Financial System

• Financial System is a combination of two terms i.e. : “finance” and “system”.

• Finance means monetary resources comprising of funds and debts. Finance is the life blood of all
economic activities. No business activity can be started without finance.
• System indicates a set of interrelated parts working together to achieve some purpose. The
financial system of an economy exists to organize the settlement of payments, to raise and
allocate finance, and to manage the risks associated with financing and exchange.
• A Financial System is a composition of various institutions, markets, regulations and laws,
practices, money manager, analysts, transactions and claims and liabilities. It functions as an
intermediary and facilitates the flow of funds from the areas where there is a surplus of funds to
the areas where there is a deficit of funds.
• It provides a mechanism by which savings are transformed to investment.
• We can also say that the services that are provided to a person by the various Financial
Institutions including banks, insurance companies, etc. constitute the financial system

Secondary sources from the internet have been used to make the presentation
 Financial System
Features of Financial System can include the following:

Secondary sources from the internet have been used to make the presentation
 Financial Institutions
Financial institutions facilitate smooth working of the financial system by making investors and
borrowers meet. They mobilize the savings of investors via financial markets, by making use of
different financial instruments as well as in the process using the services of numerous financial
services providers.
The best example of a Financial Institution is a Bank. People with surplus amounts of money make
savings in their accounts, and people in dire need of money take loans. The bank acts as an
intermediate between the two.
The financial institutions can further be divided into two types:
 Banking Institutions or Depository Institutions – This includes banks and other credit unions
which collect money from the public against interest provided on the deposits made and lend
that money to the ones in need
 Non-Banking Institutions or Non-Depository Institutions – Insurance, mutual funds and
brokerage companies fall under this category. They cannot ask for monetary deposits but sell
financial products to their customers.

Secondary sources from the internet have been used to make the presentation
 Financial Institutions
Further, Financial Institutions can be classified into three categories:
 Regulatory – Institutes that regulate the financial markets like RBI (Reserve Bank of India),
IRDA (Insurance Regulatory and Development Authority), SEBI (Securities and Exchange Board
of India), etc.
 Intermediates – Intermediate between savers and investors. They lend money as well as
mobilise savings. Their liabilities are towards ultimate savers, while their assets are from the
investors or borrowers. Commercial banks which provide loans and other financial assistance
such as SBI, PNB, etc. LIC is a non banking intermediary
 Non Intermediates – they do the loan business but their resources are not directly obtained
from the savers. Like NABARD as government efforts to provide assistance for specific
purposes, sectors, and regions for regional, under developed and backward area
development
*NABARD: National Bank for Agriculture and Rural Development (it serve as an apex financing
agency for the institutions providing investment and production credit for promoting various
developmental activities in rural areas)
 Financial Assets
• Financial Assets: The products which are traded in the Financial Markets are called Financial
Assets. The types of financial assets can include stocks, bonds, cash and cash equivalent, bank
deposits, loans and receivables, certificate of deposits.

Secondary sources from the internet have been used to make the presentation
 Financial Services
The financial services in India include:
 Banking Services – Any small or big service provided by banks like granting a loan, depositing
money, issuing debit/credit cards, opening accounts, etc.
 Insurance Services – Services like issuing of insurance, selling policies, etc. are all a part of the
Insurance services
 Investment Services – It mostly includes asset management
 Foreign Exchange Services – Exchange of currency, foreign exchange, etc. are a part of the
Foreign exchange services

