Financial Markets and institutions (FMI)

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17 Jun 2015

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Financial Markets and institutions (FMI)

  1. Introduction to Financial System • The term ‘System‘ in terms of financial system implies a set of complex & closely connected institution, agent, practices, markets, claims, transaction, liabilities in the economy. • The financial system is the process by which money flows from savers to users. • Financial,System refers to the financial needs of different sectors of the economy and the ways and means to meet such needs efficiently and economically.
  2. Role/Function of Financial System Facilitates Payments Provides Liquidity Short term and long term needs Capital Formation Risk Management Economic Development Regulates Markets
  3. Cont.. Facilitates Payment • The financial system offers convenient modes of payment for goods and services. New methods of payments like credit cards, debit cards, cheques, etc. facilitates quick and easy transactions. Provides Liquidity • In financial system, liquidity means the ability to convert into cash. The financial market provides the investors the opportunity to liquidate their investments, which are in instruments like shares, debentures, bonds, etc. Short and Long Term Needs • The financial market takes into account the various needs of different individuals and organizations. This facilitates optimum use of finances for productive purposes
  4. Cont… Capital Formation • Business require finance. These are made available through banks, households and different financial institutions. They mobilize savings which leads to Capital Formation. Risk Function • The financial markets provide protection against life, health and income risks. Risk Management is an essential component of a growing economy Finances Government Needs • Government needs huge amount of money for the development of defense infrastructure. It also requires finance for social welfare activities, public health, education, etc. This is supplied to them by financial markets
  5. Structure/Components of the Financial System Financial,System refer s to the financial needs of different sectors of the economy and the ways and means to meet such needs efficiently and economically. Funds are required for meeting various monetary needs. Assets/ Securities
  6. 1:Financial Markets • Financial Markets: Markets in which funds are transferred from people who have an excess of available funds to people who have a shortage of funds. Financial markets promote efficiency in economic system • Taking funds from those who do not have productive use of funds and • Giving to those who can best utilize the funds. Affect wealth and behavior of business firms and individuals
  7. Capital Market • A capital market is an organized market. It provides long term finance for business. According to Shri, K.S. “Capital Market refers to the facilities and institutional arrangements for borrowing and lending long-term funds. • The primal role of this market is to make investment from investors who have surplus funds to the ones who are running a deficit. • The transactions taking place in this market will be for periods over a year. Capital Market is divided into two parts:  Primary market  Secondary market
  8. functions and significance of capital market 1:Link between Savers and Investors: • The capital market functions as a link between savers and investors. It plays an important role in mobilising the savings and diverting them in productive investment. 2. Encouragement to Saving: • With the development of capital, market, the banking and non-banking institutions provide facilities, which encourage people to save more. 3. Encouragement to Investment: • The capital market facilitates lending to the businessmen and the government and thus encourages investment. It provides facilities through banks and nonbank financial institutions
  9. Cont.. 4. Promotes Economic Growth: • The capital market not only reflects the general condition of the economy, but also smoothens and accelerates the process of economic growth. Various institutions of the capital market, like nonbank financial intermediaries, allocate the resources rationally in accordance with the development needs of the country. 5. Stability in Security Prices: • The capital market tends to stabilize the values of stocks and securities and reduce the fluctuations in the prices to the minimum. The process of stabilization is facilitated by providing capital to the borrowers at a lower interest rate and reducing the speculative and unproductive activities
  10. Capital Market is divided into two parts: 1: Primary market • The Primary Market is a place where new shares and bonds are offered. • It is that market in which shares, debentures and other securities are sold for the first time for collecting long-term capital. • This market is concerned with new issues. Therefore, the primary market is also called NEW ISSUE MARKET.
  11. Features and functions of primary market • 1. Origination In primary market, origination means to investigate, evaluate and procedure new project proposals. It initiates before an issue is present in the market. It is done with the help of merchant bankers. 2. Underwriting In primary market, to ensure success of new issue, there is a need for underwriting firms. The company needs to appoint underwriters. They can be banks or financial institutions or specialized underwriting firms • 3. Distribution In primary market, the success of any grand new issue is hinges on the issue is being subscribed by the people. The sale of the securities to the supreme or highest investors is termed as distribution. • Distribution Job is given to brokers and dealers. The brokers or agents maintain direct contact with the supreme investors.
  12. Cont.. • 2. Secondary Market: Secondary market is a place where existing shares and debentures are treaded. • It is also called as Stock Market. It facilitates buying and selling of securities.
  13. Functions of Secondary Markets • Provides regular information about the value of security. • Helps to observe prices of bonds and their interstates. • Offers to investors liquidity for their assets. • Secondary markets bring together many interested parties. • It keeps the cost of transactions low.
  14. Major Stock exchanges in India • Stock exchanges are privately organized markets which are used to facilitate trading in securities. Functions of stock exchanges • 1. Continuous and ready market for securities 2. Facilitates evaluation of securities 3. Encourages capital formation 4. Provides safety and security in dealings 5. Facilitates public borrowing 6. Facilitates Bank Lending
  15. Major Stock exchanges in India (BSE) • Bombay Stock Exchange (BSE) of India The oldest stock market in Asia, and was initially known as "The Native Share & Stock Brokers Association." Incorporated in the 1875, BSE became the first exchange in India to be certified by the administration. It attained a permanent authorization from the Indian government in 1956 under Securities Contracts (Regulation) Act, 1956. • BSE is a very active stock exchange with highest number of listed securities in India. Nearly 70% to 80% of all transactions in the India are done alone in BSE.
  16. Con t… • National Stock Exchange NSE :Formation of National Stock Exchange of India Limited (NSE) in 1992 is one important development in the Indian capital market. The need was felt by the industry and investing community since 1991. The NSE is slowly becoming the leading stock exchange in terms of technology, systems and practices in due course of time. NSE is the largest and most modern stock exchange in India. In addition, it is the third largest exchange in the world next to two exchanges operating in the USA. • The NSE boasts of screen based trading system. In the NSE, the available system provides complete market transparency of trading operations to both trading members and the participates and finds a suitable match.
