FINANCIAL SYSTEM AND

MARKETS
Indian Financial System

Indian financial system is one of the most important

aspects of the economic development of our country.
This system manages the flow of funds between the
people of the country and the ones who may invest it
wisely for the wealth of both the parties.
The Indian financial system can also be broadly
divided in to the formal financial system (organized)
and the informal financial system (unorganized ).
Financial Markets

Refers to institutional arrangements for dealing in

financial assets and various credit instruments.

it can be Negotiated loan market and open market.

Market where entities can trade financial securities,

commodities, at low transaction costs and at prices
that reflect supply and demand exist in the market.
Nature of Financial Markets

A financial market plays a prominent role in the economy as

blood is to the body. The characteristics of financial markets is
listed below:
1. It acts as a link between the investors and borrowers in the
country.
2. These markets are readily available at anytime for both the
investors and the borrowers in the country.
3. Financial markets initiate trading of marketable commodities.
4.The government controls the operations of a financial market in
the country by imposing various rules and regulations.
5. These markets require various financial intermediaries such as
a bank, non-banking financial institutions, stock exchanges,
mutual fund companies, insurance companies, and brokers, to
function.
6. Financial markets provide an opportunity of putting in their
funds into various securities for short or long-term investment
benefits.
FUNCTIONS OF FINANCIAL MARKETS

Facilitates creation and distribution of credit and liquidity.

Serves as an intermediary for mobilization of savings from
public.
To assist the process of balanced regional development.
To provide financial convenience to users.
To cater to various credit needs of the business houses and
institutions.
Provides liquidity to tradable securities.
Classification of Financial Market
On the Basis of Nature of claim

Debt market
Debt market is a financial market where participants
can issue new debt, known as the primary market, or
trading debt securities known as the secondary market
or stock market.
Equity market
An equity market or share market is the aggregation of
buyers and sellers of stocks, which represent ownership
claims on companies .
On the Basis of Maturity of Claim

Money market
The money market is a major element of the economy
that provides short term funds. The money market
deals in short term loans, generally for a period of less
than one year.
Capital market
Capital market is a place where buyers and sellers
engaged in trading of financial securities like shares,
bonds etc. It is the market for long term securities.
Capital market further divided in to two:
1. Primary market
Primary market is the market for new shares or securities. A
primary market is one in which a company issues fresh
securities in exchange for money from an investor (buyer).
It deals with trade of new issues of shares and other
securities sold to the investors.
 Secondary market
Secondary market deals with the exchange of already
issued securities among various investors.
Once new securities have been sold in the primary
market, an efficient manner must exist for resale of
those securities. Secondary markets give investors the
facility to resell existing securities.
On the Basis of Timing of Delivery

Cash market
A cash market is a market in which the commodities or
securities purchased are paid for and received at the
point of sale. For example, a stock exchange is a cash
market because investors purchase the shares
immediately in exchange for cash.
A future market
Future market is a place, where only future contracts
are traded at an agreed date in the future and at a
predetermined price.
 On the Basis of Organizational Structure

Exchange traded markets

Exchange traded markets are the markets where all the
transactions are done through a centralised place or exchange.
Over the counter market
An over the counter market is a decentralised market in which
market participants trade stocks, commodities, currencies, or
other instruments directly between two parties and without a
centralised market place or exchange .
Participants in Financial Markets

1. Banks:
Banks participate in both the capital market and money
market. Within the capital market, banks take active part in
bond markets. Banks can invest in equity and mutual funds
as a part of their fund management. Banks take active
trading interest in the bond market and have certain
exposures to the equity market also. Banks also participate
in the market as clearing houses or institutions.
2. Primary Dealers (PDs):
PDs deal in government securities both in primary and
secondary markets. Their basic goal is to provide
two-way quotes and act as market makers for
government securities and improve the government
securities market.
3. Financial Institutions(FI)
FIs provide/lend long term funds for various industries. FIs raise
their resources through long-term bonds from financial system
and borrowings from international financial organizations like
International Finance Corporation (IFC), Asian Development
Bank (ADB) International Development Association (IDA),
International Bank for Reconstruction and Development (IBRD).
4. Stock Exchanges:
A Stock exchange is the arrangement to provide sale and
purchase of securities by “open cry” or “on-line” on behalf
of investors through various brokers. The stock exchanges
provide clearing house facilities for collection of payments
and securities delivery. Such clearing houses guarantees all
payments and deliveries. Securities traded in stock
exchanges include equities, debt, and derivatives.
5. Brokers:
Only brokers approved by Capital Market Regulator can
operate in stock exchanges in the country. Brokers perform
the job of intermediating between buyers and seller of
securities. They help build up order book, price discovery,
and are responsible for each contracts . For their services
brokers earn a fee known as brokerage.
6. Investment bankers /Merchant bankers