Secondary sources from the internet have been used to make the presentation
 Financial Markets
• Financial Markets:
The marketplace where buyers and sellers interact with each other and participate in the trading
of money, bonds, shares and other assets is called a financial market. The financial market can be
further divided into four types:
 Capital Market: Capital market is a market where buyers and sellers engage in trade of financial
securities like bonds, stocks, etc. The buying/selling is undertaken by participants such as individuals
and institutions. Generally, this market trades mostly in long term securities.
 Money Market: It is a financial market where short-term financial assets having liquidity of one year or
less are traded on stock exchanges. The securities or trading bills are highly liquid. Also, these facilitate
the participant’s short-term borrowing needs through trading bills. The participants in this financial
market are usually banks, large institutional investors, and individual investors.
 Foreign Exchange Market: One of the most developed markets across the world, the Foreign exchange
market, deals with the requirements related to multi-currency. The transfer of funds in this market
takes place based on the foreign currency rate.
 Derivatives market: The market deals with derivatives, which derive their value from an underlying
asset. Individuals and firms can trade in futures, options, forward contracts, and swaps here. Such
trades can be entered either via over-the-counter or in exchange-traded derivatives to manage the
financial risk
Secondary sources from the internet have been used to make the presentation
 Capital Markets
Capital market is a market where buyers and sellers engage in trade of financial securities like
bonds, stocks, etc. The buying/selling is undertaken by participants such as individuals and
institutions. Generally, this market trades mostly in long term securities.
Different Instruments of the Capital Market
The types of capital market instruments are broadly classified into two types:
• Equity Security:
 Equity Shares: Equity shares are long-term financing sources for any company. These shares are
issued to the general public and are non-redeemable in nature. Investors in such shares hold
the right to vote, share profits and claim assets of a company.
 Preference Shares: These are the secondary sources of finance for a public limited company. As
the name suggests, holders of such shares enjoy exclusive rights or preferential treatment by
that company in specific aspects. They are likely to receive their dividend before equity
shareholders. However, they do not typically have any voting rights.

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Different Instruments of the Capital Market
The types of capital market instruments are broadly classified into two types:
• Debt Security:
 Bonds: A bond is a debt instrument in which an investor loans money to an entity (typically
corporate or government) which borrows the funds for a defined period of time at a variable or
fixed interest rate. Bonds are used by companies, municipalities, states and sovereign
governments to raise money to finance a variety of projects and activities. Owners of bonds are
debt holders, or creditors, of the issuer. Bonds are secured by their physical assets. The holder
of these bonds is the lender, while the issuer of these bonds is the borrower. The borrower can
issue these bonds to the lender, only by promising to pay back the loan at a specific maturity
date with a fixed interest rate. This interest rate is generally lower than debentures because the
physical assets of a company secure bonds whereas the debentures are unsecured
instruments.

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Different Instruments of the Capital Market
The types of capital market instruments are broadly classified into two types:
• Debt Security:
 Debentures: Debentures are also debt financial instruments like bonds. Organisations use these
instruments to get funding for their daily needs. They are generally not secured by any physical
assets of the issuers, which makes them riskier than bonds. They also carry a fixed or floating
interest rate. The debenture holders get first preference over shareholders of a company when
it comes to the payment of interests/dividends. The interest rate on debentures is generally
higher than bonds because they are not secured by the physical assets of a company

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Capital markets are composed of primary and secondary markets
Primary Market: When a company publicly sells new stocks or bonds for the first time—such as in
an initial public offering (IPO)—it does so in the primary capital market. This market is sometimes
called the new issues market. When investors purchase securities on the primary capital market, the
company that offers the securities hires an underwriting firm to review it and create a prospectus
outlining the price and other details of the securities to be issued.
Marketing the sale to investors can often include a roadshow in which investment bankers and the
company's leadership travel to meet with potential investors and convince them of the value of the
security being issued.