  17. Cont… Over The Counter Exchange of India OTCEI The OTCEI was incorporated in October, 1990 as a Company under the Companies Act 1956. It became fully operational in 1992 with opening of a counter at Mumbai. It is recognised by the Government of India as a recognised stock exchange under the Securities Control and Regulation Act 1956. It was promoted jointly by the financial institutions like UTI, ICICI, IDBI, LIC, GIC, SBI, IFCI, etc
  18. DERIVATIVE MARKET • A derivative is an instrument which derives its value from an underlying asset. They have no independent value, so its value depends on the underlying asset. The underlying asset may be a commodity or a security. When a person buys derivative, he buys only a contract and not assets. If it is a commodity it is called commodity derivative, if it is a security it is called financial derivative.
  19. 2: money market • Money Market: it refers to the market where money and highly liquid marketable securities are bought and sold having a maturity period of one or less than one year. • Money Market is the market for short term funds i.e. for a period up to one year. • The money market is a mechanism that deals with the lending and borrowing of short term funds (less than one year). • It doesn’t actually deal in cash or money but deals with substitute of cash like trade bills, promissory notes & govt. papers which can converted into cash without any loss at low transaction cost. • It includes all individual, institution and intermediaries.
  20. The major functions of money market • To maintain monetary equilibrium. It means to keep a balance between the demand for and supply of money for short term monetary transactions. • To promote economic growth. Money market can do this by making funds available to various units in the economy such as agriculture, small scale industries, etc. • To provide help to Trade and Industry. Money market provides adequate finance to trade and industry. Similarly it also provides facility of discounting bills of exchange for trade and industry. • To help in implementing Monetary Policy. It provides a mechanism for an effective implementation of the monetary policy. • To help in Capital Formation. Money market makes available investment avenues for short term period. It helps in generating savings and investments in the economy.
  21. Types of money M • there are two sectors of money market. The organised sector and unorganised sector. The organised sector is within the direct purview of RBI regulations. The unorganised sector consist of indigenous bankers, money lenders, non-banking financial institutions etc.
  22. 1: ORGANISED MONEY MARKET • The RBI is the apex institution which controls and monitors all the organizations in the organized sector. The commercial banks can operate as lenders and operators. The FIs like IDBI, ICICI, and others operate as lenders. • Main constituents/components of Organised Money Market: Call and Short Notice Money Market Treasury Bills  Commercial Paper Commercial Bills Certificate of Deposits All these discussed in third unit
  23. 2:UNORGANISED MONEY MARKET • The unorganised money market mostly finances short term financial needs of farmers and small businessmen. • in rural areas there is continuance of unorganised, informal and indigenous sector. The unorganised money market mostly finances short-term financial needs of farmers and small businessmes • The main constituents of unorganised Money market are: 1. Indigenous Bankers (IBs): The IBs are individuals or private firms who receive deposits and give loans and thereby they operate as banks. Unlike moneylenders who only lend money, IBs accept deposits as well as lend money. They operate mostly in urban areas, especially in western and southern regions of the country.
  24. Cont • 2. Money Lenders (MLs): MLs are important participants in unorganised money markets in India. There are professional as well as non professional MLs. They lend money in rural areas as well as urban areas. They normally charge an invariably high rate of interest ranging between 15% p.a. to 50% p.a. and even more. The borrowers are mostly poor farmers, artisans, petty traders, manual workers and others who require short term funds and do not get the same from organised sector. • 3) Non – Banking Financial Companies (NBFCs) They consist of :-  a. Chit Funds Chit funds are savings institutions. It has regular members who make periodic subscriptions to the fund. The beneficiary may be selected by drawing of lots. Chit fund is more popular in Kerala and Tamilnadu. Rbi has no control over the lending activities of chit funds.  b. Nidhis :- Nidhis operate as a kind of mutual benefit for their members only. The loans are given to members at a reasonable rate of interest. Nidhis operate particularly in South India.
  25. Cont… • 4. Finance Brokers: They act as middlemen between lenders and borrowers. They charge commission for their services. They are found mostly in urban markets, especially in cloth markets and commodity markets. • 5. Finance Companies: They operate throughout the country. They borrow or accept deposits and lend them to others. They provide funds to small traders and others. They operate like indigenous bankers.
  26. 2:financial institution • A financial institution is an institution which collects funds from the public and places them in financial assets, such as deposits ,loans, and bonds, rather than tangible property. • Financial institutions act as financial intermediaries because they act as middlemen between savers and borrowers. Financial Institutions in India are divided in two categories as: 1: regulatory institutions 2: intermediaries
  27. 1: regulatory institutions • in India, the financial system is regulated with the help of independent regulators, associated with the field of insurance, banking, commodity market, and capital market and also the field of pension funds. On the other hand, the Indian Government is also known for playing a significant role in controlling the field of financial security and also influencing the roles of such mentioned regulators. Regulatory agencies of India are as: • Securities and Exchange Board of India(SEBI) • National Stock Exchange(NSE) • Bombay Stock Exchange (BSE) • Reserve Bank of India(RBI) • Major Financial Institutions in India • Foreign Investment Promotion Board
  28. 2: financial intermediaries • A financial intermediary is a financial institution such as bank, building society, insurance company, investment bank or pension fund. A financial intermediary offers a service to help an individual/ firm to save or borrow money. A financial intermediary helps to facilitate the different needs of lenders and borrowers. • Examples of Financial Intermediaries are: • 1. Insurance Companies • 2. Financial Advisers • 3. Credit Union. • 4. Mutual funds/ Investment trusts
  29. These financial institutions may be : 1) Banking 2) Non-Banking 1: Banking institutions a) Banking institutions Banking institutions in India can be broadly classified under two heads — • commercial banks • co-operative banks
  30. 1) Commercial Banks • Commercial Banks are those profit seeking institutions which accept deposits from general public and advance money to individuals like household, entrepreneurs, businessmen etc. with the prime objective of earning profit in the form of interest, commission etc. Examples of commercial banks – ICICI Bank, State Bank of India, Axis Bank, and HDFC Bank
  31. Of commercial banks
  32. 2: co-operative banks • The co-operative banks are small-sized units which operate both in urban and non-urban centers. They finance small borrowers in industrial and trade sectors besides professional and salary classes. Regulated by the Reserve Bank of India, they are governed by the Banking Regulations Act 1949 and banking laws (co-operative societies) act, 1965.
