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    The economic development of any country depends upon the existence of

    a well organized financial system. It is the financial system which supplies

    the necessary financial inputs for the production of goods and services

    which in turn promote the well being and standard of living of the people of

    a country. Thus, the financial system is a broader term which brings under

    its fold the financial markets and the financial institutions which support the

    system. The maor assets traded in the financial system are money and

    monetary assets. The responsibility of the financial system is to mobilize the

    savings in the form of money and monetary assets and invest them to

    productive ventures. !n efficient functioning of the financial system

    facilitates the free flow of funds to more productive activities and thus

    promotes investment. Thus, the financial system provides the intermediation

    between savers and investors and promotes faster economic development.

    "inancial institutions in countries like India are classified into banking and

    non#banking financial intermediaries wherein the commercial banks are

    considered as general or non#specialized financial institutions and the non#

    banking financial intermediaries like investment banks, insurance

    companies, term lending financial institutions and development banks are

    known as specialized financial institutions.

    $ountry like India also has dichotomy in the financial market. This

    dichotomy can be explained in terms of the existence of organized and

    unorganized financial markets. %hile all of the above will constitute the

    organized sector of the financial market, the unorganized financial market in

    India consists of traditional bankers like the &uarati shroffs, 'ultani or


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    )hikarpuri shroffs, $hettiars and 'arwari *ayas. The &uarati shroffs

    operate in +ombay, $alcutta and the industrial trading centers of &uarat.

    The 'arwari shroffs operate in $alcutta, +ombay, !ssam and other parts

    of north#east India. The multani or )hikarpuri shroffs are mainly found in

    +ombay and madras and the chettiars operate in south India. !mongst these

    traditional bankers, the &uaarati shroffs carryout the largest volume of

    unorganized banking business in India. on#banking financial companies

    like chit funds and nidhis also operate in large numbers in India. The third

    segment of the unorganized financial market in India consists of the money

    lenders. These unorganized segments are so called because they are neither

    registered as companies nor being controlled by the reserve +ank of India.


    According to Dr. Prasanna Candra, -The financial system consists of a

    variety of financial intermediaries, markets and instruments that are related

    to each other. It provides the principal means by which savings are

    transformed into investments.

    Dr. L.M. !o"# d#$in#s $inancia" s%st#& as-The financial system of any

    country consists of specialized and non#specialized financial institutions,

    of organized and unorganized financial markets, of financial instruments and

    services which facilitate transfer funds. /rocedures and practices adopted in

    the markets and financial interrelationships are also parts of the system.


    The financial system performs the following functions that are interrelated

    and are essential for the development process of a modern economy.


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    A' Pa%nt s%st#&

    !' Mo(i"i)ation and a""ocation o$ $*nds

    C' Ris+ &anag#nt

    D' Pric# in$or&ation $or d#c#ntra"i)#d d#cision &a+ing

    E' D#a"ing ,it inc#nti# ro("#&


    The commercial banking system, alternatively known as depository

    financial intermediaries constitutes the payment system in the financial

    market. The credit and debit card companies play a supplementary role.

    %ith large number of commercial banks having their independent credit

    card and debit card divisions, the credit and debit card system becomes a

    part of the banking system. 'odern economies and societies with the present

    scale and volume of transactions cannot be imagined in the absence of a

    payment system as convenient as the banking system we have now.


    The financial intermediaries both banking and non#banking plays a crucial

    role in mobilizing funds from the persons and households having surplus

    and allocating it to the deficit persons and firms. The financial markets also

    help in efficient allocation of scarce financial resources and individuals and

    households are provided the opportunity to invest their financial resources in

    attractive financial avenues of investment. The widening and deepening of

    the financial markets takes place with the growth of the financial markets

    and availability of innovative and ingenious financial products that can

    mobilize the smallest of the savings available in the society.


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    !ccording to 2obert 'erton, -! well developed, smooth#functioning

    financial system facilitates the efficient life#cycle allocation of household

    consumption and the efficient allocation of physical capital to the most

    productive use in the business sector.

    ! well developed, smooth#functioning capital market also makes possible

    the efficient separation of ownership from management of the firm. This in

    turn makes feasible efficient specialization in production according to the

    principle of comparative advantage.


    ! developed financial system provides a variety of financial instruments

    that enable financial intermediaries to mobilize3 price and exchange risk. It

    provides opportunities for risk#pooling and risk sharing for both firms and


    The three basic methods of managing risk are4

    H#dging25edging would re6uire movement from a risk#loaded asset to a

    risk# free asset.

    E3.! forward contract is a hedging device.

    Di#rsi$ication27iversification helps in redistribution of risks in such a

    manner that the risk faced by every individual is diminished. It does not

    eliminate risk entirely.

    E3.'utual fund companies offer income, balanced and growth funds.

    Ins*ranc#2 %hile income funds are risk free, the risk is balanced in

    balanced funds and growth funds carry highest level of risk. The risk#return

    relationship is direct and proportional. Insurance enables the insured to enoy

    the economic benefits of ownership while eliminating the possible losses.


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    "inancial system helps decentralized decision making.

    !ccording to 2obert 'erton, -Interest rates and security prices are used

    by households or their agents in making their consumption#saving decisions

    and in choosing the portfolio allocations of their wealth. These same prices

    provide important signals to managers of firms in their selection

    of investment proects and financings.

    The money market offers short term credit financial instruments and the

    capital market offers both long term credit financial instruments and

    permanent ownership capital. Information pertaining to these instruments is

    readily made available to all financial investors so that they can determine

    their portfolio allocations based on their risk taking abilities and

    understanding of the financial markets. &iven the information on financial

    markets, households may decide on the distribution of their incomes

    between consumption and savings.


    %hen financial information is not e6ually available to all, the problem

    of informational asymmetry or ine6uality comes into existence. This leads to

    the problems of moral hazard and adverse selection. These problems are

    known as agency problems.

    E3.! person who has insured his car will become negligent and park his or

    her car without looking at the security aspects. This is very much true in a

    country like India where thousands of cars are parked in public spaces not

    earmarked for car parking for want of car parking facilities. This is the moral

    hazard faced by the insurance company. ! person who is more likely to


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    experience car loss arising out of car theft is most likely to take car

    insurance. This is the adverse selection problem faced by the insurance



    !n understanding of the financial system re6uires an understanding of the

    following important concepts4

    Financia" ass#ts

    Financia" int#rdiari#s

    Financia" &ar+#ts

    Financia" rat#s o$ r#t*rn

    Financia" instr*nts


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    In any financial transaction, there should be a creation or transfer

    of financial asset. 5ence, the basic product of any financial system is the

    financial asset. ! financial asset is one which is used for production or

    consumption or for further creation of assets.

    E3.! buys e6uity shares and these shares are financial assets since they earn

    income in future.

    In this context, one must know the distinction between financial assets and

    physical assets. ;nlike financial assets, physical assets are not useful for

    further production of goods or for earning income.

    E3.< purchases land and buildings, or gold and silver. These are physical

    assets since they cannot be used for further production. 'any physical assets

    are useful for consumption only.

    It is interesting to note that the obective of investment decides the purposes,

    it becomes a physical asset. If the same is bought for hiring, it becomes a

    financial asset.


    "inancial assets can be classified differently under different circumstances.

    =ne such classification is4

    7 Mar+#ta("# ass#ts

    7 Non-&ar+#ta("# ass#ts


    'arketable assets are those which can be easily transferred from one

    person to another without much hindrance.