Secondary sources from the internet have been used to make the presentation
Capital Markets

Secondary sources from the internet have been used to make the presentation
 Capital Markets
How Primary Market Work?
• A company wanting to raise capital from the public is required to prepare an offer document
giving sufficient information and disclosures, which enables (potential) investors to make an
informed decision. Accordingly, the offer document is required to contain details about the
company, its promoters, the project, financial details, objects of raising the money, terms of the
issue etc.
• The issuer company engages a SEBI registered merchant banker to prepare the offer document.
Besides, due diligence in preparing the offer document, the merchant banker is also responsible
for ensuring legal compliance. The merchant banker facilitates the issue in reaching the
prospective investors (marketing the issue).
• The draft offer document thus prepared is filed with SEBI and is made available on SEBI’s website.
Company is also required to make a public announcement about the filing English, Hindi and in
regional language newspapers

Secondary sources from the internet have been used to make the presentation
 Capital Markets
How Primary Market Work?
• The Indian regulatory framework is based on a disclosure regime. SEBI reviews the draft offer
document and may issue observations on the draft offer document with a view to ensure that
adequate disclosures are made by the issuer company/merchant bankers in the offer document
to enable the investor to make an informed investment decision in the issue. It must be clearly
understood that SEBI does not “vet” and “approve” the offer document.
• SEBI’s observations on the draft offer document are forwarded to the merchant banker, who
incorporates the necessary changes and files the final offer document with SEBI, Registrar of
Companies (ROC) and stock exchange(s). This is made available on websites of the merchant
banker, stock exchange(s) and SEBI.
• After completing legal formalities, the issuer company issues advertisements in English, Hindi
and regional language news papers and the issue is open to public for subscription.
• If the prospective investor is interested in subscribing to the shares of the issuer company based
on what is disclosed in the offer document, he can apply for its shares (or debentures) before the
issue closes, by duly filling up the application form and making the payment

Secondary sources from the internet have been used to make the presentation
 Capital Markets
How Primary Market Work?
• The entire back office operation of the public issue, including processing of application forms,
despatch of refunds, allotment of securities, is handled by the Registrar to the Issue (RTI) on
behalf of the issuer company.
• It is to be noted that only one application per PAN is allowed in any issue.
• The issue then closes (investor cannot apply beyond the closing date) and the shares are allotted
to the applicants proportionally or on lottery basis, if there is oversubscription.
• Upon allotment, investor will receive demat credit within 12 days.
• The shares of the company are then listed on the stock exchange within 12 working days of the
close of the issue.
• The complete contact details of all the intermediaries involved in an issue namely merchant
banker, RTI, banker to the issue etc. are available in the offer document. In case the investor
needs any clarification they can contact them.

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Primary Market:
Different types of issues can include:
• Public issue: When a company raises funds by selling (issuing) its shares (or debenture / bonds)
to the public through issue of offer document (prospectus), it is called a public issue.
1) Initial Public Offer: When a (unlisted) company makes a public issue for the first time and gets
its shares listed on stock exchange, the public issue is called as initial public offer (IPO).
2) Further public offer: When a listed company makes another public issue to raise capital, it is
called further public / follow-on offer (FPO).
• Offer for sale: Institutional investors like venture funds, private equity funds etc., invest in
unlisted company when it is very small or at an early stage. Subsequently, when the company
becomes large, these investors sell their shares to the public, through issue of offer document
and the company’s shares are listed in stock exchange. This is called as offer for sale. The
proceeds of this issue go the existing investors and not to the company.

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Primary Market:
Different types of issues can include:
• Issue of Indian Depository Receipts (IDR): A foreign company which is listed in stock exchange
abroad can raise money from Indian investors by selling (issuing) shares. These shares are held in
trust by a foreign custodian bank against which a domestic custodian bank issues an instrument
called Indian depository receipts (IDR). IDR can be traded in stock exchange like any other shares
and the holder is entitled to rights of ownership including receiving dividend.
• Others:
1) Rights issue (RI): When a company raises funds from its existing shareholders by selling
(issuing) them new shares / debentures, it is called as rights issue. The offer document for a
rights issue is called as the Letter of Offer and the issue is kept open for 30-60 days. Existing
shareholders are entitled to apply for new shares in proportion to the number of shares already
held. Illustratively, in a rights issue of 1:5 ratio, the investors have the right to subscribe to one
(new) share of the company for every 5 shares held by the investor.

