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CHAPTER.

1-INTRODUCTION TO FINANCIAL SYSTEM The economic development of any country depends upon the existence of a well organized financial system. It is the financial system which supplies the necessary financial inputs for the production of goods and services which in turn promote the well being and standard of living of the people of a country. Thus, the financial system is a broader term which brings under its fold the financial markets and the financial institutions which support the system. The ma or assets traded in the financial system are money and monetary assets. The responsibility of the financial system is to mobilize the savings in the form of money and monetary assets and invest them to productive ventures. !n efficient functioning of the financial system facilitates the free flow of funds to more productive activities and thus promotes investment. Thus, the financial system provides the intermediation between savers and investors and promotes faster economic development. "inancial institutions in countries like India are classified into banking and non#banking financial intermediaries wherein the commercial banks are considered as general or non#specialized financial institutions and the non# banking financial intermediaries like investment banks, insurance companies, term lending financial institutions and development banks are known as specialized financial institutions. $ountry like India also has dichotomy in the financial market. This dichotomy can be explained in terms of the existence of organized and unorganized financial markets. %hile all of the above will constitute the organized sector of the financial market, the unorganized financial market in India consists of traditional bankers like the &u arati shroffs, 'ultani or

)hikarpuri shroffs, $hettiars and 'arwari *ayas. The &u arati shroffs operate in +ombay, $alcutta and the industrial trading centers of &u arat. The 'arwari shroffs operate in $alcutta, +ombay, !ssam and other parts of north#east India. The multani or )hikarpuri shroffs are mainly found in +ombay and madras and the chettiars operate in south India. !mongst these traditional bankers, the &ua arati shroffs carryout the largest volume of unorganized banking business in India. ,on#banking financial companies like chit funds and nidhis also operate in large numbers in India. The third segment of the unorganized financial market in India consists of the money lenders. These unorganized segments are so called because they are neither registered as companies nor being controlled by the reserve +ank of India. DEFINATION OF FINANCIAL SYSTEM According to Dr. Prasanna C andra, -The financial system consists of a variety of financial intermediaries, markets and instruments that are related to each other. It provides the principal means by which savings are transformed into investments.. Dr. L.M. ! o"# d#$in#s $inancia" s%st#& as -The financial system of any country consists of specialized and non#specialized financial institutions, of organized and unorganized financial markets, of financial instruments and services which facilitate transfer funds. /rocedures and practices adopted in the markets and financial interrelationships are also parts of the system.. FUNCTION OF FINANCIAL SYSYTEM The financial system performs the following functions that are interrelated and are essential for the development process of a modern economy.

A' Pa%&#nt s%st#& !' Mo(i"i)ation and a""ocation o$ $*nds C' Ris+ &anag#&#nt D' Pric# in$or&ation $or d#c#ntra"i)#d d#cision &a+ing E' D#a"ing ,it inc#nti-# .ro("#& A' PAYMENT SYSTEM The commercial banking system, alternatively known as depository financial intermediaries constitutes the payment system in the financial market. The credit and debit card companies play a supplementary role. %ith large number of commercial banks having their independent credit card and debit card divisions, the credit and debit card system becomes a part of the banking system. 'odern economies and societies with the present scale and volume of transactions cannot be imagined in the absence of a payment system as convenient as the banking system we have now. !' MO!ILI/ATION AND ALLOCATION OF FUND The financial intermediaries both banking and non#banking plays a crucial role in mobilizing funds from the persons and households having surplus and allocating it to the deficit persons and firms. The financial markets also help in efficient allocation of scarce financial resources and individuals and households are provided the opportunity to invest their financial resources in attractive financial avenues of investment. The widening and deepening of the financial markets takes place with the growth of the financial markets and availability of innovative and ingenious financial products that can mobilize the smallest of the savings available in the society.

!ccording to 2obert 'erton, -! well developed, smooth#functioning financial system facilitates the efficient life#cycle allocation of household consumption and the efficient allocation of physical capital to the most productive use in the business sector. . ! well developed, smooth#functioning capital market also makes possible the efficient separation of ownership from management of the firm. This in turn makes feasible efficient specialization in production according to the principle of comparative advantage.. C' RIS0 MANA1EMENT ! developed financial system provides a variety of financial instruments that enable financial intermediaries to mobilize3 price and exchange risk. It provides opportunities for risk#pooling and risk sharing for both firms and households The three basic methods of managing risk are4 H#dging2 5edging would re6uire movement from a risk#loaded asset to a risk# free asset. E3. ! forward contract is a hedging device. Di-#rsi$ication2 7iversification helps in redistribution of risks in such a manner that the risk faced by every individual is diminished. It does not eliminate risk entirely. E3. 'utual fund companies offer income, balanced and growth funds. Ins*ranc#2 %hile income funds are risk free, the risk is balanced in balanced funds and growth funds carry highest level of risk. The risk#return relationship is direct and proportional. Insurance enables the insured to en oy the economic benefits of ownership while eliminating the possible losses.

D' PRICE INFORMATION FOR DECENTRALI/ED DECISION MA0IN1 "inancial system helps decentralized decision making. !ccording to 2obert 'erton, -Interest rates and security prices are used by households or their agents in making their consumption#saving decisions and in choosing the portfolio allocations of their wealth. These same prices provide important signals to managers of firms in their selection of investment pro ects and financings.. The money market offers short term credit financial instruments and the capital market offers both long term credit financial instruments and permanent ownership capital. Information pertaining to these instruments is readily made available to all financial investors so that they can determine their portfolio allocations based on their risk taking abilities and understanding of the financial markets. &iven the information on financial markets, households may decide on the distribution of their incomes between consumption and savings. E' DEALIN1 4ITH PRO!LEM OF INCENTI5ES %hen financial information is not e6ually available to all, the problem of informational asymmetry or ine6uality comes into existence. This leads to the problems of moral hazard and adverse selection. These problems are known as agency problems. E3. ! person who has insured his car will become negligent and park his or her car without looking at the security aspects. This is very much true in a country like India where thousands of cars are parked in public spaces not earmarked for car parking for want of car parking facilities. This is the moral hazard faced by the insurance company. ! person who is more likely to
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experience car loss arising out of car theft is most likely to take car insurance. This is the adverse selection problem faced by the insurance company. FINANCIAL CONCEPTS !n understanding of the financial system re6uires an understanding of the following important concepts4 Financia" ass#ts Financia" int#r&#diari#s Financia" &ar+#ts Financia" rat#s o$ r#t*rn Financia" instr*&#nts