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    E3. )hares of listed companies, government securities, bonds of public

    sector undertakings etc.


    =n the other hand, if the assets cannot be transferred easily, they come

    under this category.

    E3. +ank deposits, provident funds, pension funds, national savings

    certificates, insurance policies etc.

    This classification is shown in the following 4

    Cas ass#ts2In India, all coins and currency notes are issued by the 2+I andthe ministry of finance, government of India. +esides, commercial banks can

    also create money by means of creating credit. %hen loans are sanctioned,

    li6uid cash is not granted. Instead an account is opened in the borrowers

    name and a deposit is created. It is also a kind of money asset.

    D#(t ass#ts2 7ebt asset is issued by a variety of organizations for the

    purpose of raising their debt capital. 7ebt capital entails a fixed repayment

    schedule with regard to interest and principal. There are different ways of

    raising capital advance, etc.

    Stoc+ ass#ts2)tock is issued by business organizations for the purpose of

    raising their fixed capital. There are two types of stock namely e6uity and

    preference. ?6uity shareholders are the real owners of the business and they

    enoy the fruits of ownership and at the same time they bear the risks as

    well. /reference shareholders, on the other hand get a fixed rate of dividend

    @as in the case of debt assetA and at the same time they retain some

    characteristics of e6uity.


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    The term financial intermediary includes all kinds of organizations which

    intermediate and facilitate financial transactions of both individuals and

    corporate customers. Thus, it refers to all kinds of financial institutions and

    investing institutions which facilitate financial transactions in financial

    markets. They maybe in the organized sector or in the unorganized sector.

    Caita" &ar+#t int#rdiari#s

    Mon#% &ar+#t int#rdiari#s


    These intermediaries mainly provide long term funds to individuals and

    corporate customers. They consist of term lending institutions like financial

    corporations and investing institutions like CI$.


    'oney market intermediaries supply only short term funds to individuals

    and corporate customers. They consist of commercial banks, co#operative

    banks, etc. "inancial intermediaries are those financial institutions that

    provide financial services and financial products to the customers in an

    efficient manner.

    E3. ! mutual fund mobilizes the financial resources of households and

    invests in a basket of securities according to the preferences of the buyers.

    The mutual funds enoy economies of scale in conducting large scale

    transactions, maintaining huge volumes of records and in research and

    development. The mutual funds therefore offer a highly efficient method of

    investing than what an individual can do on its own. The important financial


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    products and services of financial intermediaries are checking accounts,

    savings accounts, loans, mortgages, mutual fund schemes, insurance

    contracts, credit rating, etc. ! financial intermediary acts as an agent

    between the entrepreneurial class and the investing class.



    "unds mobilized by financial intermediaries are invested in a diversified

    portfolio of financial assets such stocks, money market products, bonds, and

    loans. 7iversification helps in spreading the risk over a number of financial

    assets and hence reduces the overall risk.


    The average size of a transaction of financial intermediary is

    disproportionately greater than that or an individual investor. The transaction

    cost is therefore negligibly low.


    $ollection of information, processing of information and regular

    monitoring of the financial markets is essential for deciding to buy or sell

    financial assets. "inancial intermediaries have the financial muscle to

    employ professional services to perform this task at a fraction of their total

    cost operations. The operational cost of financial intermediaries is less

    because of the large size of operations and conse6uent economies of scale.


    $ompanies who access the financial markets for funds or want the

    continued support of existing investors are re6uired to reveal information

    which they otherwise would like to keep it secret for maintaining their


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    competitive advantage. Information revealed to financial intermediaries has

    a greater chance of secrecy and security than to individual investors.


    "inancial intermediaries has the re6uired professional expertise to

    understand the signals and hints provided by companies and pass on the

    ac6uired understanding to the investors so that individual investors can take

    their decisions to invest.


    The financial intermediaries in India consists of banking and non#banking

    financial institution, development finance institutions, insurance companies,

    investment banks such as the mutual funds, merchant banks, venture capital

    firms and information services companies.


    The /ublic )ector +anks, foreign banks and private sector banks are the

    most important banking financial intermediary in the Indian financial

    system. The )tate +ank of India was set up in (D99 and is the largest

    commercial bank in India. +ank nationalization effort in (D:D and in (DBE

    by the &overnment of India transformed a large number of private sector

    banks into nationalized banks. !s a result, the commercial banking sector is

    dominated by public sector banks in India. ationalization of banks

    contributed to the spread of banking institutions in the hooks and corners of

    the country, led to higher mobilization of deposits and reallocation of bank

    credit to priority sectors of the economy. =n the flip side, the autonomy of

    the bank management was reduced. %ith the adoption of the ew ?conomic

    /olicy in the year (DD(, the banking sector was liberalized and new private


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    sector banks such as the 57"$ and I$I$I +anks came into existence. The

    private banking sector is dominated by these two banks since their inception.


    In order to facilitate rapid industrial development in India, the need for

    long term finance was catered to by setting up development banks in India.

    Term lending financial institutions such as the Industrial 7evelopment +ank

    of India @I7+IA, Industrial "inance $orporation of India @I"$IA, Industrial

    $redit and Investment $orporation of India @I$I$IA, )tate "inancial

    $orporations @)"$sA and )tate Industrial 7evelopment $orporations were

    set up by both $entral and )tate &overnments. The )mall Industries

    7evelopment +ank of India @)I7+IA was setup to promote the growth of

    small scale industries in India. These development banks have proved to be

    responsive to the growing need for industrial capital. They contribute in

    identifying investment opportunities, encourage entrepreneurship, promote

    development of backward regions and support modernization programs.

    The ational +ank of !griculture and 2ural 7evelopment is the apex

    agricultural financial institution. It provides assistance through a large

    number of regional, )tate level and field level institutions like the 2egional

    2ural +anks, the )tate $o#operative +anks etc. their activities can be

    classified into five. They are4

    F 7irect financing,

    F Indirect financing,

    F !ssistance financing and

    F /romotional work.

    =ut of these banks, I$I$I and I7+I have become universal banks i.e.

    performing both banking and non#banking functions at the same time.


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    ;ntil the liberalization of the financial sector in (DD(, there were only two

    insurance companies in India. They were the Cife Insurance $orporation of

    India and the &eneral Insurance $orporation of India. The CI$ is by far the

    largest insurance company in India and the new private sector entities that

    emerged in the post liberalization era are nowhere near the size of the public

    sector behemoth. This has been also due to the fact that hundred per cent

    foreign owned insurance companies are not yet allowed. The &I$ has four

    subsidiaries and also command huge resource at its disposal. /rivate sector

    insurance companies such as the I$I$I#/rudential, Tata, !I&, +irla, )un

    life, 'et life etc have been set up in India after (DD(. 5owever, these

    companies are yet to make any maor inroads into the market shares of the

    &overnment insurance companies like the CI$ and &I$.


    The /ost =ffice )avings +ank is managed by the /ost and Telegraph

    department on behalf of the 'inistry of "inance, &overnment of India

    through its net work of post offices spread over the length and breadth of

    India. This bank collects funds through different schemes like savings bank

    accounts, recurring and cumulative time deposits, public provident fund and

    *isan Gikas /atras.


    The ational 5ousing +ank was set up as an apex agency in the field

    of housing finance. The mandate for ational 5ousing +ank is to promote

    an institutional framework for the supply of finance in the housing sector.


