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CHAPTER.1-INTRODUCTION TO FINANCIAL SYSTEM
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 $alcutta, +ombay, !ssam and other parts
of north#east India. The multani or )hikarpuri shroffs are mainly found in
+ombay and madras and the chettiars operate in south India. !mongst these
traditional bankers, the &uaarati shroffs carryout the largest volume of
unorganized banking business in India. on#banking financial companies
like chit funds and nidhis also operate in large numbers in India. The third
segment of the unorganized financial market in India consists of the money
lenders. These unorganized segments are so called because they are neither
registered as companies nor being controlled by the reserve +ank of India.
DEFINATION OF FINANCIAL SYSTEM
According to Dr. Prasanna Candra, -The financial system consists of a
variety of financial intermediaries, markets and instruments that are related
to each other. It provides the principal means by which savings are
transformed into investments.
Dr. L.M. !o"# d#$in#s $inancia" s%st#& as-The financial system of any
country consists of specialized and non#specialized financial institutions,
of organized and unorganized financial markets, of financial instruments and
services which facilitate transfer funds. /rocedures and practices adopted in
the markets and financial interrelationships are also parts of the system.
FUNCTION OF FINANCIAL SYSYTEM
The financial system performs the following functions that are interrelated
and are essential for the development process of a modern economy.
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A' Pa%nt s%st#&
!' Mo(i"i)ation and a""ocation o$ $*nds
C' Ris+ &anag#nt
D' Pric# in$or&ation $or d#c#ntra"i)#d d#cision &a+ing
E' D#a"ing ,it inc#nti# ro("#&
A' PAYMENT SYSTEM
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.
!' MO!ILI/ATION AND ALLOCATION OF FUND
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.
C' RIS0 MANAEMENT
! 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
households
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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D' PRICE INFORMATION FOR DECENTRALI/ED DECISION
MA0IN
"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.
E' DEALIN 4ITH PRO!LEM OF INCENTI5ES
%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
company.
FINANCIAL CONCEPTS
!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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CHAPTER.6-FINANCIAL ASSETS
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.
CLASSIFICATION OF 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
MAR00ETA!LE ASSETS
'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.
NON MAR0ETA!LE ASSETS
=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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CHAPTER.8-FINANCIAL INTERMEDIARIES
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
CAPITAL MAR0ET INTERMEDIARIES
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$.
MONEY MAR0ET INTERMEDIARIES
'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.
!ENEFITS OF FINANCIAL INTERMEDIARIES2
A' DI5ERSIFICATION2
"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.
!' LO4ER TRANSACTION COST2
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.
C' ECONOMIES OF SCALE2
$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.
D' CONFIDENTIALITY2
$ompanies who access the financial markets for funds or want the
continued support of existing investors are re6uired to reveal information
which they otherwise would like to keep it secret for maintaining their
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competitive advantage. Information revealed to financial intermediaries has
a greater chance of secrecy and security than to individual investors.
E' SINALIN2
"inancial intermediaries has the re6uired professional expertise to
understand the signals and hints provided by companies and pass on the
ac6uired understanding to the investors so that individual investors can take
their decisions to invest.
FINANCIAL INTERMEDIARIES IN INDIA2
The financial intermediaries in India consists of banking and non#banking
financial institution, development finance institutions, insurance companies,
investment banks such as the mutual funds, merchant banks, venture capital
firms and information services companies.
A' COMMERCIAL !AN0S2
The /ublic )ector +anks, foreign banks and private sector banks are the
most important banking financial intermediary in the Indian financial
system. The )tate +ank of India was set up in (D99 and is the largest
commercial bank in India. +ank nationalization effort in (D:D and in (DBE
by the &overnment of India transformed a large number of private sector
banks into nationalized banks. !s a result, the commercial banking sector is
dominated by public sector banks in India. ationalization of banks
contributed to the spread of banking institutions in the hooks and corners of
the country, led to higher mobilization of deposits and reallocation of bank
credit to priority sectors of the economy. =n the flip side, the autonomy of
the bank management was reduced. %ith the adoption of the ew ?conomic
/olicy in the year (DD(, the banking sector was liberalized and new private
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sector banks such as the 57"$ and I$I$I +anks came into existence. The
private banking sector is dominated by these two banks since their inception.
!' DE5ELOPMENT !AN0S2
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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C' INSURANCE COMPANIES2
;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$.
D' POST OFFICE SA5INS !AN02
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.
E' THE NATIONAL HOUSIN !AN0S2
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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F' MUTUAL FUNDS2
'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.
' NON-!AN0IN FINANCIAL COMPANIES2
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
services.
H' MERCHANT !AN0S2
'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.
I' 5ENTURE CAPITAL INSTITUTIONS2
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.
9' INFORMATION SER5ICES COMPANIES2
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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CHAPTER.:-FINANCIAL MAR0ETS
&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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FUNCTIONS OF FINANCIAL MAR0ETS2
! 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
A' FACILITIES DISCO5ERY OF PRICE2
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.
!' IMPARTS LI;UIDITY TO FINANCIAL ASSETS2
"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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C' LO4 COST OF TRANSACTION2
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
information.
CLASSIFICATION OF FINANCIAL MAR0ETS2
UNORANISED MAR0ETS
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.
ORANISED MAR0ETS
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
A. CAPITAL MAR0ET2
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
CALL MONEY MAR0ET
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
loans.
COMMERCIAL !ILLS MAR0ET
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
market.