CHAPTER.6-FINANCIAL ASSETS In any financial transaction, there should be a creation or transfer of financial asset. 5ence, the basic product of any financial system is the financial asset. ! financial asset is one which is used for production or consumption or for further creation of assets. E3. ! buys e6uity shares and these shares are financial assets since they earn income in future. In this context, one must know the distinction between financial assets and physical assets. ;nlike financial assets, physical assets are not useful for further production of goods or for earning income. E3. < purchases land and buildings, or gold and silver. These are physical assets since they cannot be used for further production. 'any physical assets are useful for consumption only. It is interesting to note that the ob ective of investment decides the purposes, it becomes a physical asset. If the same is bought for hiring, it becomes a financial asset. CLASSIFICATION OF ASSET "inancial assets can be classified differently under different circumstances. =ne such classification is4 7 Mar+#ta("# ass#ts 7 Non-&ar+#ta("# ass#ts MAR00ETA!LE ASSETS 'arketable assets are those which can be easily transferred from one person to another without much hindrance.
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E3. )hares of listed companies, government securities, bonds of public sector undertakings etc. NON MAR0ETA!LE ASSETS =n the other hand, if the assets cannot be transferred easily, they come under this category. E3. +ank deposits, provident funds, pension funds, national savings certificates, insurance policies etc. This classification is shown in the following 4 Cas ass#ts2 In India, all coins and currency notes are issued by the 2+I and the ministry of finance, government of India. +esides, commercial banks can also create money by means of creating credit. %hen loans are sanctioned, li6uid cash is not granted. Instead an account is opened in the borrowers name and a deposit is created. It is also a kind of money asset. D#(t ass#ts2 7ebt asset is issued by a variety of organizations for the purpose of raising their debt capital. 7ebt capital entails a fixed repayment schedule with regard to interest and principal. There are different ways of raising capital advance, etc. Stoc+ ass#ts2 )tock is issued by business organizations for the purpose of raising their fixed capital. There are two types of stock namely e6uity and preference. ?6uity shareholders are the real owners of the business and they en oy the fruits of ownership and at the same time they bear the risks as well. /reference shareholders, on the other hand get a fixed rate of dividend @as in the case of debt assetA and at the same time they retain some characteristics of e6uity.

CHAPTER.8-FINANCIAL INTERMEDIARIES The term financial intermediary includes all kinds of organizations which intermediate and facilitate financial transactions of both individuals and corporate customers. Thus, it refers to all kinds of financial institutions and investing institutions which facilitate financial transactions in financial markets. They maybe in the organized sector or in the unorganized sector. Ca.ita" &ar+#t int#r&#diari#s Mon#% &ar+#t int#r&#diari#s CAPITAL MAR0ET INTERMEDIARIES These intermediaries mainly provide long term funds to individuals and corporate customers. They consist of term lending institutions like financial corporations and investing institutions like CI$. MONEY MAR0ET INTERMEDIARIES 'oney market intermediaries supply only short term funds to individuals and corporate customers. They consist of commercial banks, co#operative banks, etc. "inancial intermediaries are those financial institutions that provide financial services and financial products to the customers in an efficient manner. E3. ! mutual fund mobilizes the financial resources of households and invests in a basket of securities according to the preferences of the buyers. The mutual funds en oy economies of scale in conducting large scale transactions, maintaining huge volumes of records and in research and development. The mutual funds therefore offer a highly efficient method of investing than what an individual can do on its own. The important financial
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products and services of financial intermediaries are checking accounts, savings accounts, loans, mortgages, mutual fund schemes, insurance contracts, credit rating, etc. ! financial intermediary acts as an agent between the entrepreneurial class and the investing class. !ENEFITS OF FINANCIAL INTERMEDIARIES2 A' DI5ERSIFICATION2 "unds mobilized by financial intermediaries are invested in a diversified portfolio of financial assets such stocks, money market products, bonds, and loans. 7iversification helps in spreading the risk over a number of financial assets and hence reduces the overall risk. !' LO4ER TRANSACTION COST2 The average size of a transaction of financial intermediary is disproportionately greater than that or an individual investor. The transaction cost is therefore negligibly low. C' ECONOMIES OF SCALE2 $ollection of information, processing of information and regular monitoring of the financial markets is essential for deciding to buy or sell financial assets. "inancial intermediaries have the financial muscle to employ professional services to perform this task at a fraction of their total cost operations. The operational cost of financial intermediaries is less because of the large size of operations and conse6uent economies of scale. D' CONFIDENTIALITY2 $ompanies who access the financial markets for funds or want the continued support of existing investors are re6uired to reveal information which they otherwise would like to keep it secret for maintaining their

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competitive advantage. Information revealed to financial intermediaries has a greater chance of secrecy and security than to individual investors. E' SI1NALIN12 "inancial intermediaries has the re6uired professional expertise to understand the signals and hints provided by companies and pass on the ac6uired understanding to the investors so that individual investors can take their decisions to invest. FINANCIAL INTERMEDIARIES IN INDIA2 The financial intermediaries in India consists of banking and non#banking financial institution, development finance institutions, insurance companies, investment banks such as the mutual funds, merchant banks, venture capital firms and information services companies. A' COMMERCIAL !AN0S2 The /ublic )ector +anks, foreign banks and private sector banks are the most important banking financial intermediary in the Indian financial system. The )tate +ank of India was set up in (D99 and is the largest commercial bank in India. +ank nationalization effort in (D:D and in (DBE by the &overnment of India transformed a large number of private sector banks into nationalized banks. !s a result, the commercial banking sector is dominated by public sector banks in India. ,ationalization of banks contributed to the spread of banking institutions in the hooks and corners of the country, led to higher mobilization of deposits and reallocation of bank credit to priority sectors of the economy. =n the flip side, the autonomy of the bank management was reduced. %ith the adoption of the ,ew ?conomic /olicy in the year (DD(, the banking sector was liberalized and new private