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    'utual funds are investment banks. ! mutual fund is a collective

    investment arrangement. The 'utual "und is organized as a trust with a

    broad of trustees. It floats different schemes of investment in which the

    people can participate. The asset management company organized as a

    separate oint stock company manages the funds mobilized under different

    schemes. +roadly, schemes of mutual funds can be classified into three

    categories. They are income funds, balanced funds and growth funds. ?ighty

    percent of the income funds are invested in the debt market and hence

    income funds have low risk and provide low returns. The balanced funds are

    e6ually invested in the money as well capital markets and hence have a

    higher element of risk with higher returns. The growth funds are

    predominantly invested in the e6uity market and therefore carry a much

    higher risk and very high returns on investment. The mutual fund industry in

    India began with the setting up of ;nit Trust of India and now we have large

    number of mutual funds both foreign and private Indian mutual funds.

    'oney 'arket 'utual "unds have also come into existence.


    on#banking financial, companies are both in the public as well as the

    private sector. ?x. )+I $apital 'arkets, *otak 'ahindra "inance, )undaram

    "inance and Infrastructure Ceasing and "inance $orporation. These

    companies are involved in a number of fund#based and non#fund based

    activities. The main fund#based activities are leasing, hire purchase and bill

    discounting. The main nonEfund based activities are issue management,


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    corporate advisory services, loan syndication and foreign exchange advisory



    'erchant +anks help business, governments and other business entities to

    raise finance by issuing securities. They also facilitate merger, ac6uisitions

    and divestitures. The leading merchant banks in India are )+I $apital

    'arkets, 7)/ 'errill Cynch and H' 'organ.


    Genture capital is another method of financing in the form of e6uity

    participation. ! venture capitalist finances a proect based on the

    potentialities of anew innovative proect. 'uch thrust is given to new ideas

    or technological innovations. Indeed it is a long term risk capital to finance

    high technology proects. The I7+I venture capital fund was set up in(DB:.

    $apital and technology finance corporation @2$T$A. Cikewise the I$I$I and

    the ;TI have ointly set up the technology development and Information

    $ompany of India limited @T7I$IA in(DBB to provide venture capital.

    )imilarly, many state financial corporations and commercial banks have

    started subsidiaries to provide venture capital. The India venture capital fund

    and the credit capital venture fund limited come under the private sector.


    These companies are specialized in the business of providing information.

    ?x. The credit rating information services of India limited @$2I)ICA,

    investment information and credit rating @I$2!A, credit analysis and


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    research limited @$!2?Aand capital market information services like $'I?,

    probity research and capital market.


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    &enerally speaking, there is no specific place or location to indicate a

    financial market. %herever a financial transaction takes place, it is deemed

    to have taken place in the financial market. 5ence financial markets are

    pervasive in nature since financial transactions are themselves very

    pervasive throughout the economic system. ?x. Issue of e6uity shares,

    granting of loan by term lending institutions, deposit of money into a bank,

    purchase of debentures, sale of shares and so on. 5owever, financial markets

    can be referred to as those centers and arrangements which facilitate buying

    and selling of financial assets, claims and services. )ometimes, we do find

    the existence of a specific place or location for a financial market as in the

    case of stock exchange.


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    ! financial market is a market for creation and exchange of financial

    assets. %hen individuals, businesses and governments buy and sell financial

    instruments, they participate in the financial markets. "inancial markets

    plays an important role in allocating scarce resources available in an

    economy to their best possible use by performing three important functions.

    These functions are as follows4


    Individuals, businesses and governments hold financial instruments. In

    order to satisfy their re6uirements of li6uidity and to book profits holders of

    financial instruments buy and sell them at various points of time. +uying

    and selling or demand for and supply of financial assets determines their

    prices. Information pertaining to prices of financial assets is made available

    through various sources such as the internet, the print and the visual media.


    "inancial markets facilitate buying and selling of financial securities and

    thereby imparts li6uidity to them or conversion of financial assets into li6uid

    assets or hard cash. In the absence of financial markets, investors would not

    have the re6uired motivation to invest and hold financial assets and financial

    turnover would not assume the proportions the markets could achieve. The

    financial assets are negotiable and transferable through the financial

    markets. It is possible for companies to raise long term funds from investors

    with short term and medium term maturities. %hen a financial asset is

    transacted, one investor is substituted by another and the company is assured

    of long term availability of funds.


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    The two important costs related to transactions are search costs and

    information costs. )earch costs consists of explicit costs such as the

    expenses incurred on advertising when one wants to buy or sell a financial

    asset and implicit costs such as the effort and time one has to put into locate

    a customer. Information costs refer to costs incurred in evaluating the

    investment merits of financial assets. The financial markets provide an

    institutional mechanism to disseminate, information and exchange of

    financial assets on a large scale thereby reducing the unit cost of search and




    In these markets, there are a number of money lenders, indigenous

    bankers, traders, etc. who lend money to the public. Indigenous bankers also

    collect deposits from the public. There are also private finance companies,

    chit funds etc. whose activities are not controlled by the 2+I. 2ecently the

    2+I has taken steps to bring private finance companies and chit funds under

    its strict control by issuing non#banking financial companies @2eserve +ankA

    directions, (DDB. The 2+I has already taken some steps to bring the

    unorganized sector under the organized fold. They have not been successful.

    The regulations concerning their financial dealings are still inade6uate and

    their financial instruments have not been standardized.


    In the organized markets, there are standardized rules and regulations

    governing their financial dealings. There is also a high degree


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    of institutionalization and instrumentalization. These markets are subect to

    strict supervision and control by the 2+I or other regulatory bodies.

    These organized markets can be further classified into two.

    They are4

    A. Caita" &ar+#t

    !. Mon#% &ar+#t


    The capital market is a market for financial assets which have a ling

    or indefinite maturity. &enerally, it deals with long term securities which

    have a maturity period of above one year. $apital market may be further

    divided into three namely4

    a' Ind*stria" s#c*riti#s &ar+#t

    (' o#rnnt s#c*riti#s &ar+#t and

    c' Long t#r& "oans &ar+#t

    a' Ind*stria" s#c*riti#s &ar+#t2

    !s the very name implies, it is a market for industrial securities namely3

    ?6uity shares or ordinary shares, /reference shares and 7ebentures or

    bonds. It is a market where industrial concerns raise their capital or debt by

    issuing appropriate instruments. It can be further subdivided into two.

    They are4 ri&ar% and s#condar% &ar+#t.

    I' Pri&ar% &ar+#t2 /rimary market is a market for new issues or new

    financial claims. Thus it is also called new issue market. The primary market

    deals with those securities which are issued to the public for the first time.

    Thus primary market facilitates capital formation.

    It is further divided into 1 parts4


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    i' Priat# iss*#4 The most common method of raising capital by new

    companies is through sale of securities to the public. It is called public issue.

    ii' Rigt iss*#4 %hen an existing company wants to raise capital, securities

    are first offered to the existing shareholders on a pre#emptive basis. It is

    called rights issue.

    iii' Priat# "ac#nt4 /rivate placement is a way of selling securities

    privately to a small group of investors.

    II' S#condar% &ar+#t2 )econdary market is a market for secondary scale of

    security. In other words, securities which have already passed through the

    new issue market are traded in these markets.

    &enerally, such securities are 6uoted in the stock exchange and it provides a

    continuous and regular market for buying and selling of securities. These

    markets consist of all stock exchanges recognized by the government of

    India. The )tock ?xchange in India. The )tock ?xchange in India is

    regulated under securities $ontract 2egulation !ct (D9:.

