unorganized markets and

2. organized markets

1. Unorganized markets: Players in unorganized markets are money

lenders, indigenous bankers, traders etc. who lend money to the public,

indigenous bankers even collect money from public in the form of

deposits. There are also private finance companies, chit fund etc.

however activities of these players are not controlled by RBI. Directions

were issued in 1998 to bring private finance companies and chit funds

under strict control of RBI. Steps have also been taken to bring the

unorganized sector under organized fold. But these regulations and

inadequate and did not have much success. Therefore, financial

instruments in unorganized markets are not standardized.

2. Organized markets : In organized markets, there are standardized rules

and regulations for financial transactions, these markets are under strict

supervision and control of RBI or other regulatory bodies.



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PRIMARY MARKET

Primary market is the market for new issue of financial instruments.

Therefore, it is also called as new issue market. It deals in those securities

which are issued to the public for the first time.

Role of the Primary Market

The primary market provides the channel for sale of new securities. Primary

market provides opportunity to issuers of securities; Government as well as

corporates, to raise resources to meet their requirements of investmentand/or discharge some obligation. They may issue the securities at face

value, or at a discount/premium and these securities may take a variety of

forms such as equity, debt etc. They may issue the securities in domestic

market and/or international market.

FUNCTIONS OF PRIMARY MARKET

1. Companies need to issue shares to the public

Most companies are usually started privately by their promoter(s). However,

the promoters capital and the borrowings from banks and financial

institutions may not be sufficient for setting up or running the business over

a long term. So companies invite the public to contribute towards the equity

and issue shares to individual investors. The way to invite share capital from

the public is through a Public Issue . Simply stated, a public issue is an

offer to the public to subscribe to the share capital of a company. Once this

is done, the company allots shares to the applicants as per the prescribed

rules and regulations laid down by SEBI.



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2. Issue price

The price at which a company's shares are offered initially in the primary

market is called as the Issue price. When they begin to be traded, the

market price may be above or below the issue price.

3. Market Capitalization

The market value of a quoted company, which is calculated by multiplying

its current share price (market price) by the number of shares in issue is

called as market capitalization. E.g. Company A has 120 million shares in

issue. The current market price is Rs. 100. The market capitalisation of

company A is Rs. 12000 million.

4. Initial Public Offer (IPO)

An Initial Public Offer (IPO) is the selling of securities to the public in the

primary market. It is when an unlisted company makes either a fresh issue

of securities or an offer for sale of its existing securities or both for the first

time to the public. This paves way for listing and trading of the issuers

securities. The sale of securities can be either through book building or

through normal public issue.



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SECONDARY MARKET

Secondary market refers to a market where securities are traded after being

initially offered to the public in the primary market and/or listed on the

Stock Exchange. Majority of the trading is done in the secondary market.Secondary market comprises of equity markets and the debt markets.

Role of the Secondary Market

For the general investor, the secondary market provides an efficient platform

for trading of his securities. For the management of the company, Secondary

equity markets serve as a monitoring and control conduitby facilitating

value-enhancing control activities, enabling implementation of incentive-

based management contracts, and aggregating information (via price

discovery) that guides management decisions.

The secondary market, also known as the aftermarket, is the financial market

where previously issued securities and financial instruments such as stock ,

bonds , options , and futures are bought and sold. The term "secondary

market" is also used to refer to the market for any used goods or assets, or an

alternative use for an existing product or asset where the customer base is

the second market (for example, corn has been traditionally used primarily

for food production and feedstock, but a "second" or "third" market has

developed for use in ethanol production). Another commonly referred to

usage of secondary market term is to refer to loans which are sold by amortgage bank to investors such as Fannie Mae and Freddie Mac .

With primary issuances of securities or financial instruments, or the primary

market , investors purchase these securities directly from issuers such as

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corporations issuing shares in an IPO or private placement , or directly from

the federal government in the case of treasuries . After the initial issuance,

investors can purchase from other investors in the secondary market.

FUNCTIONS OF SECONDARY MARKET

Secondary marketing is vital to an efficient and modern capital market. In

the secondary market , securities are sold by and transferred from one

investor or speculator to another. It is therefore important that the secondary

market be highly liquid (originally, the only way to create this liquidity was

for investors and speculators to meet at a fixed place regularly; this is howstock exchanges originated, As a general rule, the greater the number of

investors that participate in a given marketplace, and the greater the

centralization of that marketplace, the more liquid the market.