  33. co-operative banking structure in India is divided into following 5 categories: • Primary Co-operative Credit Society • Central Co-operative Banks • State Co-operative Banks • Land Development Banks • Urban Co-operative Banks FUNCTIONS OF CO-OPERATIVE BANK • Co-operative Banks are organised and managed on the principal of co-operation, self-help, and mutual help. They work on the basis of “no profit no loss”. Profit maximization is not their goal. • Co-operative bank do banking business mainly in the agriculture and rural sector. However, UCBs, SCBs, and CCBs operate in semi urban, urban, and metropolitan areas also.
  34. Cont • Regional Rural Banks are local level banking organizations operating in different States of India. • They provide banking services and credit to small farmer, entrepreneurs and weaker sections in the rural areas. • Indigenous Bankers (IBs): The IBs are individuals or private firms who receive deposits and give loans and thereby they operate as banks. Unlike moneylenders who only lend money, IBs accept deposits as well as lend money. They operate mostly in urban areas, especially in western and southern regions of the country. • Money lenders: Money lenders are not bankers their business is money lending only. i.e. a pure money lender lends money from his own fund.
  35. 2: Non Banking Institutions • Non-banking financial companies (NBFCs) are fast emerging as an important segment of Indian financial system. It is an heterogeneous group of institutions (other than commercial and co-operative banks) performing financial intermediation in a variety of ways, like accepting deposits, making loans and advances, leasing, hire purchase, etc. • They raise funds from the public, directly or indirectly, and lend them to ultimate spenders. • The working and operations of NBFCs are regulated by the Reserve Bank of India (RBI)within the framework of the Reserve Bank of India Act, 1934 (Chapter III B) and thedirections issued by it under the Act.
  36. Function of (NBFCs) 1. Financial Intermediation: • The most important function of the non-bank financial intermediaries is the transfer of funds from the savers to the investors. 2. Economic Basis of Financial Intermediation: • Handling of funds by financial intermediaries is more economical and more efficient than that by the individual wealth owners because of the fact that financial intermediation is based on • (a) the law of large numbers, and • (b) economies of scale in portfolio management. 3. Inducement to Save: • Non-bank financial intermediaries play an important role in promoting savings in the country 4. Investment of Funds: • The main objective of NBFIs is to earn profits by investing the mobilised savings. For this purpose, these institutions follow different investment policies.
  37. Non Banking Institutions divided into two parts: a) Organized Financial Institutions b) Unorganized Financial Institutions Organized Financial Institutions: these institutions are • 1) Investment Institutions. • 2) Development Finance Institutions 1) Investment Institutions – LIC, GIC, UTI mobilize savings of public at large through various schemes and invest there funds in corporate and government securities.
  38. 1) Development banks Development banks are specialized financial institutions. They provide medium and long- term finance to the industrial and agricultural sector. They provide finance to both private and public sector. Development banks are multipurpose financial institutions. They do term lending, investment in securities and other activities. They even promote saving and investment habit in the public.
  39. Cont… b) Unorganized Financial Institutions • It includes NBFCs providing whole range of financial services. • These include hire purchase and consumer finance companies, housing finance companies, factoring companies, credit rating agencies, merchant banking companies etc.
  40. Credit rating agencies •
  41. credit rating agencies • A credit rating agency (CRA, also called a ratings service) is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely interest payments and the likelihood of default. • The credit rating agencies in India mainly include ICRA, CARE and CRISIL. main function is to grade the different sector and companies in terms of performance and offer solutions for up gradation IMPORTANCE OF CREDIT RATING  To compare the loan on the basis of quality of credit and loan.  Credit rating agencies also assist to portfolio monitoring.  Credit Rating Credit quality of transparency.  Credit rating of money market securities. -
  42. CRISIL(Credit Rating Information Services of India Limited ). • CRISIL is the largest credit rating agency in India. It was established in 1987. The world’s largest rating agency Standard & Poor's now holds majority stake in CRISIL. Till date it has rated more than 5178 SMEs across India and has issued more than 10,000 SME ratings.
  43. ICRA ICRA( investment information and credit rating agency Limited). • ICRA was established in 1991 by leading Indian financial institutions and commercial banks. International credit rating agency, Moodys, is the largest shareholder. ICRA has a dedicated team of professionals for the MSME sector and has developed a linear scale for MSME sector which makes the benchmarking with peers easier. The company changed its name to ICRA Limited, and went public on 13 April 2007, with a listing on the Bombay Stock Exchange and the National Stock Exchange
  44. CARE Incorporated in 1993, Credit Analysis and Research Limited (CARE) is a credit rating, research and advisory committee promoted by Industrial Development Bank of India (IDBI), Canara Bank, Unit Trust of India (UTI) and other financial and lending institutions. CARE has completed over 7,564 rating assignments since its inception in 1993.
  45. Investment Institutions: LIC and GIC LIC Life Insurance Corporation of India (LIC) was established in 1956 to spread the message of life insurance in the country and to mobilise people's savings for nation-building activities. (LIC) is the biggest provider of insurance and investment services in India. It is a publicly held organization held totally by the Union Government of India and also provides almost 24.6 percent of the government’s expenses. Its assets have been valued at INR 13.25 trillion. It was established when 243 provident societies and insurers merged together.
  46. Function if LIC • (a)to carry on capital redemption business, annuity certain business or reinsurance business in so far as such reinsurance business relating to life insurance business; • (c) to acquire, hold and dispose of any property for the purpose of its business; • (d) to transfer the whole or any part of the life insurance business carried on outside India to any other person or persons, if in the interest of the Corporation it is expedient so to do; • (e) to advance or lend money upon the security of any movable or immovable property or otherwise; • (f) to borrow or raise any money in such manner and upon such security as the Corporation may think fit;
  47. GIC • General Insurance Corporation of India. • The General Insurance Corporation (GIC) was formed by Central Government in 1972. With effect from January 1, 1973 the erstwhile 107 Indian and foreign insurance companies who were operating in the country prior to nationalisation, were grouped into four operating companies, namely, • (a) National Insurance Company Limited. • (b) New India Assurance Company Limited. • (c) Oriental Insurance Company Limited. • (d) United Insurance Company Limited The General Insurance business has grown in spread and volume after nationalization. The tour companies have 2, 699 branch offices, 1,360 divisional offices and 92 regional offices spread all-over the country.