    (' o#rnnt s#c*riti#s &ar+#t2

    %hen a &overnment or local council wishes to borrow money for its

    expenditure plan it may sell stock. There are loan certificates, not unlike

    debentures, which pay their holders a rate of interest and often carry a date at

    which they will be repaid. ?x. Cocal authority bonds may run for 9 years,

    while government stock or gilt edged securities may not be repaid for

    perhaps 09 years. These securities can be bought and sold on the stock

    market ust like debentures and shares issued by the firms.

    &overnment securities are the most important and uni6ue financial

    instrument in the financial market of any economy. &overnment of India


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    securities i.e. &=I section includes debt obligation of the $entral

    &overnment, stock &overnment and other financial institution owned by

    $entral and )tate &overnment. Citerally, &ilt means &old. Therefore, a gilt

    edged securities implies securities implies security of the best 6uality.

    &overnment securities are the best securities issued by the government for

    the purpose of raising public loans. These securities are referred as &ilt

    ?dged )ecurities as repayment of principle as well as interest as total

    securities. These are considered as the safest of all securities.

    c' Long t#r& "oan &ar+#t2

    7evelopment banks and commercial banks plays a significant role in these

    market by supplying long term loans to corporate customers. It is further

    divided into three parts4

    I' t#r& "oan &ar+#t2

    Institutions like I7+I, I$I$I and other )tate "inancial $orporation come

    under these categories. These institutions meet the growing and varied long

    term financial re6uirements of industries by supplying long term loans. They

    also help in identifying investment opportunities, encourage new

    entrepreneur and support modernization efforts.

    II' Mortgag# &ar+#t2

    'ortgage market refers to those centers which supply mortgage loan

    mainly to individual customers. ! mortgage loan is a loan against the

    security of immovable property like real estate. The transfer of interest in a

    specific immovable property to secure a loan is called mortgage.

    III' Financia" g*arant## &ar+#t2

    ! guarantee market is a centre where finance is provided against the

    guarantee of a reputed person in a financial circle. &uarantee is a contract to


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    discharge the liability of a third party in case of his default. &uarantee act as

    a security from the creditors point of view. In case the borrow fails to repay

    the loan, the liability falls on the shoulders of the guarantor. 5ence, the

    guarantor must be known to both borrower and lender and he must have the

    means to discharge his liability.

    !. MONEY MAR0ET2

    'oney market is a market for short term loans or financial assets. !s the

    name implies, it does not deal in cash or money. +ut it actually deals with

    near substitute for money or near money like trade bills, promissory note

    and government papers drawn for a short period not exceeding one year.

    The money market does not refer to a particular place where short term

    funds are dealt with. It includes all individuals, institutions and

    intermediaries dealing with short term funds.

    Ca"" &on#% &ar+#t

    Co&rcia" (i""s &ar+#t

    Tr#as*r% (i""s &ar+#t

    Sort-t#r& "oan &ar+#t


    The call money market is a market for extremely short period loans say

    one day to fourteen days. )o, it is highly li6uid. The loans are repayable on

    demand at the option of either the lender or the borrower. In India, call

    money markets are associated with the presence of stock exchanges and

    hence, they are located in maor industrial towns like 'umbai, *olkata,

    $hennai, 7elhi, !hmadabad etc. The special feature of this market is that

    the interest rate varies from day#to#day and even from hour#to#hour and


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    centre#to#centre. It is very sensitive to changes in demand and supply of call



    It is a market for bills of exchange arising out of genuine trade

    transactions. In the case of credit sale, the seller may draw a bill of exchange

    on the buyer. The buyer accepts such a bill promising to pay at a later date

    the amount specified in the bill. The seller need not wait until the due date of

    the bill. The seller need not wait until the due date of the bill. Instead, he can

    get immediate payment by discounting the bill. In India the bill market is under#developed. The 2+I has taken many steps

    to develop a sound bill market. The 2+I has enlarged the list of participants

    in the bill market. The 7iscount and "inance 5ouse of India was set up in

    (DBB to promote secondary market in bills. In spite of all these, the growth

    of the bill market is slow in India. There are no specialized agencies for

    discounting bills. The commercial banks play a significant role in this



    It is a market for treasury bills which have short#term maturity. !

    treasury bill is a promissory note or a finance bill issued by the government.

    It is highly li6uid because its repayment is guaranteed by the government. It

    is an important instrument for short#term borrowing of the government.

    There are two types of treasury bills namely

    =rdinary or regular and

    !d hoc treasury bills popularly known as ad hocs


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    =rdinary treasury bills are issued to the public, banks and other financial

    institutions with a view to raising resources for the central government to

    meet its short#term financial needs.

    !d hoc treasury bills are issued in favor of the 2+I only. They are not sold

    through tender or auction. They can be purchased by the 2+I only. !d hocs

    are not marketable in India but holders of these bills can sell them back to



    It is a market where short#term loans are given to corporate customersfor meeting their working capital re6uirements. $ommercial banks play a

    significant role in this market. $ommercial banks provide short term loans in

    the form of cash credit and overdraft. =verdraft facility is mainly given to

    business people whereas cash credit is given to industrialists. =verdraft is

    purely a temporary accommodation and it is given to in the current itself.

    +ut cash credit is for a period of one year and it is sanctioned in a separate



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    brokers engaged in the business of buying and selling foreign exchange. It

    also includes the central bank of each country and the treasury authorities

    who enter into this market as controlling authorities. Those engaged in the

    foreign exchange business are controlled by the "oreign ?xchange

    'aintenance !ct @"?'!A.


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    'ost households in India still prefer to invest on physical assets like land,

    buildings, gold, silver etc. +ut, studies have shown that investment in

    financial assets like e6uities in capital market fetches more return than

    investments on gold. It is imperative that one should have some basic

    knowledge about the rate of return on financial assets also.

    The return on government securities and bonds are comparatively less than

    on corporate securities due to lower risk involved therein. The government

    and the 2+I determine the interest rates on government securities. Thus, the

    interest rates are administered and controlled. The peculiar feature of the

    interest rate structure is that the interest rates do not reflect the free market

    forces. They do not reflect the scarcity value of capital in the country also.

    'ost of these rates are fixed on an adhoc basis depending upon the credit

    and monetary policy of the government.

    #n#ra""%> t# int#r#st rat# o"ic% o$ t# go#rnnt is d#sign#d to

    aci## t# $o""o,ing2

    To enable the government to borrow comparatively cheaply

    To ensure stability in the macro#economic system

    To support certain sectors through preferential lending rates

    To mobilize substantial savings in the economy

    The interest rate structure for bank deposits and bank credits is also

    influenced by the 2+I. ormally, interest is a reward for risk undertaken

    through investment and at the same time it is a return for abstaining from

    consumption. The interest rate structure should allocate scarce capital


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    between alternative uses. ;nfortunately, in India the administered interest

    rate policy of the government fails to perform the role of allocating scarce

    resources between alternative uses.


    %ith a view to bringing the interest rates nearer to the free market rates, the

    government has taken the following steps4

    The interest rates on company deposits are freed.

    The interest rates on 1:8 days. Treasury bills are determined by

    auctions and they are expected to reflect the free market rates.

    The coupon rates on government loans have been revised upwards soas to be market oriented.

    The interest rates on debentures are allowed to be fixed by companies

    depending upon the market rates.

    The maximum rates of interest payable on bank deposit are freed

    for deposits of above one year.