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sector banks such as the 57"$ and I$I$I +anks came into existence. The private banking sector is dominated by these two banks since their inception. !' DE5ELOPMENT !AN0S2 In order to facilitate rapid industrial development in India, the need for long term finance was catered to by setting up development banks in India. Term lending financial institutions such as the Industrial 7evelopment +ank of India @I7+IA, Industrial "inance $orporation of India @I"$IA, Industrial $redit and Investment $orporation of India @I$I$IA, )tate "inancial $orporations @)"$sA and )tate Industrial 7evelopment $orporations were set up by both $entral and )tate &overnments. The )mall Industries 7evelopment +ank of India @)I7+IA was setup to promote the growth of small scale industries in India. These development banks have proved to be responsive to the growing need for industrial capital. They contribute in identifying investment opportunities, encourage entrepreneurship, promote development of backward regions and support modernization programs. The ,ational +ank of !griculture and 2ural 7evelopment is the apex agricultural financial institution. It provides assistance through a large number of regional, )tate level and field level institutions like the 2egional 2ural +anks, the )tate $o#operative +anks etc. their activities can be classified into five. They are4 F 7irect financing, F Indirect financing, F !ssistance financing and F /romotional work. =ut of these banks, I$I$I and I7+I have become universal banks i.e. performing both banking and non#banking functions at the same time.
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C' INSURANCE COMPANIES2 ;ntil the liberalization of the financial sector in (DD(, there were only two insurance companies in India. They were the Cife Insurance $orporation of India and the &eneral Insurance $orporation of India. The CI$ is by far the largest insurance company in India and the new private sector entities that emerged in the post liberalization era are nowhere near the size of the public sector behemoth. This has been also due to the fact that hundred per cent foreign owned insurance companies are not yet allowed. The &I$ has four subsidiaries and also command huge resource at its disposal. /rivate sector insurance companies such as the I$I$I#/rudential, Tata, !I&, +irla, )un life, 'et life etc have been set up in India after (DD(. 5owever, these companies are yet to make any ma or inroads into the market shares of the &overnment insurance companies like the CI$ and &I$. D' POST OFFICE SA5IN1S !AN02 The /ost =ffice )avings +ank is managed by the /ost and Telegraph department on behalf of the 'inistry of "inance, &overnment of India through its net work of post offices spread over the length and breadth of India. This bank collects funds through different schemes like savings bank accounts, recurring and cumulative time deposits, public provident fund and *isan Gikas /atras. E' THE NATIONAL HOUSIN1 !AN0S2 The ,ational 5ousing +ank was set up as an apex agency in the field of housing finance. The mandate for ,ational 5ousing +ank is to promote an institutional framework for the supply of finance in the housing sector.
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F' MUTUAL FUNDS2 'utual funds are investment banks. ! mutual fund is a collective investment arrangement. The 'utual "und is organized as a trust with a broad of trustees. It floats different schemes of investment in which the people can participate. The asset management company organized as a separate oint stock company manages the funds mobilized under different schemes. +roadly, schemes of mutual funds can be classified into three categories. They are income funds, balanced funds and growth funds. ?ighty percent of the income funds are invested in the debt market and hence income funds have low risk and provide low returns. The balanced funds are e6ually invested in the money as well capital markets and hence have a higher element of risk with higher returns. The growth funds are predominantly invested in the e6uity market and therefore carry a much higher risk and very high returns on investment. The mutual fund industry in India began with the setting up of ;nit Trust of India and now we have large number of mutual funds both foreign and private Indian mutual funds. 'oney 'arket 'utual "unds have also come into existence. 1' NON-!AN0IN1 FINANCIAL COMPANIES2 ,on#banking financial, companies are both in the public as well as the private sector. ?x. )+I $apital 'arkets, *otak 'ahindra "inance, )undaram "inance and Infrastructure Ceasing and "inance $orporation. These companies are involved in a number of fund#based and non#fund based activities. The main fund#based activities are leasing, hire purchase and bill discounting. The main nonEfund based activities are issue management,

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corporate advisory services, loan syndication and foreign exchange advisory services. H' MERCHANT !AN0S2 'erchant +anks help business, governments and other business entities to raise finance by issuing securities. They also facilitate merger, ac6uisitions and divestitures. The leading merchant banks in India are )+I $apital 'arkets, 7)/ 'errill Cynch and H' 'organ. I' 5ENTURE CAPITAL INSTITUTIONS2 Genture capital is another method of financing in the form of e6uity participation. ! venture capitalist finances a pro ect based on the potentialities of anew innovative pro ect. 'uch thrust is given to new ideas or technological innovations. Indeed it is a long term risk capital to finance high technology pro ects. The I7+I venture capital fund was set up in(DB:. $apital and technology finance corporation @2$T$A. Cikewise the I$I$I and the ;TI have ointly set up the technology development and Information $ompany of India limited @T7I$IA in(DBB to provide venture capital. )imilarly, many state financial corporations and commercial banks have started subsidiaries to provide venture capital. The India venture capital fund and the credit capital venture fund limited come under the private sector. 9' INFORMATION SER5ICES COMPANIES2 These companies are specialized in the business of providing information. ?x. The credit rating information services of India limited @$2I)ICA, investment information and credit rating @I$2!A, credit analysis and

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research limited @$!2?Aand capital market information services like $'I?, probity research and capital market.

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CHAPTER.:-FINANCIAL MAR0ETS &enerally speaking, there is no specific place or location to indicate a financial market. %herever a financial transaction takes place, it is deemed to have taken place in the financial market. 5ence financial markets are pervasive in nature since financial transactions are themselves very pervasive throughout the economic system. ?x. Issue of e6uity shares, granting of loan by term lending institutions, deposit of money into a bank, purchase of debentures, sale of shares and so on. 5owever, financial markets can be referred to as those centers and arrangements which facilitate buying and selling of financial assets, claims and services. )ometimes, we do find the existence of a specific place or location for a financial market as in the case of stock exchange.