  48. mutual fund The Definition A mutual fund is nothing more than a collection of stocks and/or bonds. You can think of a mutual fund as a company that brings together a group of people and invests their money in stocks, bonds, and other securities. Each investor owns shares, which represent a portion of the holdings of the fund. We can say that Mutual Fund is trusts which pool the savings of large number of investors and then reinvests those funds for earning profits and then distribute the dividend among the investors.
  49. Advantages of Mutual Funds Portfolio diversification: • It enables him to hold a diversified investment portfolio even with a small amount of investment like Rs. 2000/-. Professional management: • The investment management skills, along with the needed research into available investment options, ensure a much better return as compared to what an investor can manage on his own. Reduction/Diversification of Risks: • The potential losses are also shared with other investors Reduction of transaction costs: • The investor has the benefit of economies of scale; the funds pay lesser costs because of larger volumes and it is passed on to the investors. Wide Choice to suit risk-return profile: • Investors can chose the fund based on their risk tolerance and expected returns.
  50. Advantages of Mutual Funds Liquidity: • Investors may be unable to sell shares directly, easily and quickly. When they invest in mutual funds, they can cash their investment any time by selling the units to the fund if it is open-ended and get the intrinsic value. Investors can sell the units in the market if it is closed ended fund. Convenience and Flexibility: • Investors can easily transfer their holdings from one scheme to other, get updated market information and so on. Funds also offer additional benefits like regular investment and regular withdrawal options. Transparency: • Fund gives regular information to its investors on the value of the investments in addition to disclosure of portfolio held by their scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook
  51. Different Types and Mutual Funds • Open-Ended - This scheme allows investors to buy or sell units at any point in time. This does not have a fixed maturity date. • Closed-Ended - In India, this type of scheme has a stipulated maturity period and investors can invest only during the initial launch period known as the NFO (New Fund Offer) period. • Interval - Operating as a combination of open and closed ended schemes, it allows investors to trade units at pre-defined intervals.
  52. Special Financial Institutions: IDBI, IFCI, SFCs, ICICI and EXIM bank of India •
  53. IDBI (Industrial Development Bank of India ) • IDBI was established as a wholly-owned subsidiary of RBI under the Industrial Development Act of Parliament on 1st July 1964 • In Feb 1976, ownership of IDBI was transferred to Govt. Of India. Currently GOI has 52.3% shareholding in IDBI. • IDBI has set up institutions like NSE of India, National Securities Depository Services Ltd (NSDSL) & the Stock Holding Corporation of India (SHCIL). • It is currently the 10th largest Development Bank in the world in terms of reach and India’s largest Financial Institution
  54. Need of IDBI • a) Provide credit and long-term financing requirements of industry and agriculture. • b) Coordinate activities of institutions engaged in financing, promoting and developing the Indian industry. • c) Development of backward areas. • d) Modernization • e) Entrepreneurship development programmes, provision of TCOs for small and medium enterprises, up gradation of technology and programmes for economic upliftment of the underprivileged.
  55. I.F.C.I • In 1948, the Government of India set up Industrial Finance Corporation of India (I.F.C.I) with a view of providing medium and long term credits/loans to industrial concerns, particularly in such circumstances where normal banking accommodation is inappropriate or recourse to capital issue methods is impracticable. • Fifty per cent of the share capital of the IFCI is held by the IDBI and the remaining 50 per cent is held by commercial and co-operative banks.
  56. major functions of the IFCI: • 1. To guarantee loans raised by industrial concerns; • 2. To grant loans and advances to or subscribe to the debentures of industrial concerns; • 3. To underwrite the issue of stocks, shares, bonds or debentures by industrial concerns; • 4. To extend guarantee in respect of deferred payments by importers; • 5. To subscribe directly to the stock or shares of any industrial concern.
  57. SFCs(STATE FINANCIAL CORPORATION OF INDIA) • A Central Industrial Finance corporation was set up under the industrial Finance corporations Act, 1948 in order to provide medium and long term credit to industrial undertakings which fall outside normal activities of commercial banks. • In order to meet the financial requirements of small scale and medium-sized industries, there was a need of special financial institutions. With this view, the Central Government passed the State Financial Corporation Act which empowered the state government to establish financial corporation to operate within the state. So far (till now) 18 state financial corporation have been established in different states.
  58. Functions of SFCs • (i) To provide loans for a period not exceeding 20 years to industrial units. • (ii) To underwrite the issue of shares, debentures and bonds for a period not exceeding 20 years of industrial units. • (iii) To give guarantee to loans taken by industrial units for a period not exceeding 20 years. • (iv) to make payment of capital goods purchased in India by these industrial units. • (v) To subscribe to the share capital of the industrial units, in case they wish to raise additional capital. • (vi) To do all such acts as may be incidental of its duties under this Act.
  59. ICICI – Industrial Credit and Investment Corporation of India • ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian financial institution, and was its wholly-owned subsidiary. • ICICI offers a wide range of banking products and financial services to corporate and retail customers in the areas of investment banking, life insurance and asset management. Broad objectives of the ICICI are: • (a) to assist in the creation, expansion and modernisation of private concerns; • (b) to encourage the participation of internal and external capital in the private concerns; • (c) to encourage private ownership of industrial investment.
  60. Functions of ICICI • (i) It provides long-term and medium-term loans in rupees and foreign currencies. • (ii) It participates L* the equity capital of the industrial concerns. • (iii) It underwrites new issues of shares and debentures. • (iv) It guarantees loans raised by private concerns from other sources. • (v) It provides technical,managerial and administrative assistance to industrial concerns.
  61. EXIM bank • Export-Import Bank of India is the premier export finance institution in India, established in 1982 under the Export-Import Bank of India Act 1981 ,for the purpose of financing, facilitating and promoting Indian's 'foreign trade. • The primary objective of the Export-Import Bank of India is to provide financial assistance to importers and exporters and function as the top financial institution. Some of the services of the bank include: overseas investment finance, film finance, export credit, finance for export oriented units and agricultural & SME finance
  62. functions of Exim Bank include: • (a) Planning, promoting and developing exports and imports; • (b) Providing technical, administrative and managerial assistance for promotion, management and expansion of exports; and • (c) Undertaking market and investment surveys and techno-economic studies related to development of exports of goods and services.