Fundamentally, secondary markets mesh the investor's preference for

liquidity (i.e., the investor's desire not to tie up his or her money for a long

period of time, in case the investor needs it to deal with unforeseencircumstances) with the capital user's preference to be able to use the capital

for an extended period of time.

Accurate share price allocates scarce capital more efficiently when new

projects are financed through a new primary market offering, but accuracy

may also matter in the secondary market because:

1) Price accuracy can reduce the agency costs of management, and make

hostile takeover a less risky proposition and thus move capital into the hands

of better managers, and

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2) Accurate share price aids the efficient allocation of debt finance

whether debt offerings or institutional borrowing.

THEY ARE FURTHER CLASSIFIED INTO:

A. Capital market

B. Money market

A. CAPITAL MARKET:

The CAPITAL MARKET is the market for financial assets which have long

and indefinite maturity. It generally deals with long term securities which

have a maturity period of more than one year. Capital markets may be

classified as primary markets and secondary markets . In primary markets,

new stock or bond issues are sold to investors via a mechanism known as

underwriting . In the secondary markets, existing securities are sold and

bought among investors or traders, usually on a securities exchange , over-

the-counter , or elsewhere.

STOCK EXCHANGE

A stock exchange is an entity which provides "trading" facilities for stock

brokers and traders , to trade stocks and other securities . Stock exchanges

also provide facilities for the issue and redemption of securities as well as

other financial instruments and capital events including the payment of

income and dividends . The securities traded on a stock exchange include

shares issued by companies, unit trusts , derivatives , pooled investment

products and bonds .

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The major stock exchanges in India are NSE, BSE

ROLE OF STOCK EXCHANGE

1. Raising capital for businesses

The Stock Exchange provide companies with the facility to raise capital for

expansion through selling shares to the investing public.

2. Mobilizing savings for investment

When people draw their savings and invest in shares, it leads to a more

rational allocation of resources because funds, which could have been

consumed, or kept in idle deposits with banks , are mobilized and redirected

to promote business activity with benefits for several economic sectors such

as agriculture , commerce and industry , resulting in stronger economic

growth and higher productivity levels of firms.

3. Facilitating company growth

Companies view acquisitions as an opportunity to expand product lines ,

increase distribution channels, hedge against volatility, increase its market

share , or acquire other necessary business assets . A takeover bid or a merger

agreement through the stock market is one of the simplest and most common

ways for a company to grow by acquisition or fusion.

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4. Profit sharing

Both casual and professional stock investors , through dividends and stock

price increases that may result in capital gains , will share in the wealth of

profitable businesses.

5. Corporate governance

By having a wide and varied scope of owners, companies generally tend to

improve on their management standards and efficiency in order to satisfy the

demands of these shareholders and the more stringent rules for public

corporations imposed by public stock exchanges and the government.

Consequently, it is alleged that public companies (companies that are owned

by shareholders who are members of the general public and trade shares on

public exchanges) tend to have better management records than privately

held companies (those companies where shares are not publicly traded, often

owned by the company founders and/or their families and heirs, or otherwise

by a small group of investors).