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FUNCTIONS OF FINANCIAL MAR0ETS2 ! financial market is a market for creation and exchange of financial assets. %hen individuals, businesses and governments buy and sell financial instruments, they participate in the financial markets. "inancial markets plays an important role in allocating scarce resources available in an economy to their best possible use by performing three important functions. These functions are as follows4 A' FACILITIES DISCO5ERY OF PRICE2 Individuals, businesses and governments hold financial instruments. In order to satisfy their re6uirements of li6uidity and to book profits holders of financial instruments buy and sell them at various points of time. +uying and selling or demand for and supply of financial assets determines their prices. Information pertaining to prices of financial assets is made available through various sources such as the internet, the print and the visual media. !' IMPARTS LI;UIDITY TO FINANCIAL ASSETS2 "inancial markets facilitate buying and selling of financial securities and thereby imparts li6uidity to them or conversion of financial assets into li6uid assets or hard cash. In the absence of financial markets, investors would not have the re6uired motivation to invest and hold financial assets and financial turnover would not assume the proportions the markets could achieve. The financial assets are negotiable and transferable through the financial markets. It is possible for companies to raise long term funds from investors with short term and medium term maturities. %hen a financial asset is transacted, one investor is substituted by another and the company is assured of long term availability of funds.

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C' LO4 COST OF TRANSACTION2 The two important costs related to transactions are search costs and information costs. )earch costs consists of explicit costs such as the expenses incurred on advertising when one wants to buy or sell a financial asset and implicit costs such as the effort and time one has to put into locate a customer. Information costs refer to costs incurred in evaluating the investment merits of financial assets. The financial markets provide an institutional mechanism to disseminate, information and exchange of financial assets on a large scale thereby reducing the unit cost of search and information. CLASSIFICATION OF FINANCIAL MAR0ETS2 UNOR1ANISED MAR0ETS In these markets, there are a number of money lenders, indigenous bankers, traders, etc. who lend money to the public. Indigenous bankers also collect deposits from the public. There are also private finance companies, chit funds etc. whose activities are not controlled by the 2+I. 2ecently the 2+I has taken steps to bring private finance companies and chit funds under its strict control by issuing non#banking financial companies @2eserve +ankA directions, (DDB. The 2+I has already taken some steps to bring the unorganized sector under the organized fold. They have not been successful. The regulations concerning their financial dealings are still inade6uate and their financial instruments have not been standardized. OR1ANISED MAR0ETS In the organized markets, there are standardized rules and regulations governing their financial dealings. There is also a high degree
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of institutionalization and instrumentalization. These markets are sub ect to strict supervision and control by the 2+I or other regulatory bodies. These organized markets can be further classified into two. They are4 A. Ca.ita" &ar+#t !. Mon#% &ar+#t A. CAPITAL MAR0ET2 The capital market is a market for financial assets which have a ling or indefinite maturity. &enerally, it deals with long term securities which have a maturity period of above one year. $apital market may be further divided into three namely4 a' Ind*stria" s#c*riti#s &ar+#t (' 1o-#rn&#nt s#c*riti#s &ar+#t and c' Long t#r& "oans &ar+#t a' Ind*stria" s#c*riti#s &ar+#t2 !s the very name implies, it is a market for industrial securities namely3 ?6uity shares or ordinary shares, /reference shares and 7ebentures or bonds. It is a market where industrial concerns raise their capital or debt by issuing appropriate instruments. It can be further subdivided into two. They are4 .ri&ar% and s#condar% &ar+#t. I' Pri&ar% &ar+#t2 /rimary market is a market for new issues or new financial claims. Thus it is also called new issue market. The primary market deals with those securities which are issued to the public for the first time. Thus primary market facilitates capital formation. It is further divided into 1 parts4

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i' Pri-at# iss*#4 The most common method of raising capital by new companies is through sale of securities to the public. It is called public issue. ii' Rig t iss*#4 %hen an existing company wants to raise capital, securities are first offered to the existing shareholders on a pre#emptive basis. It is called rights issue. iii' Pri-at# ."ac#&#nt4 /rivate placement is a way of selling securities privately to a small group of investors. II' S#condar% &ar+#t2 )econdary market is a market for secondary scale of security. In other words, securities which have already passed through the new issue market are traded in these markets. &enerally, such securities are 6uoted in the stock exchange and it provides a continuous and regular market for buying and selling of securities. These markets consist of all stock exchanges recognized by the government of India. The )tock ?xchange in India. The )tock ?xchange in India is regulated under securities $ontract 2egulation !ct (D9:. (' 1o-#rn&#nt s#c*riti#s &ar+#t2 %hen a &overnment or local council wishes to borrow money for its expenditure plan it may sell stock. There are loan certificates, not unlike debentures, which pay their holders a rate of interest and often carry a date at which they will be repaid. ?x. Cocal authority bonds may run for 9 years, while government stock or gilt edged securities may not be repaid for perhaps 09 years. These securities can be bought and sold on the stock market ust like debentures and shares issued by the firms. &overnment securities are the most important and uni6ue financial instrument in the financial market of any economy. &overnment of India
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securities i.e. &=I section includes debt obligation of the $entral &overnment, stock &overnment and other financial institution owned by $entral and )tate &overnment. Citerally, &ilt means &old. Therefore, a gilt edged securities implies securities implies security of the best 6uality. &overnment securities are the best securities issued by the government for the purpose of raising public loans. These securities are referred as &ilt ?dged )ecurities as repayment of principle as well as interest as total securities. These are considered as the safest of all securities. c' Long t#r& "oan &ar+#t2 7evelopment banks and commercial banks plays a significant role in these market by supplying long term loans to corporate customers. It is further divided into three parts4 I' t#r& "oan &ar+#t2 Institutions like I7+I, I$I$I and other )tate "inancial $orporation come under these categories. These institutions meet the growing and varied long term financial re6uirements of industries by supplying long term loans. They also help in identifying investment opportunities, encourage new entrepreneur and support modernization efforts. II' Mortgag# &ar+#t2 'ortgage market refers to those centers which supply mortgage loan mainly to individual customers. ! mortgage loan is a loan against the security of immovable property like real estate. The transfer of interest in a specific immovable property to secure a loan is called mortgage. III' Financia" g*arant## &ar+#t2 ! guarantee market is a centre where finance is provided against the guarantee of a reputed person in a financial circle. &uarantee is a contract to
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discharge the liability of a third party in case of his default. &uarantee act as a security from the creditors point of view. In case the borrow fails to repay the loan, the liability falls on the shoulders of the guarantor. 5ence, the guarantor must be known to both borrower and lender and he must have the means to discharge his liability. !. MONEY MAR0ET2 'oney market is a market for short term loans or financial assets. !s the name implies, it does not deal in cash or money. +ut it actually deals with near substitute for money or near money like trade bills, promissory note and government papers drawn for a short period not exceeding one year. The money market does not refer to a particular place where short term funds are dealt with. It includes all individuals, institutions and intermediaries dealing with short term funds. Ca"" &on#% &ar+#t Co&&#rcia" (i""s &ar+#t Tr#as*r% (i""s &ar+#t S ort-t#r& "oan &ar+#t CALL MONEY MAR0ET The call money market is a market for extremely short period loans say one day to fourteen days. )o, it is highly li6uid. The loans are repayable on demand at the option of either the lender or the borrower. In India, call money markets are associated with the presence of stock exchanges and hence, they are located in ma or industrial towns like 'umbai, *olkata, $hennai, 7elhi, !hmadabad etc. The special feature of this market is that the interest rate varies from day#to#day and even from hour#to#hour and
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centre#to#centre. It is very sensitive to changes in demand and supply of call loans. COMMERCIAL !ILLS MAR0ET It is a market for bills of exchange arising out of genuine trade transactions. In the case of credit sale, the seller may draw a bill of exchange on the buyer. The buyer accepts such a bill promising to pay at a later date the amount specified in the bill. The seller need not wait until the due date of the bill. The seller need not wait until the due date of the bill. Instead, he can get immediate payment by discounting the bill. In India the bill market is under#developed. The 2+I has taken many steps to develop a sound bill market. The 2+I has enlarged the list of participants in the bill market. The 7iscount and "inance 5ouse of India was set up in (DBB to promote secondary market in bills. In spite of all these, the growth of the bill market is slow in India. There are no specialized agencies for discounting bills. The commercial banks play a significant role in this market. TREASURY !ILL MAR0ET It is a market for treasury bills which have short#term maturity. ! treasury bill is a promissory note or a finance bill issued by the government. It is highly li6uid because its repayment is guaranteed by the government. It is an important instrument for short#term borrowing of the government. There are two types of treasury bills namely I =rdinary or regular and I !d hoc treasury bills popularly known as ad hocs