    Thus, all attempts are being taken to adopt a realistic interest rate policy so

    as to give positive return in real terms adusted for inflation. The

    proper functioning of any financial system re6uires a good interest rate



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    "inancial instruments refer to those documents which represent financial

    claims on assets. !s discussed earlier, financial asset refers to a claim to the

    repayment of a certain sum of money at the end of a specified period

    together with interest or dividend.

    E3. +ills of ?xchange, promissory note, treasury bill, government bond,

    deposit receipt, share, debenture, etc. The innovative instruments introduced

    in India have been discussed later in the chapter "inancial )ervices.

    "inancial instruments can also be called financial securities.

    "inancial securities can be classified into4

    Pri&ar% or dir#ct s#c*riti#s.

    S#condar% or indir#ct s#c*riti#s.


    These are securities directly issued by the ultimate investors to the ultimate


    E3. )hares and debentures issued directly to the public.


    These are securities issued by some intermediaries called financial

    intermediaries to the ultimate savers.

    ?x. ;nit Trust of India and mutual funds issue securities in the form of units

    to the public and the money pooled is invested in companies.

    !gain these securities may be classified on the basis of duration as follows3


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    A' Sort-t#r& s#c*riti#s2)hort#term securities are those which mature

    within a period of one year.

    E3. +ill of ?xchange, Treasury bill, etc.

    !' M#di*& t#r& s#c*riti#s2'edium term securities are those which have a

    maturity period ranging between one and five years.

    E3. 7ebentures maturing within a period of 9 years.

    C' Long-t#r& s#c*riti#s2 Cong#term securities are those which have a

    maturity period of more than 9years.

    E3. &overnment bonds maturing after (E years.


    &enerally speaking, financial instruments possess the following

    characteristic features4

    'ost of the instruments can be easily transferred from one hand to

    another without many cumbersome formalities.

    They have a ready market, i.e., they can be bought and sold fre6uently and

    thus, trading in these securities is made possible.

    They possess li6uidity. i.e., some instruments can be converted into cash


    E3. ! bill of exchange can be converted into cash readily by means of

    discounting and re#discounting.

    'ost of the securities possess security value, i.e., they can be given as

    security for the purpose of raising loans.

    )ome securities enoy tax status, i.e., investments in these securities are

    exempted from income tax, wealth tax, etc., subect to certain limits.


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    E3. /ublic )ector Tax "ree +onds, 'agnum Tax )aving $ertificates.

    They carry risk in the sense that there is uncertainty with regard to

    payment of principal or interest or dividend as the case may be.

    These instruments facilitate futures trading so as to cover risks due to price

    fluctuations, interest rate fluctuations, etc.

    These instruments involve less handling costs since expenses involved in

    buying and selling these securities are generally much less.

    The return on these instruments is directly in proportion to the

    risk undertaken.

    These instruments may be short#term or medium term or long#term

    depending upon the maturity period of these instruments.


    The expansion in size and number of financial institutions has

    conse6uently led to a considerable increase in the financial instruments also.

    ew instruments have been introduced in the form of innovative schemes of

    CI$, ;TI, +anks, /ost =ffice )avings +ank !ccounts, )hares and

    debentures of different varieties, public sector bonds, national savings

    scheme, national savings certificates, provident funds, relief bonds, Indira

    vikas patras, etc. Thus different types of instruments are available in the

    financial system so as to meet the diversified re6uirements of varied

    investors and thereby making the system more healthy and vibrant.




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    -$ommercial paper is an unsecured and discounted promissory note issued

    to finance the short#term credit needs of large institutional buyers. +anks,

    corporations and foreign governments commonly use this type of funding.

    T# caract#ristics o$ co&rcia" a#r2

    ;nsecured debt.

    +earer or depository trust company eligible.

    ! depository trust company is a firm through which the members can

    use a computer to arrange for investment securities to be delivered to

    other members via computer, thus there is no physical delivery of the

    securities. ! depository trust company uses computerized debit and

    credit entries.

    7iscount @most commonA. ! discount is the difference between the

    purchase price of a security and its par @faceA value. This discount

    represents the income to be earned on the security, and will be

    accreted over the life of the security.

    /urchased direct or through dealers.

    T# adantag#s o$ in#sting in co&rcia" a#r2

    $heaper source of funds than limits set by banks.

    =ptimal combination of li6uidity return.

    5ighly li6uid instrument.

    Transferable by endorsement J delivery.

    +acked by li6uidity J earnings of issuer.

    Issued for a minimum period of 1E days and a maximum up to one

    year .


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    Issued at a discount to face value.

    Issued in demat form. @$ompulsory demat from Huly KE(A.

    To obtain cash with which to take advantage of cash discounts offered

    by trade creditors.

    To establish national credit.

    To keep a reserve of borrowing power at local banks.

    To borrow at cheaper rates than is possible at your local banks.

    To establish a broader market for the paper than is possible locally.

    Cocal savers may provide less costly funds3 an important habit among

    clients and the public is rewarded.

    Cower interest loans provide experience for '"I in borrowed funds.

    Cocal banks become familiar with ')? @micro and small

    enterpriseA potentials.

    !ccess to larger sums more 6uickly based on track record.

    !llows longer term proections than grants.

    T# disadantag#s o$ co&rcia" a#r2

    5igher financial costs force organizational decisions and changes.

    )ubstantial initial collateral re6uirements.

    'ore risky as debt holders can force closure of '"I.

    'ore tricky cash flow management as principal is repaid.

    ?arly negotiations re6uire a new set of skills and contacts.

    Cocal banks may not be willing to be cooperative.

    Coans may be dollarized in an inflationary situation.

    Too many subsidized loans can retard move to market rate.


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    Introd*ction 2

    $ommercial /aper @$/A is an unsecured money market instrument issued in

    the form of a promissory note. $/, as a privately placed instrument, was

    introduced in India in (DDE 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. )ubse6uently, primary dealers @/7sA

    and all#India financial institutions were also permitted to issue $/ to enable

    them to meet their short#term funding re6uirements. The guidelines for issueof $/, incorporating all the amendments issued till date, are given below for

    ready reference.

    E"igi("# iss*#rs o$ CP 2

    $orporate, /7s and all#India financial institutions @"IsA that have been

    permitted to raise short#term resources under the umbrella limit fixed by the

    2eserve +ank of India @2+IA are eligible to issue $/.

    ! corporate would be eligible to issue $/ provided4

    @aA the tangible net worth of the company, as per the latest audited balance

    sheet, is not less than 2s.8crore.

    @bA the company has been sanctioned working capital limit by bankLs or "Is


    @cA the borrowed account of the company is classified as a )tandard !sset by

    the financing bankLinstitution.

    Rating R#*ir#nt 2

    !ll eligible participants shall obtain credit rating for issuance of $/ from

    any one of the following credit rating agencies @$2!sA, viz. the $redit


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    2ating Information )ervices of India Ctd. @$2I)ICA, the Investment

    Information and $redit 2ating !gency of India Ctd. @I$2!A, the $redit

    !nalysis and 2esearch Ctd. @$!2?A, the "IT$5 2atings India /vt. Ctd. and

    such other $2!s as may be specified by the 2+I from time to time, for the

    purpose. The minimum credit rating shall be /#0 of $2I)IC or such

    e6uivalent rating by other $2!s. The issuers shall ensure at the time of

    issuance of the $/ that the rating so obtained is current and has not fallen

    due for review.

    Mat*rit% 2

    $/ can be issued for maturities between a minimum of > days and amaximum of up to one year from the date of issue. The maturity date of the

    $/ should not go beyond the date up to which the credit rating of the issuer

    is valid.