  63. Financial Instruments/Assets , securities • The transfer of available funds takes place through the buying and selling of financial instruments or securities. • A financial instrument is the written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under certain conditions. • A document (such as a check, draft, bond, share, bill of exchange, futures or options contract) that has a monetary value or represents a legally enforceable (binding) agreement between two or more parties regarding a right to payment of money is called Financial Instruments.
  64. Two types of Instruments 1: Instruments traded in money market  Treasury Bills  Call/ Notice money  Commercial Paper  Certificate of Deposits  Commercial Bills. 2: Instruments traded in Capital Market:  Equity/ Ordinary Shares  Preference shares  Debentures  Bonds
  65. 1: Instruments traded in money market  T-Bills – These are the most liquid money market instrument. They are issue by the government. Most common maturities are 90 days, 180 days and 360 days. • T-bills (and other Treasuries) are considered to be the safest investments in the financial market because governments back them.  Commercial Paper - is short-term loan that is issued by a corporation use for financing accounts receivable and inventories. • an unsecured, short-term loan issued by a corporation, typically for financing accounts receivable and inventories. It is usually issued at a discount, reflecting current market interest rates. Maturities on commercial paper are usually no longer than nine months, with maturities of between one and two months being the average. • The characteristics of CDs and CPs are similar except that CDs are issued by the commercial banks.
  66. Cont Commercial Bills • a bill of exchange issued by a commercial organization to raise money for short-term needs. • Commercial bill is a short term, negotiable, and self-liquidating instrument with low risk. • Written instrument containing an unconditional order. • Once the buyer signifies his acceptance on the bill itself it becomes a legal document.
  67. Cont  Call /Notice-Money Market • Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is & quot; Notice Money". No collateral security is required to cover these transactions.  Certificate of Deposit: The certificates of deposit are basically time deposits that are issued by the commercial banks with maturity periods ranging from 3 months to five years. • Its same like Treasury Bills but The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk.
  68. 2: Instruments traded in Capital Market: • Capital Market Instruments The capital market generally consists of the following long term period i.e., more than one year period, financial instruments; In the equity segment Equity shares, preference shares, convertible preference shares, non- convertible preference shares etc and in the debt segment debentures, zero coupon bonds, deep discount bonds etc.
  69. When the instrument is issued by: • The Federal Government, it is called a Sovereign Bond; • • A state government it is called a State Bond; • • A local government, it is called a Municipal Bond; and • • A corporate body (Company), it is called a Debenture, Industrial Loan or Corporate Bond
  70. Equity/ Ordinary Shares  Equities are a type of security that represents the ownership in a company. Equities are traded (bought and sold) in stock market.  These shares are the most commonly traded shares, and they give you a vote in company matters.  Ordinary shares have no special rights or restrictions.  Equity share can be defined as the share, which is not preference shares. In other words equity shares are those shares, which do not have the following preferential rights:  (a) Preference of dividend over others.  (b) Preference for repayment of capital over others at the time of winding up of the company.
  71. FEATURES OF EQUITY SHARES • It is a financial instrument through which it bestows ownership rights to the investor in the company. • The owner has a right on the profits and on the company’s assets in case of liquidation of the company. • They have voting rights in the company. • They are distributed the surplus of profits after the interest is settled, taxes paid and depreciation provided and preference shareholders are cleared. • The financial standing, its progress and strategies for growth of the company determines the share prices. • These equity shares can be bought at the stock exchange, through stock brokers, online brokers and sometimes in banks and
  72. Types of Equity • Blue Chip Shares: These are the shares of companies which are well established and reputed in all fields. The Blue Chip companies include Reliance, ONGC, NTPC, SBI, ICICI, Tata Steels, Wipro, and a few others. The market capital of these companies is very high and scrips influence the Sansex and Nifty movement. • Income Shares: These companies have a stable share value and always pay high dividends. Since they have highdividend payout ratio, the profits of the company saved are less and so their growth opportunities are very less. • Growth Shares: These are shares of companies which are on top in their industry like Wipro in Computers, Tatas in steel, Bajaj in automobiles etc. The shares here have less dividend payout and so their growth rate is high.
  73. Cont… • Cyclical Shares: Some company’s performance keeps fluctuating like a business cycle meaning the share prices are affected with any variations in the economy. Sugar and fertiliser are two such industries. • Defensive Shares: The shares of these companies are not affected by the economical changes. • Speculative Shares: The shares here are traded on speculations. These shares are high risk in nature but also give very high returns in short terms. The scrips fall sharply suddenly so investors should always keep an eye on it always.
  74. Advantages of equity shares: • 1. Equity shares do not create any obligation to pay a fixed rate of dividend. • 2. Equity shares can be issued without creating any charge over the assets of the company. • 3. It is a permanent source of capital and the company has to repay it except under liquidation. • 4. Equity shareholders are the real owners of the company who have the voting rights. • 5. In case of profits, equity shareholders are the real gainers by way of increased dividends and appreciation in the value of shares.
  75. Disadvantages of equity shares • 1. If only equity shares are issued, the company cannot take the advantage of trading on equity. • 2. As equity capital cannot be redeemed, there is a danger of over capitalization. • 3. Equity shareholders can put obstacles for management by manipulation and organizing themselves. • 4. During prosperous periods higher dividends have to be paid leading to increase in the value of shares in the market and it leads to speculation. • 5. Investors who desire to invest in safe securities with a fixed income have no attraction for such shares.
  76. Preference shares •
  77. Features of Preference Shares: • 1. Preference shares are long-term source of finance. • 2. The dividend payable on preference shares is generally higher than debenture interest. • 3. Preference shareholders get fixed rate of dividend irrespective of the volume of profit. • 4. It is known as hybrid security because it also bears some characteristics of debentures. • 5. Preference dividend is not tax deductible expenditure. • 6. Preference shareholders do not have any voting rights. • 7. Preference shareholders have the preferential right for repayment of capital in case of winding up of the company. • 8. Preference shareholders also enjoy preferential right to receive dividend.