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=rdinary treasury bills are issued to the public, banks and other financial institutions with a view to raising resources for the central government to meet its short#term financial needs. !d hoc treasury bills are issued in favor of the 2+I only. They are not sold through tender or auction. They can be purchased by the 2+I only. !d hocs are not marketable in India but holders of these bills can sell them back to 2+I. SHORT-TERM LOAN MAR0ET It is a market where short#term loans are given to corporate customers for meeting their working capital re6uirements. $ommercial banks play a significant role in this market. $ommercial banks provide short term loans in the form of cash credit and overdraft. =verdraft facility is mainly given to business people whereas cash credit is given to industrialists. =verdraft is purely a temporary accommodation and it is given to in the current itself. +ut cash credit is for a period of one year and it is sanctioned in a separate account. FOREI1N E<CHAN1E MAR0ET The term foreign exchange refers to the process of converting home currencies into foreign currencies and vice versa. !ccording to 7r. /aul ?inzing, -"oreign ?xchange is the system or process of converting one national currency into another, and of transferring money from one country to another.. The market where foreign exchange transactions take place is called a foreign exchange market. It does not refer to a market place in the physical sense of the term. In fact, it consists of a number of dealers, banks and
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brokers engaged in the business of buying and selling foreign exchange. It also includes the central bank of each country and the treasury authorities who enter into this market as controlling authorities. Those engaged in the foreign exchange business are controlled by the "oreign ?xchange 'aintenance !ct @"?'!A. FUNCTIONS OF FOREI1N E<CHAN1E MAR0ET The most important functions of this market are4 To make necessary arrangements to transfer purchasing power from one country to another. To provide ade6uate credit facilities for the promotion of foreign trade To cover foreign exchange risks by providing hedging facility In India, the foreign exchange business has a t r##-ti#r#d structure consisting of4 Trading (#t,##n (an+s and t #ir co&&#rcia" c*sto&#rs. Trading (#t,##n (an+s t ro*g a*t ori)#d (ro+#rs. Trading ,it (an+s a(road. +rokers play a significant role in the foreign exchange market in India. !part from !uthorized 7ealers, the 2+I has permitted licensed hotels and individuals @known as authorized money changersA to deal in foreign exchange business. The "?'! helps to smoothen the flow of foreign currency and to prevent any misuse of foreign exchange which is a scarce commodity.

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CHAPTER.=-FINANCIAL RATES OF RETURN 'ost households in India still prefer to invest on physical assets like land, buildings, gold, silver etc. +ut, studies have shown that investment in financial assets like e6uities in capital market fetches more return than investments on gold. It is imperative that one should have some basic knowledge about the rate of return on financial assets also. The return on government securities and bonds are comparatively less than on corporate securities due to lower risk involved therein. The government and the 2+I determine the interest rates on government securities. Thus, the interest rates are administered and controlled. The peculiar feature of the interest rate structure is that the interest rates do not reflect the free market forces. They do not reflect the scarcity value of capital in the country also. 'ost of these rates are fixed on an adhoc basis depending upon the credit and monetary policy of the government. 1#n#ra""%> t # int#r#st rat# .o"ic% o$ t # go-#rn&#nt is d#sign#d to ac i#-# t # $o""o,ing2 To enable the government to borrow comparatively cheaply To ensure stability in the macro#economic system To support certain sectors through preferential lending rates To mobilize substantial savings in the economy The interest rate structure for bank deposits and bank credits is also influenced by the 2+I. ,ormally, interest is a reward for risk undertaken through investment and at the same time it is a return for abstaining from consumption. The interest rate structure should allocate scarce capital

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between alternative uses. ;nfortunately, in India the administered interest rate policy of the government fails to perform the role of allocating scarce resources between alternative uses. RECENT TRENDS %ith a view to bringing the interest rates nearer to the free market rates, the government has taken the following steps4 The interest rates on company deposits are freed. The interest rates on 1:8 days. Treasury bills are determined by auctions and they are expected to reflect the free market rates. The coupon rates on government loans have been revised upwards so as to be market oriented. The interest rates on debentures are allowed to be fixed by companies depending upon the market rates. The maximum rates of interest payable on bank deposit are freed for deposits of above one year. Thus, all attempts are being taken to adopt a realistic interest rate policy so as to give positive return in real terms ad usted for inflation. The proper functioning of any financial system re6uires a good interest rate structure.