TREASURY !ILL MAR0ET
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
2+I.
SHORT-TERM LOAN MAR0ET
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. $ommercial banks provide short term loans in
the form of cash credit and overdraft. =verdraft facility is mainly given to
business people whereas cash credit is given to industrialists. =verdraft is
purely a temporary accommodation and it is given to in the current itself.
+ut cash credit is for a period of one year and it is sanctioned in a separate
account.
FOREIN E
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brokers engaged in the business of buying and selling foreign exchange. It
also includes the central bank of each country and the treasury authorities
who enter into this market as controlling authorities. Those engaged in the
foreign exchange business are controlled by the "oreign ?xchange
'aintenance !ct @"?'!A.
FUNCTIONS OF FOREIN E
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CHAPTER.=-FINANCIAL RATES OF RETURN
'ost households in India still prefer to invest on physical assets like land,
buildings, gold, silver etc. +ut, studies have shown that investment in
financial assets like e6uities in capital market fetches more return than
investments on gold. It is imperative that one should have some basic
knowledge about the rate of return on financial assets also.
The return on government securities and bonds are comparatively less than
on corporate securities due to lower risk involved therein. The government
and the 2+I determine the interest rates on government securities. Thus, the
interest rates are administered and controlled. The peculiar feature of the
interest rate structure is that the interest rates do not reflect the free market
forces. They do not reflect the scarcity value of capital in the country also.
'ost of these rates are fixed on an adhoc basis depending upon the credit
and monetary policy of the government.
#n#ra""%> t# int#r#st rat# o"ic% o$ 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.
RECENT TRENDS
%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
structure.
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CHAPTER.?-FINANCIAL INSTRUMENTS
"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.
PRIMARY SECURITIES2
These are securities directly issued by the ultimate investors to the ultimate
savers.
E3. )hares and debentures issued directly to the public.
SECONDARY SECURITIES2
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.
CHARACTERISTIC FEATURES OF FINANCIAL INSTRUMENTS
&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
readily.
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 $ertificates.
They carry risk in the sense that there is uncertainty with regard to
payment of principal or interest or dividend as the case may be.
These instruments facilitate futures trading so as to cover risks due to price
fluctuations, interest rate fluctuations, etc.
These instruments involve less handling costs since expenses involved in
buying and selling these securities are generally much less.
The return on these instruments is directly in proportion to the
risk undertaken.
These instruments may be short#term or medium term or long#term
depending upon the maturity period of these instruments.
MULTIPLICITY OF FINANCIAL INSTRUMENTS
The expansion in size and number of financial institutions has
conse6uently led to a considerable increase in the financial instruments also.
ew instruments have been introduced in the form of innovative schemes of
CI$, ;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.
IMPORTANT INSTRUMENTS
COMMERCIAL PAPER2
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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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R!I UIDELINES FOR COMMERCIAL PAPER 6@11
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
and
@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
$/ can be issued in denominations of 2s.9 lakh or multiples thereof.
!mount invested by a single investor should not be less than 2s.9 lakh @face
valueA.
Li&its and t# A&o*nt o$ 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
issuer.
@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 $/, in accordance with these &uidelines.
CERTIFICATE OF DEPOSITS2
-! certificate of deposit is a promissory note issued by a bank. It is a time
deposit that restricts holders from withdrawing funds on demand. !lthough
it is still possible to withdraw the money, this action will often incur a
penalty.
T# caract#ristics o$ 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
account.
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
levels.
The investment is locked in at a specific rate, even if interest rates
increase.
R!I UIDELINES FOR CERTIFICATE OF DEPOSITS 6@11
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
market.
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
benchmark.
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
$7s.
Trans$#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
$7s issued with complete particulars.
TREASURY !ILLS2
Treasury +ills are money market instruments to finance the short term
re6uirements of the &overnment of India. These are discounted securities
and thus are issued at a discount to face value. The return to the investor is
the difference between the maturity value and issue price.
T%#s o$ 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.
$ompared with commercial banks and other financial institutions
rates, the Treasury +ills sometimes offer the highest interest rate
available.
Treasury +ills provide a regular income or cash flow which can be
used to supplement your existing income or provide an income if you
are retired.
Treasury +ills can easily be converted to cash on maturity, or they
may be sold if you need the money before the maturity dates. !s Treasury +ills are an income generating asset, they can be used as
collateral for loans from banks and other financial institutions.
Treasury +ills offer a simple mode of preserving J protecting
your investment
T# disadantag#s o$ 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.
CHAPTER.- DE5ELOPMENT OF FINANCIAL SYSTEM IN
INDIA2
)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
direction.
NATIONALISATION OF FINANCIAL INSTITUTIONS2
!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.
ROLE OF FINANCIAL SYSTEM IN ECONOMIC DE5ELOPMENT2
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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
resources.
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.
4EA0NESSES OF INDIAN FINANCIAL SYSTEM2
!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
LAC0 OF CO-ORDINATION !ET4EEN DIFFERENT
FINANCIALINSTITUTIONS2
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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.
MONOPOLISTIC MAR0ET STRUCTURES2
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.
DOMINANCE OF DE5ELOPMENT !AN0S IN INDUSTRIAL
FINANCIN2
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
mechanism.
INACTI5E AND ERRATIC CAPITAL MAR0ET2
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.
IMPRUDENT FINANCIAL PRACTICE2
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
institutions.
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.
CHAPTER.- REULATORY SYSTEM2
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
markets
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.
CONCLUSION
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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