Financial Markets & Instruments

introduction
Capital Markets Sem 5 SOE
 Session 1
• Financial System – Functions
• formal & informal sectors
• Financial Markets
– Primary /secondary
– Money Markets & Capital Markets
– Debt Markets, Equity Markets, Fex Markets, Derivatives & Commodity Markets- OTC & Exchange traded Markets
– Financial Intermediation
• Financial Services
• Financial Intermediaries
 Financial Institutions

• Financial institutions facilitate smooth working

of the financial system by making investors
and borrowers meet.
• They mobilize the savings of investors either
directly or indirectly via financial markets, by
making use of different financial instruments
as well as in the process using the services of
numerous financial services providers.
 Introduction – Financial System
• Financial system", implies a set of complex and
closely connected or interlined institutions,
agents, practices, markets, transactions, claims,
and liabilities in the economy”.
• is the system that allows the transfer of money
between savers (and investors) and borrowers.
• is the set of Financial Intermediaries, Financial
Markets and Financial Assets.
 Introduction – Financial System
• Helps in the formation of capital.
• Meets the short term and long term capital
needs of households, corporate houses, Govt.
and foreigners.
• its responsibility is to mobilize the savings in
the form of money and invest them in the
productive manner.
 What is a financial System?
• A financial system is a complex,
well-integrated set of sub-systems of
• financial institutions,
• Financial markets,
• Financial instruments, and services
• which facilitates the transfer and allocation
of funds, efficiently and effectively.
• 1000 thousand
• 1000,000 million
• 1000,000,000 billion
• 1000,000,000 trillion
• Spot market or cash market
• Forward market (contract)
• Equity Market (SEBI)
• Debt Market – Bond market- Govt securitites
• Currency Markets (OTC Market)
• Commodity Markets
• Derivatives Markets (Futures & options)
• Money Market (Short term)
Financial System Consists of
Functions of Financial System
Formal and Informal Financial Sectors

• The financial systems of most developing

countries are characterised by coexistence and
cooperation between the formal and informal
financial sectors.
• This coexistence of these two sectors is
commonly referred to as ‘financial dualism.’
Formal and Informal Financial Sectors

formal financial sector

informal financial sector

 Formal Sectors

• The formal financial sector is characterised by

the presence of an organised, institutional,
and regulated system which caters to the
financial needs of the modern spheres of
economy;
Formal and Informal Financial Sectors

• The informal financial sector is an

unorganised, non-institutional, and
non-regulated system dealing with the
traditional and rural spheres of the economy
Formal and Informal Financial Sectors

• The informal financial sector has

emerged as a result of the intrinsic
dualism of economic and social
structures in developing countries, and
financial repression which inhibits the
certain deprived sections of society from
accessing funds.
 The Indian Financial System

The Indian financial system can

also be broadly classified into
• the formal (organised) financial
system and
• the informal (unorganised) financial
system.
 The Indian Financial System

The formal financial system

comes under the purview of
1. The Ministry of Finance (MoF),
2. The Reserve Bank of India (RBI),
3. The Securities and Exchange Board of
India (SEBI), and
4. other regulatory bodies.
 The informal financial system

The informal financial system

consists of:
• Individual moneylenders such as
neighbours, relatives, landlords,
traders, and storeowners.
• Groups of persons operating as ‘funds’
or ‘associations etc
 Informal Financial System

Advantages
• Low transaction costs
• Minimum default risk
• Transparency of procedures

Disadvantages
• Wide range of interest rates
• Higher rates of interest
• Unregulated
 COMPONENTS OF THE FORMAL
FINANCIAL SYSTEM

The formal financial system consists

of four segments or components.
• These are:
1. financial institutions,
2. financial markets,
3. financial instruments, and
4. financial services
Financial Institutions
 Financial Institutions

• They could be categorized into Regulatory,

Intermediaries, Non-intermediaries and Others.
• They offer services to organizations looking for
advises on different problems including
restructuring to diversification strategies.
• They offer complete array of services to the
organizations who want to raise funds from the
markets and take care of financial assets for
example deposits, securities, loans, etc.
Classification of Financial Institutions

Banking and non-banking

Term finance
Specialised
Sectoral
Investment
State-level
 Financial Institutions

• These are intermediaries that mobilise savings

and facilitate the allocation of funds in an
efficient manner.
• Financial institutions can be classified as
banking and non-banking financial
institutions.
• Banking institutions are creators and
purveyors of credit while non-banking financial
institutions are purveyors of credit.
 Financial Institutions