    D#no&inations 2

    $/ can be issued in denominations of 2s.9 lakh or multiples thereof.

    !mount invested by a single investor should not be less than 2s.9 lakh @face


    Li&its and t# A&o*nt o$ Iss*# o$ CP 2

    @aA $/ can be issued as a K3stand aloneK3 product. The aggregate amount of

    $/ from an issuer shall be within the limit as approved by its +oard of

    7irectors or the 6uantum indicated by the $2! for the specified rating,

    whichever is lower. +anks and "Is will, however, have the flexibility to fix

    working capital limits, duly taking into account the resource pattern of

    companys financing, including $/s.


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    @bA!n "I can issue $/ within the overall umbrella limit prescribed in the

    'aster $ircular on 2esource 2aising orms for "Is, issued by 7+=7 and

    updated from time#to#time.

    @cAThe total amount of $/ proposed to be issued should be raised within a

    period of two weeks from the date on which the issuer opens the issue for

    subscription. $/ may be issued on a single date or in parts on different dates

    provided that in the latter case, each $/ shall have the same maturity date.

    @dA?very issue of $/, including renewal, should be treated as a fresh issue.

    Iss*ing and Pa%ing Ag#nt BIPA' 2

    =nly a scheduled bank can act as an I/! for issuance of $/.

    In#stnt in CP 2

    $/ may be issued to and held by individuals, banking companies, other

    corporate bodies @registered or incorporated in IndiaA and unincorporated

    bodies, on#2esident Indians and "oreign Institutional Investors @"IIsA.

    5owever, investment by "IIs would be within the limits set for them by

    )ecurities and ?xchange +oard of India @)?+IA.

    Trading in CP 2

    !ll =T$ trades in $/ shall be reported within (9 minutes of the trade to the

    "ixed Income 'oney 'arket and 7erivatives !ssociation of India

    @"I''7!A reporting platform.

    Mod# o$ Iss*anc# 2

    @aA$/ can be issued either in the form of a promissory note @)chedule IA or

    in a dematerialized form through any of the depositories approved by and

    registered with )?+I.


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    @bA$/ will be issued at a discount to face value as may be determined by the


    @cAo issuer shall have the issue of $/ underwritten or co#accepted.

    Pr#$#r#nc# $or D#&at#ria"i)ation 2

    %hile option is available to both issuers and subscribers to issueLhold $/ in

    dematerialized or physical form, issuers and subscribers are encouraged to

    opt for dematerialized form of issueLholding. 5owever, with effect from

    Hune 1E, 0EE(, banks, "Is and /7s are re6uired to make fresh investments

    and hold $/ only in dematerialized form.

    Pa%nt o$ CP 2The initial investor in $/ shall pay the discounted value of the $/ by means

    of a crossed account payee che6ue to the account of the issuer through I/!.

    =n maturity of $/, when $/ is held in physical form, the holder of $/ shall

    present the instrument for payment to the issuer through the I/!. 5owever,

    when $/ is held in demat form, the holder of $/ will have to get it

    redeemed through the depository and receive payment from the I/!.

    Proc#d*r# $or Iss*anc# 2

    ?very issuer must appoint an I/! for issuance of $/. The issuer should

    disclose to the potential investors its financial position as per the standard

    market practice. !fter the exchange of deal confirmation between the

    investor and the issuer, issuing company shall issue physical certificates to

    the investor or arrange for crediting the $/ to the investorKs account with a

    depository. Investors shall be given a copy of I/! certificate to the effect

    that the issuer has a valid agreement with the I/! and documents are in

    order @)chedule IIA.

    Doc*ntation Proc#d*r# 2


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    @aATo ensure smooth functioning of the $/ market and provide operational

    flexibility, the "I''7! may, in consultation with the 2+I, prescribe any

    standardized procedure and documentation that are to be followed by the

    participants, in consonance with the international best practices. Issuers L

    I/!s may refer to the detailed guidelines issued by "I''7! on Huly 9,

    0EE( in this regard.

    @bAGiolation of these guidelines will attract penalties and may also include

    debarring of the entity from the $/ market.

    D#$a*"ts in CP &ar+#t 2

    In order to monitor defaults in redemption of $/s, I/!s, are advised toimmediately report, on occurrence, full particulars of defaults in repayment

    of $/s to the "inancial 'arkets 7epartment, 2eserve +ank of India, $entral

    =ffice, "ort, 'umbai#8EEEE( in the format as given in !nnex I.

    Non-a"ica(i"it% o$ C#rtain Ot#r Dir#ctions 2

    othing contained in the on#+anking "inancial $ompanies !cceptance of

    /ublic 7eposits @2eserve +ankA 7irections, (DDB shall apply to any non#

    banking financial company @+"$A insofar as it relates to acceptance of

    deposit by issuance of $/, in accordance with these &uidelines.


    -! certificate of deposit is a promissory note issued by a bank. It is a time

    deposit that restricts holders from withdrawing funds on demand. !lthough

    it is still possible to withdraw the money, this action will often incur a


    T# caract#ristics o$ C#rti$icat# o$ d#osits2


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    $7s can be issued by all scheduled commercial banks, selected all

    India financial institutions, and permitted by 2+I.

    'inimum period (9 days.

    'aximum period (year.

    'inimum !mount 2s (lakh and in multiples of 2s. (lakh.

    $7s are transferable by endorsement.

    $22 J )C2 are to be maintained.

    $7s are to be stamped.

    $7s may be issued at discount on face value.

    Interest calculations are mostly based upon a standard 1:E days in a

    year called actualL1:E but some are actualL1:9.

    Investment is dependent solely upon the credit worthiness of the

    bank deposits.

    T# adantag#s o$ C#rti$icat# o$ D#osit2

    )ince one can know the returns from before, the certificates of

    deposits are considered much safe.

    =ne can earn more as compared to depositing money in savings


    The "ederal Insurance $orporation guarantees the investments in the

    certificate of deposit.

    T# disadantag#s o$ C#rti$icat# o$ d#osit2

    !s compared to other investments the returns is less.


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    The money is tied along with the long maturity period of the

    $ertificate of 7eposit. 5uge penalties are paid if one gets out of it

    before maturity.

    Investors can redeem bank#issued $7s prior to maturity. 5owever,

    you will typically be charged an early withdrawal penalty. These

    penalties are set by each bank and differ nationwide.

    ;nlike Treasury notes, the interest on $7s is not exempt from state

    and local taxes. $7s are fully taxable at the state, local and federal


    The investment is locked in at a specific rate, even if interest rates



    Introd*ction 2

    $ertificate of 7eposit @$7A is a negotiable money market instrument and

    issued in dematerialized form or as a ;sance /romissory ote against funds

    deposited at a bank or other eligible financial institution for a specified time

    period. &uidelines for issue of $7s are presently governed by various

    directives issued by the 2eserve +ank of India, as amended from time to

    time. The guidelines for issue of $7s incorporating all the amendments

    issued till date are given below for ready reference.

    E"igi(i"it% 2

    $7s can be issued by @iA scheduled commercial banks excluding 2egional

    2ural +anks @22+sA and Cocal !rea +anks @C!+sA3 and @iiA select all#India

    "inancial Institutions that have been permitted by 2+I to raise short#term

    resources within the umbrella limit fixed by 2+I.


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    Aggr#gat# A&o*nt 2

    @aA+anks have the freedom to issue $7s depending on their re6uirements.