  78. Advantages of Preference Shares: • (a) The earnings per share of existing preference shareholders are not diluted if fresh preference shares are issued. • (b) Issue of preference shares increases the earnings of equity shareholders, i.e. it has a leveraging benefit. • (c) Preference shareholders do not have any voting rights and hence do not affect the decision making of the company. • (d) Preference dividend is payable only if there is profit.
  79. Disadvantages of Preference Shares: • (a) Preference dividend is not tax deductible and hence it is costlier than a debenture. • (b) In case of cumulative preference share, arrear dividend is payable when the company earns profit, which creates a huge financial burden on the company. • (c) Redemption of preference share again creates financial burden and erodes the capital base of the company. • (d) Preference shareholders get dividend at a constant rate and it will not increase even if the company earns a huge profit, which makes this form of finance less attractive • (e) Preference shareholders do not enjoy the voting rights and hence their fate is decided by the equity shareholders.
  80. Different Types of Preference Shares: Preference share may be classified under following categories: • i. According to Redeemability: • ii. According to Right of Receiving Dividend: • iii. According to Participation: • iv. According to Convertibility:
  81. i. According to Redeemability: Redeemable Preference Shares: • Redeemable preference shares are those shares which are redeemed or repaid after the expiry of a stipulated period. Irredeemable Preference Shares: • Irredeemable preference shares are those shares which are not redeemed before a stipulated period. It does not have a specific maturity date. Such shares are redeemed at the time of liquidation of the company
  82. ii. According to Right of Receiving Dividend: a. Cumulative Preference Shares: • Preference dividend is payable if the company earns adequate profit. However, cumulative preference shares carry additional features which allow the preference shareholders to claim unpaid dividends of the years in which dividend could not be paid due to insufficient profit. b. Non-cumulative Preference Shares: • The holders of non-cumulative preference shares will get preference dividend if the company earns sufficient profit but they do not have the right to claim unpaid dividend which could not be paid due to insufficient profit.
  83. iii. According to Participation: a. Participating Preference Shares: • Participating preference shareholders are entitled to share the surplus profit of the company in addition to preference dividend. Surplus profit is calculated by deducting preference dividend and equity dividend from the distributable profit. b. Non-participating Preference Shares: • Non-participating preference shareholders are not entitled to share surplus profit and surplus assets like participating preference shareholders.
  84. iv. According to Convertibility: a. Convertible Preference Shares: • The holders of convertible preference shares are given an option to convert whole or part of their holding into equity shares after a specific period of time. b. Non-convertible Preference Shares: • The holders of non-convertible preference shares do not have the option to convert their holding into equity shares i.e. they remain as preference share till their redemption
  85. Debentures • If a company needs funds for extension and development purpose without increasing its share capital, it can borrow from the general public by issuing certificates for a fixed period of time and at a fixed rate of interest. Such a loan certificate is called a debenture. Debentures are offered to the public for subscription in the same way as for issue of equity shares. Debenture is issued under the common seal of the company acknowledging the receipt of money . • Debentures are creditor ship securities representing long-term indebtedness of a company.
  86. Features of Debentures: • The important features of debentures are as follows: • 1. Debenture holders are the creditors of the company carrying a fixed rate of interest. • 2. Debenture is redeemed after a fixed period of time. • 3. Debentures may be either secured or unsecured. • 4. Interest payable on a debenture is a charge against profit and hence it is a tax deductible expenditure. • 5. Debenture holders do not enjoy any voting right. • 6. Interest on debenture is payable even if there is a loss.
  87. Advantage of Debentures: • Following are some of the advantages of debentures: • (a) Issue of debenture does not result in dilution of interest of equity shareholders as they do not have right either to vote or take part in the management of the company. • (b) Interest on debenture is a tax deductible expenditure and thus it saves income tax. • (c) Cost of debenture is relatively lower than preference shares and equity shares. • (d) Issue of debentures is advantageous during times of inflation. • (e) Interest on debenture is payable even if there is a loss, so debenture holders bear no risk.
  88. Disadvantages of Debentures: • Disadvantages of Debentures: • (a) Payment of interest on debenture is obligatory and hence it becomes burden if the company incurs loss. • (b) Debentures are issued to trade on equity but too much dependence on debentures increases the financial risk of the company. • (c) Redemption of debenture involves a larger amount of cash outflow. • (d) During depression, the profit of the company goes on declining and it becomes difficult for the company to pay interest.
  89. The major types of debentures are as follows: 1.Types Of Debentures On The Basis Of Record Point Of View. 2. Types Of Debentures On The Basis Of Security. 3. Types Of Debentures On The Basis Of Redemption. 4. Types Of Debentures On The Basis Of Convertibility. 5. Types Of Debentures On The Basis Of Priority.
  90. 1.Types Of Debentures On The Basis Of Record Point Of View • a. Registered Debentures These are the debentures that are registered with the company. The amount of such debentures is payable only to those debenture holders whose name appears in the register of the company. b. Bearer Debentures These are the debentures which are not recorded in a register of the company. Such debentures are transferable merely by delivery. Holder of bearer debentures is entitled to get the interes
  91. 2. Types Of Debentures On The Basis Of Security • a. Secured Or Mortgage Debentures These are the debentures that are secured by a charge on the assets of the company. These are also called mortgage debentures. The holders of secured debentures have the right to recover their principal amount with the unpaid amount of interest on such debentures out of the assets mortgaged by the company. b. Unsecured Debentures. Debentures which do not carry any security with regard to the principal amount or unpaid interest are unsecured debentures. These are also called simple debentures.
  92. 3. Types Of Debentures On The Basis Of Redemption • a. Redeemable Debentures These are the debentures which are issued for a fixed period. The principal amount of such debentures is paid off to the holders on the expiry of such period. These debentures can be redeemed by annual drawings or by purchasing from the open market. b. Non-redeemable Debentures These are the debentures which are not redeemed in the life time of the company. Such debentures are paid back only when the company goes to liquidation. ،‫اخيستل‬ ‫بيا‬
  93. 4. Types Of Debentures On The Basis Of Convertibility • a. Convertible Debentures These are the debentures that can be converted into shares of the company on the expiry ofpre-decided period. The terms and conditions of conversion are generally announced at the time of issue of debentures. b. Non-convertible Debentures The holders of such debentures can not convert their debentures into the shares of the company. 5. Types Of Debentures On The Basis Of Priority • a. First Debentures These debentures are redeemed before other debentures. b. Second Debentures These debentures are redeemed after the redemption of first debentures.