Despite this claim, some well-documented cases are known where it is

alleged that there has been considerable slippage in corporate governance on

the part of some public companies. The dot-com bubble in the late 1990's,

and the subprime mortgage crisis in 2007-08, are classical examples of

corporate mismanagement. Companies like Pets.com (2000), Enron

Corporation (2001), One.Tel (2001), Sunbeam (2001), Webvan (2001),

Adelphia (2002), MCI WorldCom (2002), Parmalat (2003), American

International Group (2008), Bear Stearns (2008), Lehman Brothers (2008),

http://en.wikipedia.org/wiki/Stock_investorhttp://en.wikipedia.org/wiki/Dividendhttp://en.wikipedia.org/wiki/Stock_pricehttp://en.wikipedia.org/wiki/Stock_pricehttp://en.wikipedia.org/wiki/Capital_gainhttp://en.wikipedia.org/wiki/Managementhttp://en.wikipedia.org/wiki/Efficiency_(economics)http://en.wikipedia.org/wiki/Public_companieshttp://en.wikipedia.org/wiki/Privately_held_companyhttp://en.wikipedia.org/wiki/Privately_held_companyhttp://en.wikipedia.org/wiki/Corporate_governancehttp://en.wikipedia.org/wiki/Dot-com_bubblehttp://en.wikipedia.org/wiki/Subprime_mortgage_crisishttp://en.wikipedia.org/wiki/Pets.comhttp://en.wikipedia.org/wiki/Enron_Corporationhttp://en.wikipedia.org/wiki/Enron_Corporationhttp://en.wikipedia.org/wiki/One.Telhttp://en.wikipedia.org/wiki/Sunbeam_Productshttp://en.wikipedia.org/wiki/Webvanhttp://en.wikipedia.org/wiki/Adelphia_Communications_Corporationhttp://en.wikipedia.org/wiki/MCI_WorldComhttp://en.wikipedia.org/wiki/Parmalathttp://en.wikipedia.org/wiki/American_International_Grouphttp://en.wikipedia.org/wiki/American_International_Grouphttp://en.wikipedia.org/wiki/Bear_Stearnshttp://en.wikipedia.org/wiki/Lehman_Brothershttp://en.wikipedia.org/wiki/Stock_investorhttp://en.wikipedia.org/wiki/Dividendhttp://en.wikipedia.org/wiki/Stock_pricehttp://en.wikipedia.org/wiki/Stock_pricehttp://en.wikipedia.org/wiki/Capital_gainhttp://en.wikipedia.org/wiki/Managementhttp://en.wikipedia.org/wiki/Efficiency_(economics)http://en.wikipedia.org/wiki/Public_companieshttp://en.wikipedia.org/wiki/Privately_held_companyhttp://en.wikipedia.org/wiki/Privately_held_companyhttp://en.wikipedia.org/wiki/Corporate_governancehttp://en.wikipedia.org/wiki/Dot-com_bubblehttp://en.wikipedia.org/wiki/Subprime_mortgage_crisishttp://en.wikipedia.org/wiki/Pets.comhttp://en.wikipedia.org/wiki/Enron_Corporationhttp://en.wikipedia.org/wiki/Enron_Corporationhttp://en.wikipedia.org/wiki/One.Telhttp://en.wikipedia.org/wiki/Sunbeam_Productshttp://en.wikipedia.org/wiki/Webvanhttp://en.wikipedia.org/wiki/Adelphia_Communications_Corporationhttp://en.wikipedia.org/wiki/MCI_WorldComhttp://en.wikipedia.org/wiki/Parmalathttp://en.wikipedia.org/wiki/American_International_Grouphttp://en.wikipedia.org/wiki/American_International_Grouphttp://en.wikipedia.org/wiki/Bear_Stearnshttp://en.wikipedia.org/wiki/Lehman_Brothers


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General Motors (2009) and Satyam Computer Services (2009) were among

the most widely scrutinized by the media.

However, when poor financial, ethical or managerial records are known by

the stock investors , the stock and the company tend to lose value. In the

stock exchanges, shareholders of underperforming firms are often penalized

by significant share price decline, and they tend as well to dismiss

incompetent management teams.

6. Creating investment opportunities for small investors

As opposed to other businesses that require huge capital outlay, investing in

shares is open to both the large and small stock investors because a person

buys the number of shares they can afford. Therefore the Stock Exchange

provides the opportunity for small investors to own shares of the same

companies as large investors.

7. Government capital-raising for development projects

Governments at various levels may decide to borrow money in order to

finance infrastructure projects such as sewage and water treatment works or

housing estates by selling another category of securities known as bonds .

These bonds can be raised through the Stock Exchange whereby members of

the public buy them, thus loaning money to the government. The issuance of

such bonds can obviate the need to directly tax the citizens in order tofinance development, although by securing such bonds with the full faith

and credit of the government instead of with collateral, the result is that the

government must tax the citizens or otherwise raise additional funds to make

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any regular coupon payments and refund the principal when the bonds

mature.

Capital market may further divided into:

( a) Equity Shares or ordinary shares:

An equity share, commonly referred to as ordinary share, represents the form

of fractional ownership in a business venture. They do not get fixed rate of

dividend, they carry second preferential right in the payment of dividend.

The person who holds equity shares are the holder of those shares, they are

the real owner of the company.