• While the liabilities of banks are part of the

money supply, this may not be true of
non-banking financial institutions.
• In India, non-banking financial institutions,
namely,
• the developmental financial institutions (DFIs),
and non-banking financial companies (NBFCs)
as well as housing finance companies (HFCs)
are the major institutional purveyors of credit.
 Financial Institutions

• Financial institutions can also be classified as

term-finance institutions such as the
• Industrial Development Bank of India (IDBI), the
Industrial Credit and Investment Corporation of
India (ICICI),
• the Industrial Financial Corporation of India (IFCI),
• the Small Industries Development Bank of India
(SIDBI), and
• the Industrial Investment Bank of India (IIBI).
 Financial institutions
• Financial institutions can be specialised finance
institutions like
• the Export Import Bank of India (EXIM),
• the Tourism Finance Corporation of India (TFCI),
ICICI Venture,
• the Infrastructure Development Finance Company
(IDFC), and
• sectoral financial institutions such as the National
Bank for Agricultural and Rural Development
(NABARD) and the National Housing Bank (NHB).
 Financial Institutions
• Investment institutions in the business of
mutual funds Unit Trust of India (UTI),
• public sector and private sector mutual funds
and insurance activity of Life Insurance
Corporation (LIC), General Insurance
Corporation (GIC) and its subsidiaries are
classified as financial institutions
Banking and Non-Banking Institutions

Bank’s Characteristics:
• Characteristics of the banking business as defined
in Section 5(b) of the Banking Regulation Act are as
follows.
• Acceptance of deposits from the public
• For the purpose of lending or investment
• Repayable on demand or otherwise
• Withdrawable by means of any instrument
whether a cheque or otherwise
 Banks are creators of credit

• Banks are a special type of financial

intermediaries which not only accept and
deploy large amounts of uncollateralised
deposits in a fiduciary capacity, but also
leverage such funds through credit creation
• The creation of credit is an important function
of a bank and this function distinguishes banks
from the non-banking institutions
 Ancillary Functions
of Banks
• Banks provide a range of ancillary services,
including transfer of funds, collection, foreign
exchange, safe deposit locker, gift cheques,
and merchant banking.
• Thus, banks provide a wide variety of banking
and ancillary services.
 Market Size – Banks in India

The Indian banking system consists of

• 12 public sector banks
• 22 private sector banks,
• 44 foreign banks,
• 56 regional rural banks,
• 1,589 urban cooperative banks and
• 93,550 rural cooperative banks
 Broad Sectors for Priority Sector
Lending
• Agriculture
• Small Enterprises
• Retail Trade
• Micro Trade
• Education Loans
• Housing Loans
 • RBI – Reserve Banks of India :
• SEBI – Securities and Exchange Board of India
• IRDA – Insurance Regulatory and Development
Authority
• PFRDA – Pension Fund Regulatory and
Development Authority
Financial • FMC – Forward Markets Commission

Regulatory
Bodies in
India
 Financial Markets

Financial markets are a mechanism

enabling participants to deal in
financial claims.
The markets also provide a facility in
which their demands and
requirements interact to set a price for
such claims
 Financial Markets

The main organised financial markets in India

are the money market and the capital
market.

The first is a market for short-term securities

while the second is a market for long-term
securities, i.e., securities having a maturity
period of one year or more.
 Financial Markets

• A financial market is the place where financial

assets are created or transferred.
• It can be broadly categorized into money
markets and capital markets.
• Money market handles short-term financial
assets (less than a year) whereas capital
markets take care of those financial assets that
have maturity period of more than a year.
Money versus Capital Market Maturities
 Financial Markets

• One more classification is possible: primary

markets and secondary markets.
• Primary markets handles new issue of
securities in contrast secondary markets take
care of securities that are presently available
in the stock market.
 Types of Financial Securities

Types
• Money market
• Capital market

Segments
• Primary market
• Secondary market

Distinct Features
• Marketable
• Tradeable
• Tailor-made
 Financial Markets

Financial markets can also be classified as

primary and secondary markets.
• While the primary market deals with new issues,
• the secondary market is meant for trading in outstanding
or existing securities.