  94. Bonds • A long term contract under which a borrower agrees to make payments of interest and principal on specific date, to the holders of the bond • Bonds are fixed income instruments which are issued for the purpose of raising capital. Both private entities, such as companies, financial institutions, and the central or state government and other government institutions use this instrument as a means of garnering funds. Bonds issued by the Government carry the lowest level of risk but could deliver fair returns.
  95. Advantages of Bonds • The main advantage of issuing bonds is that you do not have to share profits. Your costs are fixed, and as long as you can cover the debt servicing, you get to keep the rest. Additionally, once the bond is paid off, you have no further obligation to the bondholder. Your payments are temporary. Also, no matter how much you borrow, you will still maintain executive control of your company. There is no tax consequence to borrowing money, unless the loan is eventually forgiven.
  96. Bond Features 1: Term to maturity: of years until the bond expires : Usually just called “term” or “maturity.” • Bond terms: • Short term: 1 to 5 years. • Intermediate term: 5 to 12 years. • Long term: > 12 years. 2: Principal amount • The amount the issuer agrees to repay to bondholders at the maturity date. • Also commonly called: face value, par value, maturity value. 3: Coupon Rate: the annual interest rate the issuer agrees to pay on the face value (principal). The coupon is the annual amount the issuer promises to pay (in RS):
  97. CONT,, • 4: Amortization: The principal on a bond can be paid two ways: • Paid all at once at expiration (“bullet” maturity). • Paid little-by-little over the life of the bond according to a schedule (amortizing). • 5: Embedded Options: Convertible bond – gives bondholders the right to exchange the bond for a specified number of shares of common stock. • This is advantageous to investors if firm’s stock price goes up. • Exchangeable bond – allows bondholders to exchange the bond for a specified number of shares of common stock of another firm.
  98. Types of Bonds 1:Corporate bonds. represent money borrowed by a corporation or institution • A corporate bond is a bond issue by a corporation.• It is a bond that a corporation issues to raise money effectively in order to expand its business.• The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. (The term "commercial paper" is sometimes used for instruments with a shorter maturity.) Generally, a short-term corporate bond is less than five years; intermediate is five to 12 years, and long term is over 12 years. 1: Corporate bonds. 2: Municipal bonds. 3: Zero coupon bonds.
  99. Municipal bonds. • DEBT issued by states, counties, cities and local government authorities. When you purchase a municipal bond, you are lending money to a state or local government entity, which in turn promises to pay you a specified amount of interest (usually paid semiannually) and return the principal to you on a specific maturity date •
  100. Zero coupon bonds • a bond that is issued at a deep discount to its face value but pays no interest. • Zero-coupon bonds don't make interest payments. Instead, they are issued at a discount to face value and mature at face value. For example, a bond with a face value of $1000 might be issued at a price of 50 cents on the dollar. The yield is a function of the purchase price, the face value and the time remaining till maturity. Because zero-coupon bonds provide no cash flow prior to maturity, their duration is equal to their maturity
  101. IPO • If a brand new company or a company already in existence, but with no shares listed on the stock exchange, decides to invite the public to buy its shares, it is called an Initial Public Offering or an IPO. • The first sale of stock by a company to the public. Companies offering an IPO are sometimes new, young companies, or sometimes companies which have been around for many years but are finally deciding to go public. IPOs are often risky investments, but often have the potential for significant gains. IPOs are often used as a way for a young company to gain necessary market capital
  102. Book building • Book building is actually a price discovery method. In this method, the company doesn't fix up a particular price for the shares, but instead gives a price range, e.g. Rs 80-100. When bidding for the shares, investors have to decide at which price they would like to bid for the shares, for e.g. Rs 80, Rs 90 or Rs 100. They can bid for the shares at any price within this range. Based on the demand and supply of the shares, the final price is fixed. The lowest price (Rs 80) is known as the floor price and the highest price (Rs 100) is known as cap price.
  103. Underwriters • An underwriter to the issue could be a banker, broker, merchant banker (see below) or a financial institution. They give a commitment to underwrite the issue. • Underwriting means they will subscribe to the balance shares if all the shares offered at the IPO are not picked up. • Suppose there is an issue is for Rs 100 crore (Rs 1 billion) and subscriptions are received only for Rs 80 crore (Rs 800 million). It is then left to the underwriters to pick up the balance Rs 20 crore (Rs 200 million). • If underwriters don't pay up, SEBI will cancel their licenses.
  104. Modes of procuring Long term funds: • Public issue, • Right issue • private placement
  105. Rights issue
  106. Private Placement • In a private placement, you sell equity shares of your business to a select group of investors.
  107. Public issue, • When shares, bonds etc are made available for anyone to buy. • Public issue means raising funds from public. Promoters of the Company may have plans for the Company, which may require infusion of money. The main purpose of the public issue, amongst others, is to raise money through public and get its shares listed at any of the recognized stock exchanges in India.
  108. Unit 5-Financial Regulatory mechanism •
  109. Regulatory agencies • in India, the financial system is regulated with the help of independent regulators, associated with the field of insurance, banking, commodity market, and capital market and also the field of pension funds. On the other hand, the Indian Government is also known for playing a significant role in controlling the field of financial security and also influencing the roles of such mentioned regulators. Regulatory agencies of India are as: • Securities and Exchange Board of India(SEBI) • National Stock Exchange(NSE) • Bombay Stock Exchange (BSE) • Reserve Bank of India(RBI) • IRDA • Foreign Investment Promotion Board
  110. RBI • The Reserve Bank of India is India's central bank. It is the apex monetary institution which supervise, regulates controls and develops the monetary and financial system of the country. The Reserve bank was established on April 1, 1935 under the Reserve Bank of India Act, 1934. Initially, it was constituted as a private share- holders* bank with a fully paid-up capital of Rs. 5 crore. But, it was nationalised on January 1, 1949.