(b) Preference shares:

Owners of these kind of shares are entitled to a fixed dividend or dividend

calculated at a fixed rate to be paid regularly before dividend can be paid in

respect of equity share. They also enjoy priority over the equity shareholders

in payment of surplus. But in the event of liquidation, their claims rank

below the claims of the companys creditors, bondholders/debenture holders.

(c) Debentures or bonds:

Debentures can be defined as acknowledgement of debt, given under the

seal of the company and containing a contract for the repayment of the

principal sum at a specified date and for the payment of interest at fixed rate

percent until the principal sum is repaid and it may or may not give the

charge on the assets to the company as security of the loan.

Bond is a negotiable certificate evidencing indebtedness. It is normally

unsecured. A debt security is generally issued by a company, municipality or



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government agency. A bond investor lends money to the issuer and in

exchange, the issuer promises to repay the loan amount on a specified

maturity date. The issuer usually pays the bond holder periodic interest

payments over the life of the loan.

Industrial entities raise their required capital or debt by issuing appropriate

instruments. The market where these securities/instruments are transacted is

called as industrial securities market.

2. Government securities market

It is the market where government securities are traded. Govt. securities can

be short term or long term. Short-term are traded in money market whereas

long term are traded in capital market. The securities are issued by central

govt., state governments, semi-governments authorities like city

corporations, port trusts etc.; state electricity boards, All India and State

level financial institutions and public sector enterprises. It consists of central

and state government securities. It means that, loans are being taken by thecentral and state government. It is also the most dominant category in the

India debt market. The government securities market is at the core of

financial markets in most countries. It deals with tradable debt instruments

issued by the Government for meeting its financing requirements.1 The

development of the primary segment of this market enables the managers of

public debt to raise resources from the market in a cost effective manner with due recognition to associated risks. A vibrant secondary segment of the

government securities market helps in the effective operation of monetary

policy through application of indirect instruments such as open market

operations, for which government securities act as collateral. The



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government securities market is also regarded as the backbone of fixed

income securities markets as it provides the benchmark yield and imparts

liquidity to other financial markets. The existence of an efficient government

securities market is seen as an essential precursor, in particular, for development of the corporate debt market. Furthermore, the government

securities market acts as a channel for integration of various segments of the

domestic financial market and helps in establishing inter-linkages between

the domestic and external financial markets.

MAJOR PARTICIPANTS IN FINANCIAL MARKETS

Commercial Banks: A commercial bank is a type of financial

intermediary and a type of bank . Commercial banking is also known

as business banking. It is a bank that provides checking accounts,

savings accounts, and money market accounts and that accepts time

deposits Mutual funds: Mutual funds can be defined as the money-managing

systems that are introduced to professionally invest money collected

from the public. The Asset Management Companies (AMCs) manage

different types of mutual fund schemes. The AMCs are supported by

various financial institutions or companies. Investment in mutual

funds in India means pooling money in bonds, short-term money

market, financial institutions, stocks and securities and dishing out

returns as dividends. In India, Fund Managers manage the mutual

funds.

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Underwriters: A company or other entity that administers the public

issuance and distribution of securities from a corporation or other

issuing body. An underwriter works closely with the issuing body to

determine the offering price of the securities, buys them from theissuer and sells them to investors via the underwriter's distribution

network.

Insurance companies: Insurance is a form of risk

management primarily used to hedge against the risk of a

contingent, uncertain loss. Insurance is defined as the equitable

transfer of the risk of a loss, from one entity to another, in exchangefor payment. An insurer is a company selling the insurance;

an insured , or policyholder, is the person or entity buying the

insurance policy. The insurance rate is a factor used to determine the

amount to be charged for a certain amount of insurance coverage,

called the premium . Risk management , the practice of appraising and

controlling risk, has evolved as a discrete field of study and practice.

The transaction involves the insured assuming a guaranteed and

known relatively small loss in the form of payment to the insurer in

exchange for the insurer's promise to compensate ( indemnify ) the

insured in the case of a loss. The insured receives a contract , called

the insurance policy , which details the conditions and circumstances

under which the insured will be compensated.

Financial Institution: Financial Institution is an institution that

provides financial services for its clients or members. Probably the

most important financial service provided by financial institutions is

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acting as financial intermediaries . Most financial institutions are

highly regulated by government .