    @bA!n "I may issue $7s within the overall umbrella limit fixed by 2+I, i.e.,

    issue of $7 together with other instruments, viz., term money, term

    deposits, commercial papers and inter#corporate deposits should not exceed

    (EE per cent of its net owned funds, as per the latest audited balance sheet.

    Mini&*& Si)# o$ Iss*# and D#no&inations 2

    'inimum amount of a $7 should be 2s.(lakh, i.e., the minimum deposit

    that could be accepted from a single subscriber should not be less than 2s.(

    lakh and in the multiples of 2s. (lakh thereafter.

    In#stors 2

    $7s can be issued to individuals, corporations, companies, trusts, funds,

    associations, etc. on# 2esident Indians @2IsA may also subscribe to $7s,

    but only on non#repatriable basis, which should be clearly stated on the

    $ertificate. )uch $7s cannot be endorsed to another 2I in the secondary


    Mat*rit% 2

    @aAThe maturity period of $7s issued by banks should be not less than >

    days and not more than one year.

    @bAThe "Is can issue $7s for a period not less than ( year and not exceeding

    1 years from the date of issue.

    Disco*nt Co*on Rat# 2

    $7s may be issued at a discount on face value. +anks L "Is are also allowed

    to issue $7s on floating rate basis provided the methodology of compiling

    the floating rate is obective, transparent and market#based. The issuing bank

    L "I is free to determine the discount L coupon rate. The interest rate on


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    floating rate $7s would have to be reset periodically in accordance with a

    pre#determined formula that indicates the spread over a transparent


    R#s#r# R#*ir#nts 2

    +anks have to maintain appropriate reserve re6uirements, i.e., cash reserve

    ratio @$22A and statutory li6uidity ratio @)C2A, on the issue price of the


    Trans$#ra(i"it% 2

    $7s in physical form are freely transferable by endorsement and delivery.

    $7s in demat form can be transferred as per the procedure applicable toother demat securities. There is no lock#in period for the $7s.

    Loans !*%-(ac+s 2

    +anks L "Is cannot grant loans against $7s. "urthermore, they cannot buy#

    back their own $7s before maturity. 5owever, the 2eserve +ank may relax

    these restrictions for temporary periods through a separate notification.

    S#c*rit% As#ct 2

    )ince $7s in physical form are freely transferable by endorsement and

    delivery, it will be necessary for banks to see that the certificates are printed

    on good 6uality security paper and necessary precautions are taken to guard

    against tampering with the document. They should be signed by two or more

    authorized signatories.

    Iss*# o$ D*"icat# C#rti$icat#s 2

    @aAIn case of the loss of physical certificates, duplicate certificates can be

    issued after compliance with the following4

    @iA! notice is re6uired to be given in at least one local newspaper3


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    @iiACapse of a reasonable period @say (9 daysA from the date of the notice in

    the newspaper3 and

    @iiiA?xecution of an indemnity bond by the investor to the satisfaction of the

    issuer of $7s

    @bAThe duplicate certificate should be issued only in physical form. o fresh

    stamping is re6uired as a duplicate certificate is issued against the original

    lost $7. The duplicate $7 should clearly state that the $7 is a 7uplicate

    one stating the original value date, due date, and the date of issue @as

    M7uplicate issued on NNNNNNNNMA.

    Acco*nting 2

    +anks L "Is may account the issue price under the 5ead M$7s issuedM and

    show it under deposits. !ccounting entries towards discount will be made as

    in the case of Mcash certificatesM. +anks L "Is should maintain a register of

    $7s issued with complete particulars.


    Treasury +ills are money market instruments to finance the short term

    re6uirements of the &overnment of India. These are discounted securities

    and thus are issued at a discount to face value. The return to the investor is

    the difference between the maturity value and issue price.

    T%#s o$ Tr#as*r% !i""s

    There are different types of Treasury bills based on the maturity period and

    utility of the issuance like4

    Ad-oc Tr#as*r% (i""s>

    8 &onts>

    ? &onts and

    16&onts Tr#as*r% (i""s #tc.


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    In India, at present, the Treasury +ills are issued for the following tenors

    D(#days, (B0#days and 1:8#days Treasury bills.

    Caract#ristic o$ tr#as*r% (i""s 2

    For& 2

    The treasury bills are issued in the form of promissory note in physical form

    or by credit to )ubsidiary &eneral Cedger @)&CA account or &ilt account in

    dematerialized form.

    Mini&*& A&o*nt O$ !ids 2

    +ids for treasury bills are to be made for a minimum amount of 2s 09EEEL#only and in multiples thereof.

    E"igi(i"it% 2

    !ll entities registered in India like banks, financial institutions, /rimary

    7ealers, firms, companies, corporate bodies, partnership firms, institutions,

    mutual funds, "oreign Institutional Investors, )tate &overnments, /rovident

    "unds, trusts, research organizations, epal 2ashtra bank and even

    individuals are eligible to bid and purchase Treasury bills.

    R#a%nt 2

    The treasury bills are repaid at par on the expiry of their tenor at the office of

    the 2eserve +ank of India, 'umbai.

    Aai"a(i"it% 2

    !ll the treasury +ills are highly li6uid instruments available both in the

    primary and secondary market.

    Da% Co*nt 2

    "or treasury bills the day count is taken as 1:9 days for a year.


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    T# adantag#s o$ Tr#as*r% !i""s2

    T#bills remain one of the safest investments for investors.

    The advantage of purchasing these short terms, li6uid instruments, is

    access to your funds at any time, with the peace of mind knowing that

    your funds will not be tied up in long term investments, should an

    emergency arise.

    T#bills can be held to maturity, with constant roll over into other T#

    bill purchases, or can be sold at any time an investor chooses.

    $ompared with commercial banks and other financial institutions

    rates, the Treasury +ills sometimes offer the highest interest rate


    Treasury +ills provide a regular income or cash flow which can be

    used to supplement your existing income or provide an income if you

    are retired.

    Treasury +ills can easily be converted to cash on maturity, or they

    may be sold if you need the money before the maturity dates. !s Treasury +ills are an income generating asset, they can be used as

    collateral for loans from banks and other financial institutions.

    Treasury +ills offer a simple mode of preserving J protecting

    your investment

    T# disadantag#s o$ Tr#as*r% !i""s2

    The main disadvantage of Treasury +ills is that income from Treasury

    +ills is fixed for the term of the investment. In times of high inflation,

    the purchasing power of your money will be reduced.


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    The only downside to T#bills is that you wonKt get a great return

    because Treasuries are exceptionally safe. $orporate, certificates and

    money market funds will often give higher rates of interest. %hats

    more, you might not get back all of your investment if you cash out

    before the maturity date.



    )ome serious attention was paid to the development of a sound financial

    system in India only after the launching of the planning era in the country.

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    !t the time of independence in (D8>, there was no strong financial

    institutional mechanism in the country. There was absence of issuing

    institutions and non#participation of intermediary financial institutions. The

    industrial sector also had no access to the savings of the community. The

    capital market was very primitive and shy. =n the whole, chaotic conditions

    prevailed in the system.

    %ith the adoption of the theory of mixed economy, the development of the

    financial system took a different true so as to fulfill the socio#economic and

    political obectives. The government started creating new financial

    institutions to supply finance both for agricultural and industrial

    development and it also progressively started nationalizing some important

    financial institutions so that the flow of finance might be in the right



    !s stated earlier the 2+I is the leader of the financial system. +ut, it was

    established as private institution in(D19. It was nationalized in (D8B. It was

    followed by the nationalization of the Imperial +ank of India in (D9: by

    renaming it as )tate +ank of India. In the same year, 089 life insurance

    companies were brought under government control by merging all of them

    into a single corporation called Cife Insurance $orporation of India. !nother

    significant development in our financial system was the nationalization of (8

    maor commercial banks in (D:D.!gain, : banks were nationalized in (DBE.

