What do you mean by financial system?

A financial system (within the scope of finance) is a system that

allows the exchange of funds between lenders, investors, and
borrowers. Financial systems operate at national, global, and firm-
specific levels. They consist of complex, closely related services,
markets, and institutions intended to provide an efficient and regular
linkage between investors and depositors. Money, credit, and finance
are used as media of exchange in financial systems.

What are the functions of financial system?.

1. The Savings Function:

As already stated, public savings find their way into the hands of
those in production through the financial system. Financial claims are
issued in the money and capital markets, which promise future
income flows.

2. Liquidity Function:

Money in the form of deposits offers the least risk of all financial
instruments. But its value mostly eroded by inflation.

3. Payment Function:

The financial systems offer a very convenient mode of payment for

goods and services. The check system, credit card systems et al are
the easiest methods of payment in the economy; they also drastically
reduce the cost and rime of transactions.

4. Risk Function:

The financial markets provide protection against life, health, and

income risks. These are accomplished through the sale of life, health,
and property insurance policies.

5. Policy Function:
Most governments intervene in the financial system to influence
macroeconomic variables like interest rates or inflation.

Financial Concepts

Understanding of the financial system require an understanding of

the following financial concepts.

Financial assets

Financial intermediaries

Financial markets

Financial rates of return

Financial instruments

What do you mean by Financial Assets?

Financial assets are the basic product of a financial system. These

assets are used for production or consumption or further creation of
assets. The financial assets or near money are the claims of money
and performs some functions of money. They have high degree of
liquidity but not, as liquid as money has. In other words financial
asset is a claim against the income or wealth ot a business firm,
household, or unit of government usually represented by a
certificate, receipt, or other legal document.

Financial assets are cash and other assets that convert.directly into
known amounts of cash.

The three basic categories of financial assets are cash, marketable

securities. and receivables. In the balance sheet, financial assets are
listed at the current value.
What are different Classification of Financial Assets?

Financial assets can be classifled in diferent ways. One type of

classification consists of

1) Primary or direct assets

2) Secondary or indirect assets

Primary assets: These are the financial claim against real sector
units created by themselves for raising funds to finance their
deficient spending. E.g.. bills, bonds, equities ete are primary assets

Secondary assets: These are financial claims issued by financial

institutions against themselves to raise funds from the public. E.g.
bank deposits, life insurance policies, UTI units ete are secondary
assets,

Marketable assets & Non-marketable assets

Marketable assets: These are the financial assets which can be

transterred from person to person without much diffculty. It consists
of shares, government securities, bonds, Mutual fund units, UTI
uníts, Bearer debentures etc.

Non marketable assets: These are the financial assets which

cannot be transferred easily. It mainly consists of Banks deposits,
Provident funds. LIC schemes, Company deposits, Post office
certificates.

Money/cash asset, Debt asset and Stock assets

Cash assets: Money assets consist of coins and currency notes and
created money.

Debt asset: Different types of organization issues debt assets for

raising their debt capital.

Stock asset: Corporate issue stocks for the purpose of raising their
fixed capital.

There are mainly two types of stocks such as prelerence and equity
stock.

What do you mean by a financial intermediary?

A financial intermediary is an institution which connects the deficit

and the surplus. The best example of an intermediary can be a bank
which transforms the bank deposits to bank loans. The role of
financial intermediary is to channel funds from people who have
extra inflow of money i.e., the savers to those who do not have
enough money to fulfill the needs or to carry out the basic activities
i.e. the borrowers.

What do you mean by a Financial Market?

Financial markets are the centre that facilitate buying and selling of
financial instruments, claims or services.It caters the credit needs of
the individuals, firms and institutions.It deals with the financial assets
of different types such as currency deposits, cheques, bills, bonds
etc.

It is defined as a transmission mechanism between investors and the

borrowers through which transfer of funds is facilitated.It consists of
individual investors, financial institutions and other intermediaries
who are linked by a formal trading rules and communication network
for trading the various financial assets and credit instruments.

