SATISH K. MATTAM.COM, PGDBM, MBA, M.PHIL.

ASSTT. PROFESSOR

LLOYD BUSINESS SCHOOLGREATER NOIDA

VRINDA PUBLICATIONS (P) LTD.

MANAGEMENT OF FINANCIAL INSTITUTIONS

AND SERVICES

Dedicated to theALMIGHTY

AndMy Parents

Sh. Roshan Lal Matta&

Smt.Indira MattaThe inspiration and

Strength behind this work

1Chapter

FINANCIAL SYSTEM AND MARKETS

OBJECTIVE: The objective of this lesson is to give an overview of financial systems and markets in India.

STRUCTUREConcept of Financial SystemFinancial ConceptsFinancial AssetsFinancial IntermediariesFinancial MarketsFinancial Rates of ReturnFinancial InstrumentsForeign Exchange Market

CONCEPT OF FINANCIAL SYSTEM

Financial system is one of the industries in an economy. It is a particularly important

industry that frequently has a far reaching impact on society and the economy.

Financial industry as a whole, produces a wide range of services but all these

services are related directly or indirectly to assets and liabilities, that is, claims on

people, organization, institutions, companies and government. These are the forms in

which people accumulate much of their wealth. In simple terms we are referring to

paper assets: shares, debentures, deposits, mortgages and other securities. Thus,

financial system performs certain essential functions for the economy, including

maintenance of payment system (through which purchasing power is transferred

from one participant to another i.e. from buyer to seller), collection and allocation of

the savings of society, and creation of a variety of stores of wealth to suit the

preferences of savers. This brief sketch of functions of financial system gives us its

gist. Performance of these functions pre-supposes the existence of financial assets,

financial institutions (intermediaries) and financial markets. A combination of these

three constitutes financial system.

FUNCTIONS OF FINANCIAL SYSTEM

a) Provision of Liquidityb) Mobilization of Savingsc) Service Function

FINANCIAL CONCEPTS

An understanding of the financial system requires an understanding of the following concepts:

(i) Financial assets (ii) Financial intermediaries (iii) Financial markets (iv) Financial rates of return (v) Financial instruments

Financial Assets

Classification of Financial Assets (i) Marketable assets (ii) Non-marketable assets

Yet another classification is as follows: (i) Money or cash market (ii) Debt asset (iii) Stock asset

Financial Intermediaries

They may also be classified into two: (i) Capital market intermediaries (ii) Money market intermediaries

Financial Markets

Classification of Financial Markets (a) Unorganized Markets (b) Organized Markets

These organized markets can be further classified into two. They are:

(i) Capital market (ii) Money market

Capital Market

Capital market may be further divided into three namely:

(i) Industrial securities market (ii) Government securities market and (iii) Long term loans market

I. Industrial securities market

As the very name implies, it is a market for industrial securities namely: (i) Equity shares or ordinary shares, (ii) Preference shares, and (iii) Debentures or bonds

It can be further subdivided into two. They are: (i) Primary market or new issue market (ii) Secondary market or Stock exchange

Primary Market

There are three ways by which a company may raise capital in a primary market. They are:

(i) Public issue (ii) Rights issue (iii) Private placement

Secondary Market

Secondary market is a market for secondary sale of securities. In other words, securities which have already passed through the new issue market are traded in this market. Generally, such securities are quoted in the stock exchange and it provides a continuous and regular market for buying and selling of securities. This market consists of all stock exchanges recognized by the Government of India.

ii. Government Securities Market

The Government securities are in many forms. These are generally:

(i) Stock certificates or inscribed stock (ii) Promissory Notes (iii) Bearer Bonds which can be discounted.

iii. Long Term Loans Market

Long term loans market may further be classified into:

(i) Term loans market (ii) Mortgages market (iii) Financial Guarantees market

MONEY MARKET

The money market may be subdivided into four parts. They are:

(i) Call money market(ii) Commercial bills market(iii) Treasury bills market(iv) Short term loan market

Money Market Vs Capital Market

Money Market1. It is market for short term funds

for a period of not exceeding one year.

2. This market supplies funds for working capital.

3. This market deals in instruments like bill of exchange, treasury bills, commercial papers, certificates of deposits etc.

4. Each single money market instrument is of large amount minimum for Rs. 1 lacs to 25 lacs.

5. The central bank and commercial banks are major players in this market.

6. Money market generally have no secondary market.

7. Generally there is no formal place.

8. Brokers are not required.

Capital Market1. It is market for long term funds

exceeding a period of one year2. This market supplies fund for

fixed capital as well as long term requirements of Govt.

3. This market deals in instruments like share, debentures and bonds etc.

4. Each single capital market instrument is of small amount. i.e. Normally face value of share is Rs. 10 and debenture Rs. 100

5. Development banks, insurance companies and mutual funds play a dominant role in capital market.

6. Capital market have secondary market.

7. Transactions takes place on a formal place like stock exchanges.

8. Transactions have to be conducted only through authorized dealers.

Characteristics or Features of a Developed Money Market

(l) Highly Organized Banking System(ii) Presence of a Central Bank(iii) Availability of Proper Credit

Instruments(iv) Existence of Sub-markets(v) Ample Resources(vi) Existence of Secondary Market(vii) Demand and Supply of Funds

Importance of Money Market

(i) Development of Trade and Industry(ii) Development of Capital Market(iii) Smooth Functioning of Commercial

Banks(iv) Effective Central Bank Control(v) Formulation of Suitable Monetary

Policy(vi) Non-inflationary source of Finance

to Government

Foreign Exchange Market

Functions of Foreign Exchange Market (i) Transfer Function (ii) Credit Function (iii)Hedging Function

MAJOR FOREIGN EXCHANGE INSTRUMENTS

The major foreign-exchange instruments are:Spot MarketForward MarketOptionsFutures

Participants in the Forward Market

i) Traders ii) Arbitrageurs iii) Hedgers iv) Speculators v) Banks vi) Governments

Options Terminology

i) Call Option ii) Put Option iii) Strike Price (also called Exercise Price) iv) Maturity Date v) American Option vi) European Option vii) Option Premium (Option Price, Option

Value) viii) Intrinsic Value of an Option ix) Time value of an Option x) Option at the Money xi) Option out of Money xii) Option in the Money

Major Features of Futures Contracts

i) Organized Exchanges ii) Standardization iii) Clearing House iv) Initial Margins v) Marking to Market vi) Actual Delivery is Rare