These are agencies controlled and licensed by SEBI,

the Capital Markets Regulator. They arrange collection
of funds through equity and debt route and assist
companies in completing various procedures like filing
of the prescribed document and other compliances.
They advise the issuing company on book building, pricing
of issue, arranging registrars, bankers to the issue and other
support services. They can underwrite the issue and also
function as issue managers. They may also trade on their
account. As per regulatory norms, such own account
business should be separately booked and confined to
scrip’s where insider information is not available to the
merchant banker.
7. Foreign Institutional Investors (FIIs):
FIIs are foreign based funds authorized by Capital Market
Regulator to invest in equity and debt market through stock
exchanges. They are allowed to conduct sale proceeds of
their holdings, provided sales have been made through an
authorized stock market and taxes have been paid. FIIs
enjoy de-facto capital account convertibility.
8. Custodians:
Custodians are organizations which are allowed to hold securities
on behalf of customers and carry out operations on their behalf.
They handle both funds and securities of Qualified Institutional
Borrowers (QIBs) including FIIs. Custodians are supervised by
the Capital Market Regulator. In view of their position and as
they handle the payment and settlements, banks are able to play
the role of custodians effectively. Thus most banks perform the
role of custodians.
9. Depositories:
Depositories hold securities in electronic form,
maintain accounts of depository participants who,
maintain accounts of their customers. On instructions
of stock exchange clearing houses, supported by
documentation, a depository transfers securities from
buyers to sellers’ accounts in demat format.
Instruments in Financial Markets

Instruments in financial markets can be

classified in to three, which are
Cash instruments
Derivative instruments
Foreign exchange instruments
1. Cash Instruments
Cash instruments are financial instruments with values directly
influenced by the condition of the markets. Cash instruments can
be divided in to two; securities and deposits, and loans.
Securities: A security is a financial instrument that has
monetary value and is traded on the stock exchange. When
purchased or traded, a security represents ownership of a part
of a publicly-traded company on the stock exchange.
Deposits and Loans: Both deposits and loans are considered
cash instruments because they represent monetary assets that
have some sort of contractual agreement between parties.
2. Derivative Instruments
Derivative instruments are financial instruments that have values
determined from underlying assets such as resources, currency,
bonds, stocks, and stock indexes. derivatives instruments are
forwards, futures, options, and swaps.
Forward: A forward is a contract between two parties that involves
customizable derivatives in which the exchange occurs at the end of the
contract at a stipulated price.

Future: A future is a derivative contract that provides the exchange of

derivatives on a determined future date at a predetermined exchange rate.

Options: An option is a contract between two parties in which the seller

grants the buyer the right to purchase or sell a certain number of derivatives
at a predetermined price for a specific period of time.
Swap: A swap is an agreement or a derivative contract between two parties for a
financial exchange so that they can exchange cash flows or liabilities. Through a
swap, one party promises to make a series of payments in exchange for receiving
another set of payments from the second party. Swaps usually include cash flows
based on notional principal amounts like bonds or loans but the instruments can vary.

3. Foreign Exchange Instruments

Foreign exchange instruments are financial instruments that are represented on the
foreign market and primarily consist of currency agreements and derivatives.

In terms of currency agreements, they can be divided into three groups.

Spot: A currency agreement in which the actual exchange of currency is no
later than the second working day after the original date of the agreement. It
is termed “spot” because the currency exchange is done “on the spot”
(limited timeframe).
Outright Forwards: A currency agreement in which the actual exchange
of currency is done “forwardly” and before the actual date of the agreed
requirement. It is beneficial in cases of fluctuating exchange rates that
change often.
Currency Swap: A currency swap refers to the act of simultaneously
buying and selling currencies with different specified value dates.
Asset Classes of Financial Instruments
Beyond the types of financial instruments listed above,
financial instruments can also be grouped into two
asset classes. The two asset classes of financial
instruments are debt-based financial instruments and
equity-based financial instruments.
1. Debt-Based Financial Instruments
Debt-based financial instruments are grouped as mechanisms
that an entity can use to increase the amount of capital in a
business. This include bonds, debentures, mortgages, U.S.
treasuries, credit cards, and line of credits (LOC).
They are a crucial part of the business environment because
they enable corporations to increase profit through growth in
capital.
2. Equity-Based Financial Instruments
Equity-based financial instruments are divided as mechanisms
that serve as legal ownership of an entity. Examples
include common stock convertible debentures, preferred stock,
and transferable subscription rights.
They help businesses grow capital over a longer period of time
compared to debt-based but benefit in the fact that the owner is
not responsible for paying back any sort of debt.