What is the Function of Financial Markets?

1. Borrowing and Lending : Financial markets permit the transfer of

funds from one agent to another for either investment or
consumption purposes.
2. Price Determination: It provides means by which prices are set
both for newly issued financial assets and for the existing stock of
financial assets.

3. Information Aggregation and Coordination: It acts as collectors

and aggregators of information about financial asset values and the
flow of funds from lenders to borrowers.

4. Risk Sharing: It allow a transfer of risk from those who undertake

investments to those who provide funds for those investments.

5. Liquidity: It provides the holders of financial assets with a chance

to resell or liquidate these assets.

6. Efficiency: It reduce transaction costs and information costs.

What are different kinds or classification of financial markets?

Money market: money market is a market for short term funds

normally upto 1 year. that means it deals with relatively liquid and
critically marketable assets like short term government securities,
treasury bills of exchange etc.

Capital markets: the capital market is the market for the issue and
trading of long-term securities. The term in this instance is measured
as the term to maturity of the security. The term of maturity should
be longer than three years. if the term of security is up to 5 years it is
short term capital market, if it is in between 5 and 10 years it is
known as medium term capital market and if the term of the
securities is more than 10 years it is known as Long term capital
market.

Financial mortgages market: is market through which mortgage

loans are granted to individual customers. mortgage loans are
granted against immovable property like real estate. Mortgage is the
transfer of an interest in the specific immovable property for the
purpose of securing loans. The transferor is called mortgagor and
the transferee is called mortgagee.
Financial guarantees market: is an independent market. It is a
financial service market. It is the centre where insurance is provided
against the guarantee of a reputed person in the financial circle.
Before providing loan. the lender will demand the borrower to find a
guarantor who assures the repayment of the debt to the creditor.

Foreign Exchange Market: Foreign exchange market is a market in

which foreign exchange transactions take place. Foreign exchange
refers to the process of conversion of home currencies into foreign
currencies and vice versa.

Commodity market: Commodity market is a significant component of

the financial markets of every country. These markets are at the core
of the global economy. It is the market where a wide range of
products, such as base metals, precious metals, crude oll. energy
and soft commodities like palm oil, coffee etc. are traded.

Debt market: Debt market is one of the important constituent or

financial system. A major part of the financial markets of the
developed countries is the debt market. A debt market is a part of
the capital market. Debt market is a market where different types of
debt instruments are traded. Debt instruments Include fixed income
securities issued by central and state governments, municipal
corporations, government bodies and commercial bodies such as
banks, financial institutions, public sector under takings, public
limited companies etc.

What do you mean by financial instruments or financial

securities?

An instrument or security is a legal evidence of a deposit or claim for

a specific sum of money. These are documents which represent
financial claims on assets.

What are the basic features of financial instruments?

Transferability: majority of the financial instruments can be

transferred easily.

Minimum transaction cost: for an ideal security or financial

instrument minimum transaction cost should be the lowest.

Ready market: these securities can be bought and sold easily.

Liquidity: liquidity denotes the ability of the investment to convert as

cash according to the wish of the investor.

Security value: these instruments can be used for raising loans by

providing them as security.

Tax status: investment made in some securities will be exempted for

payment of tax.

Prevalence of uncertainty: the uncertainty is with to the payment of

principal or interest or dividend on securities. So an element of risk is
there.

Rate of return: selection of a security depends upon the rate of

interest for dividend offered for it.

Facilitates future trading: the instruments facilitate future trading, so

it is possible to cover the risk arising out of price fluctuation, interest
rate fluctuations etc.

Maturity period: there are different types of security based on

maturity period which is short term, medium term or long term
securities.

What are different classification of financial securities?

On the basis of issue: it can be classified as

Primary securities: these securities are issued by the ultimate use of

the capital to the final investors.
Secondary securities: these securities are issued by financial
intermediaries to the ultimate savers.