B. MONEY MARKET:

Money market means market where money to its equivalent are traded.

Money is synonym of liquidity. Money market includes financial

institutions and dealers in money or credit who wish to generate liquidity.

Therefore, money market is the market for short term funds. It is a

market for dealing in financial assets which have maturity period of one

year or less. Due to highly liquid nature of securities and there short termmaturities, money market is treated as a safe place. In money market,

short term obligations such as treasury bills, commercial papers and

bankers acceptance etc, are bought and sold.

There are various categories of money market:

Money market can be divided into four categories:

(i) Call money market

(ii) Commercial bills market

(iii) Treasury bills market

(iv) Short - term loan market

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(i) Call money market:

It is the market for very short period of time having maturity

from one day to fourteen days. Commercial banks participate inthis market to meet their CRR and SLR requirements. Loans are

repayable on demand at the option of either the lender or the

borrower. Interest rate varies from day-to-day and even from

hour-to-hour. It is very sensitive to changes in demand and

supply of call loans.

(ii) Commercial Bills Market:

It is the market for bills of exchange arising out genuine credit

transactions. Creditor(drawer) draws the bill on his debtor which

is accepted by the debtor(drawee). On due date, the bill amount is

paid by the drawee. In case of urgent need of cash, drawer can

discount the bill and get the amount of bill.

(iii) Treasury bills market:

It is the market for treasury bills which have short term maturity.

Treasury bill is a promissory notes or a finance bill issued by the

government. It is highly liquid as its repayment is guaranteed by

the government. These bills have maturity period of 91 days or

182 days or 364 days only.



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CHAPTER 4: FINANCIAL INSTRUMENT

Financial instruments differ from each other in respect of their

investment characteristics which are independent and interrelated.

Among the investment characteristics of financial assets or financial

products.

The following are important:

1. Liquidity

2. Marketability

3. Reversibility

4. Transferability

5. Transaction cost

6. Risk and default

7. Maturity period

8. Tax status

9. Option such as call back or buy back option10.Volatility

11.Rate of return



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There are various Financial Instruments.

1. Financial Assets:

The financial assets represents a claim to the payment of sum of money

sometime in future. (repayment of principal amount) and/ or a payment in

the form of interest or dividend.

2. There are two types of securities, it is further classified into:

Primary and Secondary:

Financial securities are classified as Primary(direct)

Secondary(indirect) securities.

Primary securities are issued by ultimate investor directly to the

ultimate savers as ordinary shares or debentures.

Secondary securities are issued by financial intermediaries to the

ultimate savers as bank deposits, units, insurance policies and so on.

3. It is further classified into three terms:

Short-term: Short-term securities have a maturity a period of a

year or less. Examples: shares

Medium-term: Medium-term securities have a maturity period of

1, 3, or 5 years. Examples: certificate of deposits, commercial papers, T- bills

Long term : Long-term securities have a maturity period of more

than 3 or 5 years. Examples: venture capital



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TYPES OF FINANCIAL MARKET INSTRUMENTS IN INDIA:

Money Market:

The money market can be defined as a market for short-term money and

financial assets that are near substitutes for money. The term short-term means

generally a period upto one year and near substitutes to money is used to denote

any financial asset which can be quickly converted into money with minimum

transaction cost.

Benefits and functions of money market:

Money market facilitates efficient transfer of short term funds between lenders

and borrowers of money. For the lender/ investor, it provides a good return on

their funds, for the borrower, it enables rapid and relatively inexpensive

acquisition of money to meet short term liabilities

Money market instruments:

1. Call /Notice-Money Market:

Call/Notice money is the money borrowed or lent on demand for a very short

period. When money is borrowed or lent for a day, it is known as Call

(Overnight) Money. Intervening holidays and/or Sunday are excluded for this

purpose. Thus money, borrowed on a day and repaid on the next working day,

(irrespective of the number of intervening holidays) is & quot; Call Money&

quot;. When money is borrowed or lent for more than a day and up to 14 days,

it is & quot; Notice Money& quot;. No collateral security is required to cover

these transactions.



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2. Inter-Bank Term Money:

Inter-bank market for deposits of maturity beyond 14 days is referred to as the

term money market. The entry restrictions are the same as those for Call/Notice

Money except that, as per existing regulations, the specified entities are notallowed to lend beyond 14 days.