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Primary Market:
Different types of issues can include:
• Others:
2) Bonus Issue: In a Bonus Issue, the company issues new shares to its existing shareholders. As
the new shares are issued out of the company’s reserves (accumulated profits), shareholders
need not pay any money to the company for receiving the new shares. The net worth (owner’s
money) of a company consist of its equity capital and its reserves. After a bonus issue, there is an
increase in the equity capital of the company with a corresponding decrease in the reserves,
while the net worth remains constant. In a bonus issue of 5:1 ratio, the investor will receive five
new shares of the company for each share the investor held

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Secondary Market: The secondary market is a place where trading takes place for existing
securities. It is known as stock exchange or stock market. Here the securities are bought and sold by
the investors. Secondary market provides regular information about the value of security, offers
liquidity to the investors for their assets, continuous and active trading, provide a market place, etc.

Different Instruments in Secondary Market:

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Secondary Market:
Different Instruments in Secondary Market:

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Secondary Market:
Different Instruments in Secondary Market:

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Secondary Market:
Functions of Secondary Market can include:

Secondary sources from the internet have been used to make the presentation
 Capital Markets
Secondary Market:
Types of Secondary Market can include:
• Stock Exchange: These are centralised platforms where securities trading takes place. National
Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are examples of such platforms. A stock
exchange is simply an institution, a platform, or a facility where different stockbrokers and
traders can interact and bring about transactions by buying and selling shares. They can be
shares of a stock, a bond or any other related financial instrument. People involved in the
business of a stock market can be anyone, ranging from individual stock buyers to even big trade
investors and conglomerates. Participants can be based anywhere in the world without any
restrictions. Stock exchange markets also include banks and insurance companies who trade in
stock with other organizations.
Functions of Stock Exchange can include:
 One of the primary functions of the stock exchange is to provide a quick, persistent and
constant demand for the purchase and sale of securities. It has a ready outlet for the purpose of
buying and selling these securities. It also functions as an outlet for the sale of securities that
are listed on the stock exchange.
Secondary sources from the internet have been used to make the presentation
 Capital Markets
Secondary Market:
Functions of Stock Exchange can include:
 Among different functions of the stock exchange, one is to speed up, as much as possible, the
whole process of capital accumulation and formation. It induces or inculcates the habit of saving
and investing and risk-taking among the investors. The stock exchange aims at converting their
precious savings into profit. It also serves as a tool for capital formation. It functions as a
medium for a secure and profitable investment.
 It is among the fundamental functions of stock exchange to impart necessary and essential
information to the potential and current investors. Such information can be easily found on their
websites. They regularly put out advertisements in various newspapers, business magazines and
television channels regarding different investment opportunities and provide proper guidance.
This is aimed to encourage investors and make them aware of stock market investments.
 It is one of the top priority functions of the stock exchange to provide a safe and secure way of
conducting business and investments. The transactions in the stock exchange are done under
clearly outlined rules and regulations. It is the responsibility of the authority body of a stock
exchange to keep in check its employees. Practising forgery is discouraged and swiftly dealt
with.
 Capital Markets
Secondary Market:
Functions if Stock Exchange can include:
 In a stock exchange, the companies which are listed have to consistently comply with the
already well-defined rules and regulations. Before enlisting themselves they are asked to submit
various documents, providing all the information about their return. Providing the documents
acts as an instrument to monitor any important activity that the organization is planning to
undertake in the course of the future. These rules and regulations have been made to ensure
the safety of investments and funds.
Features of Stock Exchange can include:
 It is a platform where shares and securities of government, corporate sectors are purchased, as
well as, sold.
 Another feature of stock exchange is that only listed companies can engage in trading.
 A major characteristic feature of stock exchange is that it becomes a representation of the
economic functioning of a nation.
 It is a common platform that attracts hundreds of corporations and investors.
Secondary sources from the internet have been used to make the presentation
 Capital Markets
Secondary Market:
Types of Secondary Market can include
• Over the Counter (OTC) market:

Secondary sources from the internet have been used to make the presentation
Capital Markets: Primary Market vs Secondary Market:

Secondary sources from the internet have been used to make the presentation
Capital Markets: Primary Market vs Secondary Market

Secondary sources from the internet have been used to make the presentation
 Money Market
Money Market is a financial market where short-term financial assets having liquidity of one year or
less are traded on stock exchanges. The securities or trading bills are highly liquid. Also, these
facilitate the participant’s short-term borrowing needs through trading bills. The participants in this
financial market are usually banks, large institutional investors, and individual investors.
Some important money market instruments have been discussed briefly below:
 Call Money: When a loan is granted for one day and is repaid on the second day, it is called
call money. No collateral securities are required for this kind of transaction.
 Notice Money: When a loan is granted for more than a day and for less than 14 days, it is
called notice money. No collateral securities are required for this kind of transaction.
 Term Money: When the maturity period of a deposit is beyond 14 days, it is called term
money.
 Treasury Bills: Also known as T-Bills, these are Government bonds or debt securities with
maturity of less than a year. Buying a T-Bill means lending money to the Government.

Secondary sources from the internet have been used to make the presentation
 Money Market
Some important money market instruments have been discussed briefly below:
 Certificate of Deposits: Certificates of Deposit are issued by scheduled commercial banks and
select financial institutions. A certificate of deposit issued by banks, the maturity period is not
less than seven days and not above one year while for financial institutions, a certificate of
deposit should not be issued for less than one year and not above three years.
 Commercial Paper: Corporates issue CP’s to meet their short-term working capital
requirements. Hence serves as an alternative to borrowing from a bank. Also, the period of
commercial paper ranges from 15 days to 1 year

Secondary sources from the internet have been used to make the presentation
 SEBI
The Securities and Exchange Board of India (SEBI) is a statutory regulatory body established by the
Government of India in 1992 to regulate the securities market in India and protect the interests of
investors in securities.
SEBI has the power to regulate and perform functions such as check the books of accounts of stock
exchanges and call for periodical returns, approve by-laws of stock exchanges, inspect the books of
financial intermediaries, compel certain companies to get listed on one or more stock exchanges,
and handle the registration of brokers.
Purpose of SEBI
SEBI was established to keep a check on unfair and malpractices and protect the investors from such
malpractices. The organization was created to meet the requirements of the following three groups:
• Issuers: SEBI works toward providing a marketplace to the investors where they can efficiently
and fairly raise their funds.
• Intermediaries: SEBI works towards providing a professional and competitive market to the
intermediaries
• Investors: SEBI protects and supplies accurate information to investors.
Secondary sources from the internet have been used to make the presentation
 SEBI
Functions of SEBI:
SEBI carries out the following tasks to meet its objectives:
Protective functions: Functions that SEBI performs as a part of its protective functions can include:
• It checks price manipulation
• It bans Insider trading
• It prohibits unfair and fraudulent trade practices
• It promotes a fair code of conduct in the security market
• It takes efforts to educate the investors regarding ways to evaluate the investment options better
Regulatory functions: Functions that SEBI performs as a part of its regulatory functions can
include:
• It has designed a code of conduct, rules, and regulations to regulate the brokers, underwriters,
and other intermediaries.
• SEBI also governs a company’s takeover.

Secondary sources from the internet have been used to make the presentation
 SEBI
Functions of SEBI:
SEBI carries out the following tasks to meet its objectives:
Regulatory functions: Functions that SEBI performs as a part of its regulatory functions can
include:
• It regulates and registers the workings of stockbrokers, merchant bankers and others who are
linked with the stock exchange.
• It conducts audits and inquiries of stock exchanges.
Developmental Functions: Functions that SEBI performs as a part of its developmental functions
can include:
• It facilitates the training of the intermediaries.
• It aims at promoting activities of the stock exchange by having an adoptable and flexible
approach.

Secondary sources from the internet have been used to make the presentation