FINANCIAL SERVICES

Financial service is part of financial system that provides different

types of finance through various credit instruments, financial
products and services. Financial service is a term used to refer to the
services provided by the finance industry. Banks, insurance
companies, investment banks, and brokerages. are examples of the
types of firms forming this industry: They provide money and
investment and related services.

Financial service is the term used to describe those organizations

that deal with the management of money.

What are different types of financial services?

Factoring

Leasing

Hire purchase finance

Credit rating

Merchant banking

Book building

Asset liability management

Housing finance

Portfolio finance

Underwriting
Credit rating

Interest and credit swap

Mutual fund

what are the basis different types of financial

Fee based services: fee based services are advisory services, credit
rating etc.

Fund based services: fund based services include factoring, venture

capital, mutual funds etc.

MERCHANT BANKING

Merchant Banking is a British concept and brought in India by Grind

lays bank in 1969.Since then a number banks like SBI, Bank of
Baroda, Bank of India, Canara bank. Syndicate bank and Indian
Overseas bank have organized their merchant bank divisions.

Merchant banking involves rendering services ot non banking nature

to the industrial and business houses. the services provided by them.
It includes

1. They manage market and underwrite new issues.

2. They provide project promotion services and project finance.

3. Organisation credít and other facilities.

4. Leasing including project leasing.

5. They will provide corporate services.

6. They will provide investment advisory services.

7. It will provide bought out deals.

8. It will provide venture capital

9. It will provide mutual funds and offshore funds.

10. Investment management

Stock Broking

Stock brokers have an important position in the stock market. They

play significant roles .They are the members of the recognized stock
exchanges. They buy. sell or deal in securities. It emerged as
professional advisory service in India. They have to work within the
prescribed frame work. They must obtain a certificate of registration
from the Securities and Exchange Board of India. (SEBI).

Credit Rating

As a fee based advisory financial service, credit rating is of a

comparatively recent origin. Credit Rating is essentially a symbolic
indicator of the relative grading of the investment / credit qualities of
financial instruments. It relects the relative ability of the issuers of
such instruments to meet the servicing obligations as and when they
arise.

Factoring Service

Factor is a financial institution which manages the collection of

accounts receivables of the business firm and bears the credit risk
associated with it, Factoring involves provision of specíalized
services relating to credit investigation, sales ledger management,
purchase and collection of debts and credit protection. In factoring
there are three main parties such as client (seller), the customer
(buyer) and factor. Under factoring system, a client enters into a
formal agreement with a factor to create a legal relationship of buyer
and seller.
Leasing

A lease can be defined as an arrangement between the lessor (owner

of the asset) and the lessee (user of the asset) whereby the lessor
purchases an asset from the lessee and allows him to use it in
exchange for periodical payments called lease rentals or minimum
lease payments (MLP).

Hire purchase finance

Hire purchase (HP) or leasing is a type of asset finance that allows

firms or individuals to possess and control an asset during an agreed
term, while paying rent or instalments covering depreciation of the
asset, and interest to cover capital cost.

Book building

Every business organization needs funds for its business activities. It

can raise funds either externally or through internal sources. Two of
the most popular means to raise money are initial Public Offer (IPO)
and Follow on Public Offer (FPO). During the IPO or FPO. the
company offers its shares to the public either at fixed price or offers
a price range, so that the investors can decide on the Right price.
The method of offering shares by providing a price range is called
book Building method.

VENTURE CAPITAL FINANCING

Venture capital can be loosely referred as the financing of new ideas

and technologies". The term venture capital is normally delined as an
equity investment in a high risk project related to some innovations
or new technological developments pondered by a company.

Forfeiting

Forfaiting is a means ot financing that enables exporters to receive

immediate cash by selling their medium and long term receivables. A
forefaiter is basically a bank or a financial firm that specialises in
export financing.

Underwriting

Underwriting is the process that a lender or other financial service

users to access the creditworthiness or risk of a potential customer.
Underwriting also refers to an investment bankers process of
packaging and selling the security on behalf of a client.