3. Treasury Bills:

Treasury Bills are short term (up to one year) borrowing instruments of the

union government. It is an IOU of the Government. It is a promise by the

Government to pay a stated sum after expiry of the stated period from the dateof issue (14/91/182/364 days i.e. less than one year). They are issued at a

discount to the face value, and on maturity the face value is paid to the holder.

The rate of discount and the corresponding issue price are determined at each

auction.

4. Certificate of Deposits:

Certificates of Deposit (CDs) is a negotiable money market instrument and

issued in dematerialised form or as a Usance Promissory Note, for 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, as amended from time to time.

CDs can be issued by (i) scheduled commercial banks excluding Regional RuralBanks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial

Institutions that have been permitted by RBI to raise short-term resources

within the umbrella limit fixed by RBI.

Banks have the freedom to issue CDs depending on their requirements. An FI



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may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD

together with other instruments viz., term money, term deposits, commercial

papers and intercorporate deposits should not exceed 100 per cent of its net

owned funds, as per the latest audited balance sheet.

5. Commercial Paper:

CP is a note in evidence of the debt obligation of the issuer. On issuing

commercial paper the debt obligation is transformed into an instrument. CP is

thus an unsecured promissory note privately placed with investors at a discount

rate to face value determined by market forces. CP is freely negotiable byendorsement and delivery.

A company shall be eligible to issue CP provided - (a) the tangible net worth of

the company, as per the latest audited balance sheet, is not less than Rs. 4 crore;

(b) the working capital (fund-based) limit of the company from the banking

system is not less than Rs.4 crore and (c) the borrowal account of the company

is classified as a Standard Asset by the financing banks. The minimum maturity period of CP is 7 days. The minimum credit rating shall be P-2 of CRISIL or

such equivalent rating by other agencies.



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Capital Market Instruments:

The capital market generally consists of the following long term period i.e.,

more than one year period, financial instruments; In the equity segment Equity

shares, preference shares, convertible preference shares, non-convertible

preference shares etc and in the debt segment debentures, zero coupon bonds,

deep discount bonds etc.

1. Equity Shares:

An equity share, commonly referred to as ordinary share, represents the form

of fractional ownership in a business venture.

2. Preference shares:

Owners of these kind of shares are entitled to a fixed dividend or dividend

calculated at a fixed rate to be paid regularly before dividend can be paid in

respect of equity share. They also enjoy priority over the equity shareholders

in payment of surplus. But in the event of liquidation, their claims rank

below the claims of the companys creditors, bondholders/debenture holders.

3. Zero Coupon Bond:

Bond issued at a discount and repaid at a face value. No periodic interest is

paid. The difference between the issue price and redemption price represents

the return to the holder. The buyer of these bonds receives only one

payment, at the maturity of

the bond.



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4. Convertible Bond:

A bond giving the investor the option to convert the bond into equity at a

fixed conversion price.

5. Treasury Bills:

Short-term (up to one year) bearer discount security issued by government

as a means of financing their cash requirements

HYBRID INSTRUMENTS:

Hybrid instruments have both the features of equity and debenture. This kind of instruments is called as hybrid instruments. Examples are convertible

debentures, warrants etc.

There are different types of hybrid instruments:

1. Premium Bonds:

Premium bonds are bonds that are priced higher than their face value. These

bonds are sold at a premium because the interest rate paid on them is higher

than the prevailing interest rates.

2. Convertible bonds:

Convertible bonds means corporate bonds that are converted into common

stock of the issuing company at the behest of the bond holder. However, theconversion of convertible bonds is subject to certain restrictions, depending

on the policies of the issuing authority.



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3. Zero Coupon Bond:

Bond issued at a discount and repaid at a face value. No periodic interest is

paid. The difference between the issue price and redemption price representsthe return to the holder. The buyer of these bonds receives only one

payment, at the maturity of the bond.

4. Mortgage Bonds:

A Mortgage bond are a special type of bond and is essentially a debt

instrument. In such a case bond is secured against real estate or any assets

like machines. The risk involved is considerably low and is more secured

than any other instruments. These bonds are purchased or sold under

secondary market. The people who purchase these bonds is known as holder.