0B

CHAPTER.?-FINANCIAL INSTRUMENTS "inancial instruments refer to those documents which represent financial claims on assets. !s discussed earlier, financial asset refers to a claim to the repayment of a certain sum of money at the end of a specified period together with interest or dividend. E3. +ills of ?xchange, promissory note, treasury bill, government bond, deposit receipt, share, debenture, etc. The innovative instruments introduced in India have been discussed later in the chapter "inancial )ervices. "inancial instruments can also be called financial securities. "inancial securities can be classified into4 Pri&ar% or dir#ct s#c*riti#s. S#condar% or indir#ct s#c*riti#s. PRIMARY SECURITIES2 These are securities directly issued by the ultimate investors to the ultimate savers. E3. )hares and debentures issued directly to the public. SECONDARY SECURITIES2 These are securities issued by some intermediaries called financial intermediaries to the ultimate savers. ?x. ;nit Trust of India and mutual funds issue securities in the form of units to the public and the money pooled is invested in companies. !gain these securities may be classified on the basis of duration as follows3

0D

A' S ort-t#r& s#c*riti#s2 )hort#term securities are those which mature within a period of one year. E3. +ill of ?xchange, Treasury bill, etc. !' M#di*& t#r& s#c*riti#s2 'edium term securities are those which have a maturity period ranging between one and five years. E3. 7ebentures maturing within a period of 9 years. C' Long-t#r& s#c*riti#s2 Cong#term securities are those which have a maturity period of more than 9years. E3. &overnment bonds maturing after (E years. CHARACTERISTIC FEATURES OF FINANCIAL INSTRUMENTS &enerally speaking, financial instruments possess the following characteristic features4 I 'ost of the instruments can be easily transferred from one hand to another without many cumbersome formalities. I They have a ready market, i.e., they can be bought and sold fre6uently and thus, trading in these securities is made possible. I They possess li6uidity. i.e., some instruments can be converted into cash readily. E3. ! bill of exchange can be converted into cash readily by means of discounting and re#discounting. I 'ost of the securities possess security value, i.e., they can be given as security for the purpose of raising loans. I )ome securities en oy tax status, i.e., investments in these securities are exempted from income tax, wealth tax, etc., sub ect to certain limits.
1E

E3. /ublic )ector Tax "ree +onds, 'agnum Tax )aving $ertificates. I They carry risk in the sense that there is uncertainty with regard to payment of principal or interest or dividend as the case may be. I These instruments facilitate futures trading so as to cover risks due to price fluctuations, interest rate fluctuations, etc. I These instruments involve less handling costs since expenses involved in buying and selling these securities are generally much less. I The return on these instruments is directly in proportion to the risk undertaken. I These instruments may be short#term or medium term or long#term depending upon the maturity period of these instruments. MULTIPLICITY OF FINANCIAL INSTRUMENTS The expansion in size and number of financial institutions has conse6uently led to a considerable increase in the financial instruments also. ,ew instruments have been introduced in the form of innovative schemes of CI$, ;TI, +anks, /ost =ffice )avings +ank !ccounts, )hares and debentures of different varieties, public sector bonds, national savings scheme, national savings certificates, provident funds, relief bonds, Indira vikas patras, etc. Thus different types of instruments are available in the financial system so as to meet the diversified re6uirements of varied investors and thereby making the system more healthy and vibrant. IMPORTANT INSTRUMENTS COMMERCIAL PAPER2

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-$ommercial paper is an unsecured and discounted promissory note issued to finance the short#term credit needs of large institutional buyers. +anks, corporations and foreign governments commonly use this type of funding.. T # c aract#ristics o$ co&&#rcia" .a.#r2 ;nsecured debt. +earer or depository trust company eligible. ! depository trust company is a firm through which the members can use a computer to arrange for investment securities to be delivered to other members via computer, thus there is no physical delivery of the securities. ! depository trust company uses computerized debit and credit entries. 7iscount @most commonA. ! discount is the difference between the purchase price of a security and its par @faceA value. This discount represents the income to be earned on the security, and will be accreted over the life of the security. /urchased direct or through dealers. T # ad-antag#s o$ in-#sting in co&&#rcia" .a.#r2 $heaper source of funds than limits set by banks. =ptimal combination of li6uidity return. 5ighly li6uid instrument. Transferable by endorsement J delivery. +acked by li6uidity J earnings of issuer. Issued for a minimum period of 1E days and a maximum up to one year .
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Issued at a discount to face value. Issued in demat form. @$ompulsory demat from Huly KE(A. To obtain cash with which to take advantage of cash discounts offered by trade creditors. To establish national credit. To keep a reserve of borrowing power at local banks. To borrow at cheaper rates than is possible at your local banks. To establish a broader market for the paper than is possible locally. Cocal savers may provide less costly funds3 an important habit among clients and the public is rewarded. Cower interest loans provide experience for '"I in borrowed funds. Cocal banks become familiar with ')? @micro and small enterpriseA potentials. !ccess to larger sums more 6uickly based on track record. !llows longer term pro ections than grants. T # disad-antag#s o$ co&&#rcia" .a.#r2 5igher financial costs force organizational decisions and changes. )ubstantial initial collateral re6uirements. 'ore risky as debt holders can force closure of '"I. 'ore tricky cash flow management as principal is repaid. ?arly negotiations re6uire a new set of skills and contacts. Cocal banks may not be willing to be cooperative. Coans may be dollarized in an inflationary situation. Too many subsidized loans can retard move to market rate.