Interest and credit swap

Interest rate swap is an agreement between two parties to exchange

one stream of interest payments for another, over a set of period of
time. Swaps are derivative contracts and trade Over The Counter.
Interest rate swaps are performed to lower the cost of credit by
taking advantage of another company's credit lines.

Mutual Funds

A mutual fund is formed when capital collected from different

investors is invested in company Shares, stocks or bonds. It refers to
a pool of money accumulated by several investors who aim at saving
and making money through their investment.

Financial porfolio

It is a collection of financial assets. It includes stocks, bonds, cash

and cash equivalents, or alternative investments. The investor want
to have a mix of different asset classes in their portfolio to balance
the potential for growth and the risk that they will lose money.

What are the Weakness of the Indian Financial System?

1. Lack of Institutional Investors: The disinvestments and

privatisation program has also been inherited by lack of institutional
investors in private sector.
2. Lack of coordination between different financial intermediaries:
even though there are a large number of intermediaries in the
financial market. The government held controlling interest in these
companies. Due to its multiplicity there is lack of coordination.

3. Lack of emergence of financial corporations: the international

trend in past decade has been convergence of different segments of
financial and capital markets which resulted in financial corporations,
but in India such corporations should be developed.

4. Dominance of monopolies: some financial institutions have created

monopolistic market structure in financial system.

5. Lack of integration of the segments of the financial system: the

different factors of the financial system like capital market, money
market, bullions market etc are not properly coordinated.

6.Dominance of development market: the development Banks play a

significant role for the development of financial system. But they are
not able to mobilise the savings of the people, which is a necessity
for the growth of financial system.

7. Dominance of the public sector firms: the domination of public

sector finance inhibit the market for corporate control and
development of widely held, board managed, professionally run
companies.

8. Market irregularities: the securities market have experienced the

steady stream of episodes of market irregularities in the decade of
the 90s.

9. Neglect for small and new enterprises: small and new enterprises
are not able to raise funds at easy term and cost.

10. Cyber threats: an estimated 95% of transactions in India are paid

for in cash but with growing penetration of computers and
smartphones. Cyber crime is becoming a greater threat as a result.
Growth Of Indian Financial System

Before independence, Indian financial system was in a very weak

spot. Since it was dominated by the unorganised financial service
providers. The monetary sector of the country was also in a very
weak position.
Post independence era, the government of India took a mixed
economic policy. Later on, Indian financial system started growing
with stronger organised sector. Now Indian financial system is much
more organised and diversified. But it still on its growing stage.
The growth of banking sector in Indian financial system
After independence, India saw a boom in banking sector.
Nationalisation of banks in 1969 and 1980, played a major role in
strengthening the banking sector in India. Now in all rural and urban
areas banking sector has a strong presence. Also, in urban areas
there is presence of foreign banks.

Growth of non banking financial institutions

After the liberalisation in 1990s, the non banking financial sector of
India also witnessed a tremendous growth. Especially the stock
markets, as well as the stock market indices of India also rise heavily.
Later, information technology got strengthened in India as a result
ATM services and internet banking also became popular.

Chapter 2 Money Market

What are the functions of New Issue Markets or Primary

Market?

(a) Origination : Origination refers to the work of investigation and

analysis and processing of new proposals.

b) Underwriting: The idea of underwriting originated on account

of uncertainties prevailing in the capital market as a result of
which the success of the issue becomes unpredictable.
(c) Distribution : The sale of securities to the ultimate investors is
referred to as distribution; it is another specialised job, which can
be performed by brokers and dealers in securities who maintain
regular and direct contact with the ultimate investors.

What are different Methods of Floatation of Securities in

Primary Market?

1. Public Issue through Prospectus: Under this method the

company issues a prospectus to inform and attract general public.
In prospectus the company provides details about the purpose for
which funds are being raised, past financial performance of the
company, background and future prospects of the company. The
information in the prospectus helps the public to know about the
risk and earning potential of the company and accordingly they
decide whether to invest or not in that company

2. Offer for Sale: Under this method new securities are offered to
general public but not directly by the company but by an
intermediary who buys a whole lot of securities from the
company.