    This process was then extended to &eneral Insurance $ompanies which

    were reorganized under the name of &eneral Insurance $orporation of India.

    Thus, the important financial institutions were brought under public control.



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    The pace of economic development and the rate of growth of the economy

    are entirely dependent upon the extent of financial development in a country.

    %hile financial development becomes a part of the overall economic

    development of a country, it enables the economy from within to realize its

    potential development. In the absence of financial development, the gulf

    between actual development and potential development would be very wide.

    E3. The Indian economy of the (Bth century and that of the present century.

    7evelopment of the financial system entails setting up of a variety

    of financial institutions in the country so that all possible real resources in

    the economy are mobilized with the help of monetary resources. !lthough

    monetary resources are only a claim on the real resources, the development

    of real resources in the economy cannot be imagined without the monetary


    T#r# ar# t,o di$$#r#nt i#,s #3r#ss#d ,it r#gard to t#

    r#"ationsi (#t,##n $inancia" d##"ont and #cono&ic gro,t.

    According to on# i#,, an efficient financial system#effectively mobilizes

    scarce financial resource and allocates them to their best possible use

    through the market mechanism.

    According to t# ot#r i#,, financial development takes place as a

    result of economic developments.

    5owever, it is a fact that both economic development and financial

    development are mutually complementary. It means that while economic

    development leads to financial development, it is also led by financial

    development. In fact the role of financial development in accelerating the

    process of economic development cannot be simply denied. The role of

    financial system in relation to economic growth can be explained in terms of

    the ability of the financial markets to reduce risks and uncertainty and make


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    the best possible or the most profitable use of resources. The financial

    system must also reconcile the re6uirements of efficient use of resources and

    the development re6uirements of the economy. This however cannot be

    achieved through the market mechanism and hence the role of the

    government in the financial system is warranted so that scarce resources in

    the economy are also used for obtaining economic development in such a

    manner that the competing re6uirements of e6uity and efficiency in financial

    allocations achieved.

    The banks and non#banking financial companies on the one hand and the

    stock markets on the other facilitate mobilization and allocation of

    resources. %hile market financial systems have played important role in the

    economic growth and development of countries like ;)! and ;*, bank#

    based financial system has dominated the financial systems of countries like

    Hapan and &ermany.


    !fter the introduction of planning, rapid industrialization has taken place.

    It has in turn led to the growth of the corporate sector and the government

    sector. In order to meet the growing re6uirements of the government and the

    industries, many innovative financial instruments have been introduced.

    +esides, there has been a mushroom growth of financial intermediaries to

    meet the ever growing financial re6uirements of different types of

    customers. 5ence, the Indian financial system is more developed and

    integrated today than what it was 9E years ago. Oet, it suffers from some

    weaknesses as listed below4




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    There are a large number of financial intermediaries. 'ost of the vital

    financial institutions are owned by the government. !t the same time, the

    government is also the controlling authority of these institutions. !s there is

    multiplicity of institutions in the Indian financial system, there is lack of co#

    ordination in the working of these institutions.


    In India some financial institutions are so large that they have created a

    monopolistic market structures in the financial system.

    ?x. The entire life insurance business is in the hands of CI$. The ;TI hasmore or less monopolized the mutual fund industry. The weakness of this

    large structure is that it could lead to inefficiency in their working or

    mismanagement or lack of effort in mobilizing savings of the public and so

    on. ;ltimately it would retard the development of the financial system of the

    country itself.



    The development banks constitute the backbone of the Indian financial

    system occupying an important place in the capital market. The industrial

    financing today in India is largely through the financial institutions created

    by the government both at the national and regional levels. These

    development banks act as distributive agencies only, since, they derive most

    of their funds from their sponsors. !s such, they fail to mobilize the savings

    of the public. This would be a serious bottleneck which stands in the ways

    of the growth of an efficient financial system in the country. "or industries

    abroad, institutional finance has been a result of institutionalization


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    of personal savings through media like banks, CI$, pension and provident

    funds, unit trusts and so on. +ut they play a less significant role in Indian

    financial system, as far as industrial financing is concerned. 5owever, in

    recent times attempts are being made to raise funds from the public through

    the issue of bonds, units, debentures and so on. It will go a long way in

    forging a link between the normal channels of savings and the distributing



    The important function of any capital market is to promote economicdevelopment through mobilization of savings and their distribution to

    productive ventures. !s far as industrial finance in India is concerned,

    corporate customers are able to raise their financial resources through

    development banks. )o, they need not go to the capital market. 'oreover,

    they dont resort to capital market since it is very erratic and inactive.

    Investors too prefer investments in physical assets to investments in

    financial assets. The weakness of the capital market is a serious problem in

    our financial system.


    The dominance of development banks has developed imprudent financial

    practice among corporate customers. The development banks provide most

    of the funds in the form of term loans. )o there is a preponderance of debt in

    the financial structure of corporate enterprises. This predominance of debt

    capital has made the capital structure of the borrowing concerns uneven and

    lopsided. To make matters worse, when corporate enterprises face any


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    financial crisis, these financial institutions permit a greater use of debt than

    is warranted. It is against the traditional concept of a sound capital structure.

    5owever, in recent times all effort have been taken to activate the capital

    market. Integration is also taking place between different financial


    E3. The ;nit Cinked Insurance )chemes of the ;TI are being offered to the

    public in collaboration with the CI$. )imilarly, the refinance and

    rediscounting facilities provided by the I7+I aim at integration. Thus, the

    Indian financial system has become a developed one.


    The government of India is responsible to regulate the financial market in

    India. The two important regulatory institutions of the government of India


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    are the 2eserve +ank of India and the securities and exchange board of

    India. The 2eserve +ank of India is the central bank of the country and as

    the apex monetary authority, it performs the following central banking and

    development functions4

    It provides currency and operates the clearing system for the banks

    It formulates and implements the monetary and credit policies

    It serves as the bankers bank

    It supervises the operations of credit institutions

    It regulates foreign exchange transactions.

    It controls the fluctuations in the exchange value of the rupee.

    It seeks to integrate the financial system in India

    It encourages banking development in India

    It influences the allocation of credit, and

    It promotes the development of new institutions.

    T# S#c*riti#s and E3cang# !oardof India is responsible for dealing

    with various matters pertaining to the capital market. The )?+I is

    responsible for the following4

    2egulate the business in stock exchanges and any other securities


    2egister and regulate the capital market intermediaries @brokers,

    merchant bankers, portfolio managers, etcA

    2egister and regulate the working of mutual funds

    /romote and regulate self#regulatory organizations

    /rohibit fraudulent and unfair trade practices in securities markets


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    /romote investors education and training of intermediaries of

    securities markets

    2egulate substantial ac6uisition of shares and takeovers of companies

    /rohibit insider trading in securities.


    The word MsystemM in the term Mfinancial systemM, 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.

    It refers to sources of raising revenue for the activities and functions of a

    &overnment. 5ere some of the definitions of the word KfinanceK both as a

    source and as an activity i.e. as a noun and a verb.

    !n efficient functioning of the financial system facilitates the free flow

    of funds to more productive activities and thus promotes investment. Thus,

    the financial system provides the intermediation between savers and

    investors and promotes faster economic development.

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