11

R!I 1UIDELINES FOR COMMERCIAL PAPER 6@11 Introd*ction 2 $ommercial /aper @$/A is an unsecured money market instrument issued in the form of a promissory note. $/, as a privately placed instrument, was introduced in India in (DDE with a view to enable highly rated corporate borrowers to diversify their sources of short#term borrowings and to provide an additional instrument to investors. )ubse6uently, primary dealers @/7sA and all#India financial institutions were also permitted to issue $/ to enable them to meet their short#term funding re6uirements. The guidelines for issue of $/, incorporating all the amendments issued till date, are given below for ready reference. E"igi("# iss*#rs o$ CP 2 $orporate, /7s and all#India financial institutions @"IsA that have been permitted to raise short#term resources under the umbrella limit fixed by the 2eserve +ank of India @2+IA are eligible to issue $/. ! corporate would be eligible to issue $/ provided4 @aA the tangible net worth of the company, as per the latest audited balance sheet, is not less than 2s.8crore. @bA the company has been sanctioned working capital limit by bankLs or "Is and @cA the borrowed account of the company is classified as a )tandard !sset by the financing bankLinstitution. Rating R#A*ir#&#nt 2 !ll eligible participants shall obtain credit rating for issuance of $/ from any one of the following credit rating agencies @$2!sA, viz. the $redit

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2ating Information )ervices of India Ctd. @$2I)ICA, the Investment Information and $redit 2ating !gency of India Ctd. @I$2!A, the $redit !nalysis and 2esearch Ctd. @$!2?A, the "IT$5 2atings India /vt. Ctd. and such other $2!s as may be specified by the 2+I from time to time, for the purpose. The minimum credit rating shall be /#0 of $2I)IC or such e6uivalent rating by other $2!s. The issuers shall ensure at the time of issuance of the $/ that the rating so obtained is current and has not fallen due for review. Mat*rit% 2 $/ can be issued for maturities between a minimum of > days and a maximum of up to one year from the date of issue. The maturity date of the $/ should not go beyond the date up to which the credit rating of the issuer is valid. D#no&inations 2 $/ can be issued in denominations of 2s.9 lakh or multiples thereof. !mount invested by a single investor should not be less than 2s.9 lakh @face valueA. Li&its and t # A&o*nt o$ Iss*# o$ CP 2 @aA $/ can be issued as a K3stand aloneK3 product. The aggregate amount of $/ from an issuer shall be within the limit as approved by its +oard of 7irectors or the 6uantum indicated by the $2! for the specified rating, whichever is lower. +anks and "Is will, however, have the flexibility to fix working capital limits, duly taking into account the resource pattern of companys financing, including $/s.

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@bA!n "I can issue $/ within the overall umbrella limit prescribed in the 'aster $ircular on 2esource 2aising ,orms for "Is, issued by 7+=7 and updated from time#to#time. @cAThe total amount of $/ proposed to be issued should be raised within a period of two weeks from the date on which the issuer opens the issue for subscription. $/ may be issued on a single date or in parts on different dates provided that in the latter case, each $/ shall have the same maturity date. @dA?very issue of $/, including renewal, should be treated as a fresh issue. Iss*ing and Pa%ing Ag#nt BIPA' 2 =nly a scheduled bank can act as an I/! for issuance of $/. In-#st&#nt in CP 2 $/ may be issued to and held by individuals, banking companies, other corporate bodies @registered or incorporated in IndiaA and unincorporated bodies, ,on#2esident Indians and "oreign Institutional Investors @"IIsA. 5owever, investment by "IIs would be within the limits set for them by )ecurities and ?xchange +oard of India @)?+IA. Trading in CP 2 !ll =T$ trades in $/ shall be reported within (9 minutes of the trade to the "ixed Income 'oney 'arket and 7erivatives !ssociation of India @"I''7!A reporting platform. Mod# o$ Iss*anc# 2 @aA$/ can be issued either in the form of a promissory note @)chedule IA or in a dematerialized form through any of the depositories approved by and registered with )?+I.

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@bA$/ will be issued at a discount to face value as may be determined by the issuer. @cA,o issuer shall have the issue of $/ underwritten or co#accepted. Pr#$#r#nc# $or D#&at#ria"i)ation 2 %hile option is available to both issuers and subscribers to issueLhold $/ in dematerialized or physical form, issuers and subscribers are encouraged to opt for dematerialized form of issueLholding. 5owever, with effect from Hune 1E, 0EE(, banks, "Is and /7s are re6uired to make fresh investments and hold $/ only in dematerialized form. Pa%&#nt o$ CP 2 The initial investor in $/ shall pay the discounted value of the $/ by means of a crossed account payee che6ue to the account of the issuer through I/!. =n maturity of $/, when $/ is held in physical form, the holder of $/ shall present the instrument for payment to the issuer through the I/!. 5owever, when $/ is held in demat form, the holder of $/ will have to get it redeemed through the depository and receive payment from the I/!. Proc#d*r# $or Iss*anc# 2 ?very issuer must appoint an I/! for issuance of $/. The issuer should disclose to the potential investors its financial position as per the standard market practice. !fter the exchange of deal confirmation between the investor and the issuer, issuing company shall issue physical certificates to the investor or arrange for crediting the $/ to the investorKs account with a depository. Investors shall be given a copy of I/! certificate to the effect that the issuer has a valid agreement with the I/! and documents are in order @)chedule IIA. Doc*&#ntation Proc#d*r# 2