3. Private Placement: Under this method the securities are sold

by the company to an intermediary at a fixed price and in second
step intermediaries sell these securities not to general public but
to selected clients at higher price. The issuing company issues
prospectus to give details about its objectives, future prospects
so that reputed clients prefer to buy the security from an
intermediary.

4. Right Issue (For Existing Share holders): This is the issue of

new shares to existing shareholders. It is called right issue
because it is the pre-emptive right of shareholders that company
must offer them the new issue before subscribing to outsiders.
Each shareholder has the right to subscribe to the new shares in
the proportion of shares he already holds.
5. e-IPOs, (electronic Initial Public Offer): It is the new method of
issuing securities through on line system of the stock exchange.
In this company has to appoint registered brokers for the purpose
of accepting applications and placing orders. The company
issuing security has to apply for listing of its securities on any
exchange other than the exchange it has offered its securities
earlier. The manager coordinates the activities through various
intermediaries connected with the issue

What Is a Merchant Bank?

The term merchant bank refers to a financial institution that

conducts underwriting, loan services, financial advising, and
fundraising services for large corporations and high-net-worth
individuals (HWNIs). Merchant banks are experts in international
trade, which makes them specialists in dealing with multinational
corporations. Unlike retail or commercial banks, merchant banks
do not provide financial services to the general public.

What is the role of merchant bankers in the new issue

management?

The services of the merchant bankers can be classified into two

head.

Pre issue management

Post issue management

Pre issue management: includes

1.Obtain SEBI's approval for the issue.

2.Arrange underwriting

3.Draft and finalise the prospectus

4.Draft and finalize other documents such as application forms,

newspaper advertisements and other statutory requirements.

5.Selection of registrar to issue, printing press, advertising

agencies, brokers and bankers to the issue and finalisation of fees
and charges paid to them.

Post issue management includes

1.Collection of application money

2.Write to the related stock exchange regarding closure of

subscription list

3.Send compliance reports to SEBI

4.Submission of records

5.Obtain approval of basis of allotment from stock exchange

What is offshore mutual funds?

Offshore mutual Funds are used to collect subscriptions from

resident's stationed in abroad.

What are the recent trends in primary market or new issue

market in India?

1.Raising of capital: the fresh capital raised through new issue

market has enhanced from decade to decade. Indian stock
exchanges ranked ninth in worldwide.

a)Public issues: according to data 12 initial public offerings as

raised around rupees 25000 crore in the year 2020.

b)Private placement: it is the selling of securities to known

people like friends are family or to financial institutions without
the help of financial intermediaries. The data have also shown a
tremendous jump in the amount raised through private placement.

2.Revival of primary market: the primary market actually revived

after 10 year break according to facts.

3.Domination: various public sector undertakings like financial

institutions and public sector institutions have started dominating
in primary market

4.Major revamp in IPO norms: SEBI as issued new norms for

which gives a great boost to startups.

5.Paperless primary market issues: primary market dealings are

mainly concentrated on online transaction rather than traditional
paper method.

6.poor performance for primary market

The trends in the primary market in the past few years is showing
tremendous changes in features of the primary market.

a)Manifestation of real economy: capital market is dependent upon

macroeconomic factors like industrial growth, infrastructural
growth, domestic demand, domestic savings. And the poor
performance of the capital market is caused by the poor
performance of these macroeconomic indicators.

b)Failure to mobilise household savings: less than 10% of the

household savings have reached the primary market.

c)Passive situation: prolong to passive situation in the secondary

market has also depressed the situation of primary market
incentives.

d)Gap in the primary market: there is institutional and functional

gap in primary market.

e)Free pricing of issues: with the introduction of economic reforms,

the Government of India introduced free pricing of issues. Since
Indian companies started to price their shares freely with us
caused adversely in primary market.

f)Data to investors: many companies are not providing analytical

and quality information to investors.

g)Developments in international market: development in

international market also affect the response of domestic market.