There are two components of the secondary

market:
• Over-the-counter (OTC) market and
• the exchange traded market.
 Financial Markets

• The key functions are:

• 1. Assist in creation and allocation of credit
and liquidity.
2. Serve as intermediaries for mobilization of
savings.
3. Help achieve balanced economic growth.
4. Offer financial convenience.
 Financial Markets
• The government securities market is an OTC
market. In an OTC market, spot trades are
negotiated and traded for immediate delivery
and payment while in the exchange-traded
market, trading takes place over a trading
cycle in stock exchanges.
• Derivatives Market (Futures and Options)
operate through Exchanges
 Nature of Financial Markets
• Financial markets create liquidity that allows
businesses to grow and entrepreneurs to raise
money for their ventures.
• They reduce risk by having information
publicly available to investors and traders.
• These markets calm the economy by instilling
confidence in investors.
• Investor confidence stabilizes the economy.
 Financial Instruments

• A financial instrument is a claim against a

person or an institution for payment, at a
future date, of a sum of money and/or a
periodic payment in the form of interest or
dividend.
• The term ‘and/or’ implies that either of the
payments will be sufficient but both of them
may be promised.
 Financial Instruments

• Financial instruments represent paper wealth shares,

debentures, like bonds and notes.
• Many financial instruments are marketable as they are
denominated in small amounts and traded in
organised markets.
• This distinct feature of financial instruments has
enabled people to hold a portfolio of different financial
assets which, in turn, helps in reducing risk.
• Different types of financial instruments can be
designed to suit the risk and return preferences of
different classes of investors
 Financial Instruments

• This is an important component of financial

system.
• The products which are traded in a financial
market are financial assets, securities or other
type of financial instruments.
• There is a wide range of securities in the
markets since the needs of investors and
credit seekers are different.
 Financial Instruments

• They indicate a claim on the settlement of

principal down the road or payment of a
regular amount by means of interest or
dividend.
• Equity shares, debentures, bonds, etc are
some examples.
 Financial instruments
• Financial instruments differ in terms of
marketability, liquidity, reversibility, type of
options, return, risk, and transaction costs.
• Financial instruments help financial markets and
financial intermediaries to perform the important
role of channelising funds from lenders to
borrowers.
• Availability of different varieties of financial
instruments helps financial intermediaries to
improve their own risk management
 Financial securities
• Financial securities are financial instruments that are
negotiable and tradeable.
• Financial securities may be primary or secondary
securities. Primary securities are also termed as direct
securities as they are directly issued by the ultimate
borrowers of funds to the ultimate savers.
• Examples of primary or direct securities include equity
shares and debentures.
• Secondary securities are also referred to as indirect
securities, as they are issued by the financial
intermediaries to the ultimate savers. Bank deposits,
mutual fund units, and insurance policies are
secondary securities.
 What are Financial Assets?
• Financial assets refer to assets that arise from
contractual agreements on future cash flows
or from owning equity instruments of another
entity. Eg : Debt instruments - Bonds
• Financial instruments refer to a contract that
generates a financial asset to one of the
parties involved, and an equity instrument or
financial liability to the other entity.
 Need of Financial Services

• Borrowing and funding

• Lending and investing
• Buying and selling securities
• Making and enabling
• Payments and settlements
• Managing risk
 Concept of intermediation

Intermediation involves the

"matching" of lenders with
savings to borrowers who
need money by an agent or
third party, such as a bank.
 Financial intermediaries
• an important source of external funding for
corporates.
• Unlike the capital markets where investors
contract directly with the corporates creating
marketable securities, financial
intermediaries borrow from lenders or
consumers and lend to the companies that
need investment.
 Financial Intermediaries
• Come in between the ultimate borrowers and
ultimate lenders
• provide key financial services such as merchant
banking, leasing, credit rating, factoring etc.
• Services provided by them are:
– Convenience ( maturity and divisibility),
– Lower Risk(diversification),
– Expert Management and
– Economies of Scale.
Types of Financial Intermediaries
 Financial Services

• Financial services consist of services provided

by Asset Management and Liability
Management Companies.
• They help to get the necessary funds and also
make sure that they are efficiently deployed.
• They assist to determine the financing
combination and extend their professional
services upto the stage of servicing of lenders.
 Financial Services

• They help with borrowing, selling and

purchasing securities, lending and investing,
making and allowing payments and
settlements and taking care of risk exposures
in financial markets.
• These range from the leasing companies,
mutual fund houses, merchant bankers,
portfolio managers, bill discounting and
acceptance houses.
 Financial Services

• The financial services sector offers a number of

professional services like credit rating, venture
capital financing, mutual funds, merchant
banking, depository services, book building, etc.
• Financial institutions and financial markets help in
the working of the financial system by means of
financial instruments.
• To be able to carry out the jobs given, they need
several services of financial nature.
• Therefore, Financial services are considered as the
major component of the financial system.