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
Role/Function of Financial System
Short term and long term needs
• 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
• 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
• Business require finance. These are made available through
banks, households and different financial institutions. They
mobilize savings which leads to Capital Formation.
• 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
Structure/Components of the Financial
s to the financial
needs of different
sectors of the
economy and the
ways and means to
meet such needs
are required for
• Financial Markets: Markets in which funds are
transferred from people who have an excess of
available funds to people who have a shortage of
Financial markets promote efficiency in economic
• 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
• 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
• 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:
functions and significance of capital
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
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
Capital Market is divided into two
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.
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
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
• Distribution Job is given to brokers and dealers. The brokers or
agents maintain direct contact with the supreme investors.
• 2. Secondary Market: Secondary market is a
place where existing shares and debentures
• It is also called as Stock Market. It facilitates
buying and selling of securities.
Functions of Secondary Markets
• Provides regular information about the value
• Helps to observe prices of bonds and their
• Offers to investors liquidity for their assets.
• Secondary markets bring together many
• It keeps the cost of transactions low.
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
Major Stock exchanges in India
• 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.
• 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.
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
• 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.
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
• 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.
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
• 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
• 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.
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.
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
• Main constituents/components of Organised Money
Call and Short Notice Money Market
Certificate of Deposits
All these discussed in third unit
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
• 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.
• 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
• 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
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.
• 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
• 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
1: regulatory institutions
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
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
These financial institutions may be :
1: Banking institutions
a) Banking institutions
Banking institutions in India can be broadly
classified under two heads —
• commercial banks
• co-operative banks
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
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,
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.
• 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.
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.
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
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.
Non Banking Institutions divided into
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.
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.
b) Unorganized Financial Institutions
• It includes NBFCs providing whole range of
• These include hire purchase and consumer
finance companies, housing finance
companies, factoring companies, credit rating
agencies, merchant banking companies etc.
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
Credit rating agencies also assist to portfolio monitoring.
Credit Rating Credit quality of transparency.
Credit rating of money market securities. -
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.
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
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.
Investment Institutions: LIC and GIC
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.
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
• (c) to acquire, hold and dispose of any property for the purpose of its
• (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;
• 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
• (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.
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.
Advantages of Mutual Funds
• It enables him to hold a diversified investment portfolio even with
a small amount of investment like Rs. 2000/-.
• 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
Wide Choice to suit risk-return profile:
• Investors can chose the fund based on their risk tolerance and
Advantages of Mutual Funds
• 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
• 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
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.
IDBI (Industrial Development Bank of
• 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
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
• 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.
• 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.
major functions of the IFCI:
• 1. To guarantee loans raised by industrial
• 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.
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.
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
• (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.
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
• 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.
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
• (iii) It underwrites new issues of shares and
• (iv) It guarantees loans raised by private concerns
from other sources.
• (v) It provides technical,managerial and
administrative assistance to industrial concerns.
• 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
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
Financial Instruments/Assets ,
• The transfer of available funds takes place through the
buying and selling of financial instruments or
• 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
• 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
Two types of Instruments
1: Instruments traded in money market
Call/ Notice money
Certificate of Deposits
2: Instruments traded in Capital Market:
Equity/ Ordinary Shares
1: Instruments traded in money
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
Commercial Paper - is short-term loan that is issued by a
corporation use for financing accounts receivable and
• 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.
• 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
• Once the buyer signifies his acceptance on the bill
itself it becomes a legal document.
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
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.
2: Instruments traded in Capital
• 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.
When the instrument is issued by:
• The Federal Government, it is called a Sovereign
• A state government it is called a State Bond;
• A local government, it is called a Municipal
• A corporate body (Company), it is called
a Debenture, Industrial Loan or Corporate Bond
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.
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
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.
• 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.
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
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.
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
• 8. Preference shareholders also enjoy preferential right
to receive dividend.
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
• (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
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
• (e) Preference shareholders do not enjoy the voting rights
and hence their fate is decided by the equity
Different Types of Preference Shares:
Preference share may be classified under following
• i. According to Redeemability:
• ii. According to Right of Receiving Dividend:
• iii. According to Participation:
• iv. According to Convertibility:
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
ii. According to Right of Receiving
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
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
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.
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
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
• 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.
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
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
• (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
• (e) Interest on debenture is payable even if there is a
loss, so debenture holders bear no risk.
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.
The major types of debentures are as
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
4. Types Of Debentures On The Basis Of
5. Types Of Debentures On The Basis Of Priority.
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
2. Types Of Debentures On The Basis
• 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.
3. Types Of Debentures On The Basis
• 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.
4. Types Of Debentures On The Basis
• 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
• 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
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.
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):
• 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
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.
• 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
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
• 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
• 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.
• 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
• 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
• In a private placement, you sell equity shares
of your business to a select group of investors.
• 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.
• 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
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)
• Foreign Investment Promotion Board
• 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.
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
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
* For the development of organized money market in the
* 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
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
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.
• 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
• Purpose and Role of SEBI:
• SEBI was set up with the main purpose of keeping
a check on malpractices and protect the interest
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
• 4. To regulate and develop a code of conduct for
intermediaries such as brokers, underwriters, etc.
Functions of SEBI:
. To meet three objectives SEBI has three
important functions. These are:
• i. Protective functions
• ii. Developmental functions
• iii. Regulatory functions.
1. Protective Functions:
As protective functions SEBI performs following
• (i) It Checks Price Rigging:
• (ii) It Prohibits Insider trading:
• (iii) SEBI prohibits fraudulent and Unfair Trade
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
• (ii) SEBI tries to promote activities of stock exchange by
adopting flexible and adoptable approach in following
• (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.
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
• (v) SEBI regulates takeover of the companies.
• (vi) SEBI conducts inquiries and audit of stock exchanges.
• (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.
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.
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
• Specifying financial reporting norms of insurance companies
• Regulating investment of policyholders’ funds by insurance
• Ensuring the maintenance of solvency margin by insurance
• Ensuring insurance coverage in rural areas and of vulnerable sections
Modern techniques of financing:
Factoring can be defined as the conversion of credit sales into
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
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.
• 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
• 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.”
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.
• Improves capital structure
• Extends credit pool
• Reduces credit concentration
• Risk management by risk transfers
• Avoids interest rate risk
• Improves accounting profits
First securitization deal in India between Citibank and GIC Mutual Fund
in 1991 for Rs 160 million.