These people are entitled to receive a payment on the basis of rate of interest

or principal amount.

5. High yield Bonds:

High yield bonds are debt securities that are issued by low credit quality

organizations. These are organizations that have poor financial health and do

not qualify for investment-grade ratings conferred by leading credit rating

agencies.



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CHAPTER 5: FINANCIAL SERVICES

Financial services refer to services provided by the finance industry. The

finance industry encompasses a broad range of organizations that deal with

the management of money. Among these organizations are banks , credit

card companies, insurance companies, consumer finance companies, stock

brokerages , investment funds and some government sponsored enterprises .

As of 2004, the financial services industry represented 20% of the market

capitalization of the S&P 500 in the United States .

BANKS

A "commercial bank " is what is commonly referred to as simply a "bank".

The term " commercial " is used to distinguish it from an " investment bank ,"

a type of financial services entity which, instead of lending money directly

to a business, helps businesses raise money from other firms in the form of

bonds (debt) or stock (equity).

Banking services

The primary operations of banks include:

Keeping money safe while also allowing withdrawals when needed Issuance of checkbooks so that bills can be paid and other kinds of

payments can be delivered by post Provide personal loans , commercial loans , and mortgage loans

(typically loans to purchase a home, property or business) Issuance of credit cards and processing of credit card transactions and

billing

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Issuance of debit cards for use as a substitute for checks Allow financial transactions at branches or by using Automatic Teller

Machines (ATMs)

Provide wire transfers of funds and Electronic fund transfers between banks

Facilitation of standing orders and direct debits , so payments for bills

can be made automatically

Provide overdraft agreements for the temporary advancement of the

Bank's own money to meet monthly spending commitments of a

customer in their current account. Provide Charge card advances of the Bank's own money for

customers wishing to settle credit advances monthly. Provide a check guaranteed by the Bank itself and prepaid by the

customer, such as a cashier's check or certified check . Notary service for financial and other documents

Other types of bank services

Private banking - Private banks provide banking services exclusively

to high net worth individuals . Many financial services firms require a

person or family to have a certain minimum net worth to qualify for

private banking services. Private banks often provide more personal

services, such as wealth management and tax planning, than normal

retail banks. Capital market bank - bank that underwrite debt and equity , assist

company deals (advisory services, underwriting and advisory fees),

and restructure debt into structured finance products.

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Bank cards - include both credit cards and debit cards . Bank Of

America is the largest issuer of bank cards. Credit card machine services and networks - Companies which

provide credit card machine and payment networks call themselves"merchant card providers".

FOREIGN EXCHANGE SERVICES

Foreign exchange services are provided by many banks around the world.

Foreign exchange services include:

Currency Exchange - where clients can purchase and sell foreign

currency banknotes. Wire transfer - where clients can send funds to international banks

abroad. Foreign Currency Banking - banking transactions are done in

foreign currency.

INVESTMENT SERVICES

Asset management - the term usually given to describe companies

which run collective investment funds . Also refers to services

provided by others, generally registered with the Securities and

Exchange Commission as Registered Investment Advisors .

Hedge fund management - Hedge funds often employ the services of "prime brokerage" divisions at major investment banks to execute

their trades.

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CHAPTER 6: CONCLUSION

Thus, the financial system is the system that allows the transfer of

money between savers and borrowers. It comprises a set of complex and

closely interconnected financial institutions, markets, instruments,

services, practices, and transactions. Thus, financial system in India has

various sections. Primary markets and secondary markets are the major

markets in Financial System and has various roles to the economy,

The financial system is concerned about money, credit and finance-the

three terms are intimately related yet are somewhat different from eachother. These markets help the investors to invest in certain products and

get good returns. Indian financial system consists of financial market,

financial instruments and financial intermediation.



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BIBLIOGRAPHY:

WEBSITES :www.nse-india.com

Refered from NCFM-module

www.google.com

www.wikipedia.com

www.investopedia.com

BOOKS:

Indian Financial Institutions and Financial Markets.

Debt Markets- Sandeep gupta and Sachin Bhandarkar.
http://www.nse-india.com/http://www.google.com/http://www.wikipedia.com/http://www.investopedia.com/http://www.nse-india.com/http://www.google.com/http://www.wikipedia.com/http://www.investopedia.com/

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FINANCIAL SYSYTEM

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