  111. Role of RBI • As a central bank, the Reserve Bank has significant powers and duties to perform. For smooth and speedy progress of the Indian Financial System, it has to perform some important tasks. Among others it includes maintaining monetary and financial stability, to develop and maintain stable payment system, to promote and develop financial infrastructure and to regulate or control the financial institutions.
  112. Main objectives of RBI • To manage the monetary and credit system of the country. * To stabilizes internal and external value of rupee. * For balanced and systematic development of banking in the country. * For the development of organized money market in the country. * For proper arrangement of agriculture finance. * For proper arrangement of industrial finance. * For proper management of public debts. * To establish monetary relations with other countries of the world and international financial institutions. * For centralization of cash reserves of commercial banks. * To maintain balance between the demand and supply of currency.
  113. functions of the Reserve Bank Issue of Currency Notes: • The RBI has the sole right or authority or monopoly of issuing currency notes except one rupee note and coins of smaller denomination. Banker to Government: • As banker to the government the Reserve Bank manages the banking needs of the government. It has to-maintain and operate the government’s deposit accounts. It collects receipts of funds and makes payments on behalf of the government,. RBI as Banker of Banks: • RBI is bank of all banks in India. The other banks keep their current accounts with RBI and RBI helps them in maintaining statutory reserves with itself. RBI as a regulator and supervisor of financial system • One of the most important functions of RBI is to work as regulator and supervisor of financial system. Management of foreign exchange reserves . Developmental & Promotional roles . Granting license to banks.
  114. (SEBI) • Securities Exchange Board of India (SEBI) was set up in 1988 to regulate the functions of securities market. AND in May 1992, SEBI was granted legal status by the government . SEBI is a body corporate having a separate legal existence and perpetual succession. • Purpose and Role of SEBI: • SEBI was set up with the main purpose of keeping a check on malpractices and protect the interest of investors.
  115. Objectives of SEBI: • The overall objectives of SEBI are to protect the interest of investors and to promote the development of stock exchange and to regulate the activities of stock market. The objectives of SEBI are: • 1. To regulate the activities of stock exchange. • 2. To protect the rights of investors and ensuring safety to their investment. • 3. To prevent fraudulent and malpractices by having balance between self regulation of business and its statutory regulations. • 4. To regulate and develop a code of conduct for intermediaries such as brokers, underwriters, etc.
  116. Functions of SEBI: . To meet three objectives SEBI has three important functions. These are: • i. Protective functions • ii. Developmental functions • iii. Regulatory functions.
  117. 1. Protective Functions: As protective functions SEBI performs following functions: • (i) It Checks Price Rigging: • (ii) It Prohibits Insider trading: • (iii) SEBI prohibits fraudulent and Unfair Trade Practices
  118. 2. Developmental Functions: These functions are performed by the SEBI to promote and develop activities in stock exchange and increase the business in stock exchange: • (i) SEBI promotes training of intermediaries of the securities market. • (ii) SEBI tries to promote activities of stock exchange by adopting flexible and adoptable approach in following way: • (a) SEBI has permitted internet trading through registered stock brokers. • (b) SEBI has made underwriting optional to reduce the cost of issue. • (c) Even initial public offer of primary market is permitted through stock exchange.
  119. 3. Regulatory Functions: These functions are performed by SEBI to regulate the business in stock exchange. • i) SEBI has framed rules and regulations and a code of conduct to regulate the intermediaries such as merchant bankers, brokers, underwriters, etc. • (ii) These intermediaries have been brought under the regulatory purview and private placement has been made more restrictive. • (iv) SEBI registers and regulates the working of mutual funds etc. • (v) SEBI regulates takeover of the companies. • (vi) SEBI conducts inquiries and audit of stock exchanges.
  120. IRDA • (Insurance Regulatory & Development Authority) is regulatory and development authority under Government of India in order to protect the interests of the policyholders and to regulate, promote and ensure orderly growth of the insurance industry. It is basically a ten members' team comprising of a Chairman, five full time members and four part-time members, all appointed by Government of India. This organization came into being in 1999 after the bill of IRDA was passed in the Indian parliament.
  121. Objectives of IRDA a) To protect the interests of the policyholders b) To promote, regulate and ensure orderly growth of the insurance industry and for matters connected therewith or incidental thereto c) Conduction of insurance bussinesses across India in an ethical manner.
  122. Functions and Duties of IRDA Section 14 of the IRDA Act, 1999 lays down the duties, powers and functions of IRDA. • Registering and regulating insurance companies • Protecting policyholders’ interests • Licensing and establishing norms for insurance intermediaries • Promoting professional organisations in insurance • Regulating and overseeing premium rates and terms of non-life insurance covers • Specifying financial reporting norms of insurance companies • Regulating investment of policyholders’ funds by insurance companies • Ensuring the maintenance of solvency margin by insurance companies • Ensuring insurance coverage in rural areas and of vulnerable sections of society
  123. Modern techniques of financing: Factoring  Factoring can be defined as the conversion of credit sales into cash.  Factoring is a transaction where the exporter sells its receivables to a financial institution which is usually a bank.  The Factoring institution buys the accounts receivable and pays up to 80% of the amount to a company usually a client.  Examples includes factoring against goods purchased, factoring against medical insurance, factoring for construction services etc. Forefaiting : old French word ‘forfait’, which means forfeiting or surrender of right.  is a mechanism by which the right for export receivables of an exporter (Client) is purchased by a Financial Intermediary (Forfaiter) without recourse to him.
  124. Venture capital • Venture capital is a new financial service, the emergence of which wants towards developing strategies to help a new class of new entrepreneurs to translate their business ideas into realities. • Venture Capital is “equity support to fund a new concepts that involve a higher risk and at the same time, have a high growth and profit.” • Venture Capital is broadly implies an investment of long term, equity finance in high • risk projects with high rewards possibilities.”
  125. Securitization"Securitization" refers to the process of turning assets into securities - - financial instruments that can be readily bought and sold in financial markets, the way stocks, bonds and futures contracts are traded. advantage • Improves capital structure • Extends credit pool • Reduces credit concentration • Risk management by risk transfers • Avoids interest rate risk • Improves accounting profits Example: First securitization deal in India between Citibank and GIC Mutual Fund in 1991 for Rs 160 million.