chap 1 financial system

7/28/2019 Chap 1 Financial System

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Financial SystemAn institutional framework existing in a country to

enable financial transactions

Three main parts Financial assets (loans, deposits, bonds, equities, etc.)

Financial institutions (banks, mutual funds, insurancecompanies, etc.)

Financial markets (money market, capital market, forexmarket, etc.)

Financial rate of return

Financial instrumments


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Financial assets Enable channelizing funds from surplus units to

deficit units

There are instruments for savers such as deposits,equities, mutual fund units, etc.

Like businesses, governments too raise funds throughissuing of bonds, Treasury bills, etc.


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Assets Classification on tangibility

1. Physical assets

2. Financial Assets Classification on basis of marketability

1. Marketable

2. Non marketable


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Financial Institutions Includes institutions and mechanisms which

Affect generation of savings by the community

Mobilisation of savings Effective distribution of savings

Institutions are banks, insurance companies, mutualfunds- promote/mobilise savings

Individual investors, industrial and tradingcompanies- borrowers


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Financial Markets Money Market- for short-term funds (less than a year)

Organised (Banks)

Unorganised (money lenders, chit funds, etc.)

Capital Market- for long-term funds Primary Issues Market

Stock Market

Bond Market


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Type Organized market

1. Capital market

2. Money market Unorganized market


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Capital Market Market for long-term capital.

Demand comes from the industrial, service sector and

government Supply comes from individuals, corporate, banks,

financial institutions, etc.


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Capital Market Industrial security market: New Issues Market- also

known as the primary market- refers to raising of newcapital in the form of shares and debentures

Primary market

1. Public issue

2. Right issue3. Private placement


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Government security market Reliable

Tax exemption

Return Forms

1. Stock certificate

2. Promissory note

3. Bearer bond


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Long term loans market Term loan market

Mortgage loan

Financial guarantee market


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STRIPS Separate trading of registered interest and principal of

securities

Dividing in coupons


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Organised Money Market Call money market

Treasury bills

Commercial bills Bank loans (short-term)


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Money Market Instruments Certificates of Deposit

Commercial Paper

Inter-bank term money Treasury Bills

Bill rediscounting

Call/notice/term money

Market Repo


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Purpose of the money market Banks borrow in the money market to:

Fill the gaps or temporary mismatch of funds

To meet the CRR and SLR mandatory requirements as

stipulated by the central bank

Short-term liquidity position of the banks


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Call money market Is an integral part of the Indian money market where

day-to-day surplus funds are traded.

The loans are of short-term duration (1 to 14 days).

Money lent for one day is called call money; if itexceeds 1 day but is less than 15 days it is called noticemoney. Money lent for more than 15 days is termmoney

The borrowing is exclusively limited to banks, who aretemporarily short of funds.


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Call money market The main function of the call money market is to

redistribute the pool of day-to-day surplus funds ofbanks among other banks in temporary deficit offunds

The call market helps banks economies their cash andyet improve their liquidity

It is a highly competitive and sensitive market It acts as a good indicator of the liquidity position


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Treasury Bill market Treasury Bill market- Also called the T-Bill market

These bills are short-term liabilities (91-day, 182-day, 364-day)of the Government of India

It is an IOU of the government, a promise to pay the statedamount after expiry of the stated period from the date of issue

They are issued at discount to the face value and at the end ofmaturity the face value is paid

The rate of discount and the corresponding issue price are

determined at each auction RBI auctions 91-day T-Bills on a weekly basis, 182-day T-Bills

and 364-day T-Bills on a fortnightly basis on behalf of thecentral government


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Certificates of Deposit Introduced in 1989

Maturity of not less than 7 days and maximum up to a year. FIs areallowed to issue CDs for a period between 1 year and up to 3 years

Subject to payment of stamp duty under the Indian Stamp Act, 1899 Issued to individuals, corporations, trusts, funds and associations

They are issued at a discount rate freely determined by themarket/investors

Freely transferable


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Commercial Papers Short-term borrowings by corporates, financial institutions,

primary dealers from the money market

Can be issued in the physical form (Usance Promissory Note) ordemat form

Introduced in 1990

When issued in physical form are negotiable by endorsement anddelivery and hence, highly flexible

Maturity is 7 days to 1 year

Unsecured and backed by credit rating of the issuing company Issued at discount to the face value


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Market Repos Repo (repurchase agreement) instruments enable

collateralised short-term borrowing through theselling of debt instruments

A security is sold with an agreement to repurchase it ata pre-determined date and rate Reverse repo is a mirror image of repo and reflects the

acquisition of a security with a simultaneouscommitment to resell


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Foreign exchange market Dealing with foreign market

Currencies exchange rate

Foreign trade


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Financial rate of return DEMAND AND SUPPLY

chap 1 financial system

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