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@aATo ensure smooth functioning of the $/ market and provide operational flexibility, the "I''7! may, in consultation with the 2+I, prescribe any standardized procedure and documentation that are to be followed by the participants, in consonance with the international best practices. Issuers L I/!s may refer to the detailed guidelines issued by "I''7! on Huly 9, 0EE( in this regard. @bAGiolation of these guidelines will attract penalties and may also include debarring of the entity from the $/ market. D#$a*"ts in CP &ar+#t 2 In order to monitor defaults in redemption of $/s, I/!s, are advised to immediately report, on occurrence, full particulars of defaults in repayment of $/s to the "inancial 'arkets 7epartment, 2eserve +ank of India, $entral =ffice, "ort, 'umbai#8EEEE( in the format as given in !nnex I. Non-a.."ica(i"it% o$ C#rtain Ot #r Dir#ctions 2 ,othing contained in the ,on#+anking "inancial $ompanies !cceptance of /ublic 7eposits @2eserve +ankA 7irections, (DDB shall apply to any non# banking financial company @,+"$A insofar as it relates to acceptance of deposit by issuance of $/, in accordance with these &uidelines. CERTIFICATE OF DEPOSITS2 -! certificate of deposit is a promissory note issued by a bank. It is a time deposit that restricts holders from withdrawing funds on demand. !lthough it is still possible to withdraw the money, this action will often incur a penalty.. T # c aract#ristics o$ C#rti$icat# o$ d#.osits2
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$7s can be issued by all scheduled commercial banks, selected all India financial institutions, and permitted by 2+I. 'inimum period (9 days. 'aximum period (year. 'inimum !mount 2s (lakh and in multiples of 2s. (lakh. $7s are transferable by endorsement. $22 J )C2 are to be maintained. $7s are to be stamped. $7s may be issued at discount on face value. Interest calculations are mostly based upon a standard 1:E days in a year called actualL1:E but some are actualL1:9. Investment is dependent solely upon the credit worthiness of the bank deposits. T # ad-antag#s o$ C#rti$icat# o$ D#.osit2 )ince one can know the returns from before, the certificates of deposits are considered much safe. =ne can earn more as compared to depositing money in savings account. The "ederal Insurance $orporation guarantees the investments in the certificate of deposit. T # disad-antag#s o$ C#rti$icat# o$ d#.osit2 !s compared to other investments the returns is less.

1D

The money is tied along with the long maturity period of the $ertificate of 7eposit. 5uge penalties are paid if one gets out of it before maturity. Investors can redeem bank#issued $7s prior to maturity. 5owever, you will typically be charged an early withdrawal penalty. These penalties are set by each bank and differ nationwide. ;nlike Treasury notes, the interest on $7s is not exempt from state and local taxes. $7s are fully taxable at the state, local and federal levels. The investment is locked in at a specific rate, even if interest rates increase. R!I 1UIDELINES FOR CERTIFICATE OF DEPOSITS 6@11 Introd*ction 2 $ertificate of 7eposit @$7A is a negotiable money market instrument and issued in dematerialized form or as a ;sance /romissory ,ote against funds deposited at a bank or other eligible financial institution for a specified time period. &uidelines for issue of $7s are presently governed by various directives issued by the 2eserve +ank of India, as amended from time to time. The guidelines for issue of $7s incorporating all the amendments issued till date are given below for ready reference. E"igi(i"it% 2 $7s can be issued by @iA scheduled commercial banks excluding 2egional 2ural +anks @22+sA and Cocal !rea +anks @C!+sA3 and @iiA select all#India "inancial Institutions that have been permitted by 2+I to raise short#term resources within the umbrella limit fixed by 2+I.

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Aggr#gat# A&o*nt 2 @aA+anks have the freedom to issue $7s depending on their re6uirements. @bA!n "I may issue $7s within the overall umbrella limit fixed by 2+I, i.e., issue of $7 together with other instruments, viz., term money, term deposits, commercial papers and inter#corporate deposits should not exceed (EE per cent of its net owned funds, as per the latest audited balance sheet. Mini&*& Si)# o$ Iss*# and D#no&inations 2 'inimum amount of a $7 should be 2s.(lakh, i.e., the minimum deposit that could be accepted from a single subscriber should not be less than 2s.( lakh and in the multiples of 2s. (lakh thereafter. In-#stors 2 $7s can be issued to individuals, corporations, companies, trusts, funds, associations, etc. ,on# 2esident Indians @,2IsA may also subscribe to $7s, but only on non#repatriable basis, which should be clearly stated on the $ertificate. )uch $7s cannot be endorsed to another ,2I in the secondary market. Mat*rit% 2 @aAThe maturity period of $7s issued by banks should be not less than > days and not more than one year. @bAThe "Is can issue $7s for a period not less than ( year and not exceeding 1 years from the date of issue. Disco*nt C Co*.on Rat# 2 $7s may be issued at a discount on face value. +anks L "Is are also allowed to issue $7s on floating rate basis provided the methodology of compiling the floating rate is ob ective, transparent and market#based. The issuing bank L "I is free to determine the discount L coupon rate. The interest rate on

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floating rate $7s would have to be reset periodically in accordance with a pre#determined formula that indicates the spread over a transparent benchmark. R#s#r-# R#A*ir#&#nts 2 +anks have to maintain appropriate reserve re6uirements, i.e., cash reserve ratio @$22A and statutory li6uidity ratio @)C2A, on the issue price of the $7s. Trans$#ra(i"it% 2 $7s in physical form are freely transferable by endorsement and delivery. $7s in demat form can be transferred as per the procedure applicable to other demat securities. There is no lock#in period for the $7s. Loans C !*%-(ac+s 2 +anks L "Is cannot grant loans against $7s. "urthermore, they cannot buy# back their own $7s before maturity. 5owever, the 2eserve +ank may relax these restrictions for temporary periods through a separate notification. S#c*rit% As.#ct 2 )ince $7s in physical form are freely transferable by endorsement and delivery, it will be necessary for banks to see that the certificates are printed on good 6uality security paper and necessary precautions are taken to guard against tampering with the document. They should be signed by two or more authorized signatories. Iss*# o$ D*."icat# C#rti$icat#s 2 @aAIn case of the loss of physical certificates, duplicate certificates can be issued after compliance with the following4 @iA! notice is re6uired to be given in at least one local newspaper3

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@iiACapse of a reasonable period @say (9 daysA from the date of the notice in the newspaper3 and @iiiA?xecution of an indemnity bond by the investor to the satisfaction of the issuer of $7s @bAThe duplicate certificate should be issued only in physical form. ,o fresh stamping is re6uired as a duplicate certificate is issued against the original lost $7. The duplicate $7 should clearly state that the $7 is a 7uplicate one stating the original value date, due date, and the date of issue @as M7uplicate issued on NNNNNNNNMA. Acco*nting 2 +anks L "Is may account the issue price under the 5ead M$7s issuedM and show it under deposits. !ccounting entries towards discount will be made as in the case of Mcash certificatesM. +anks L "Is should maintain a register of $7s issued with complete particulars. TREASURY !ILLS2 Treasury +ills are money market instruments to finance the short term re6uirements of the &overnment of India. These are discounted securities and thus are issued at a discount to face value. The return to the investor is the difference between the maturity value and issue price. T%.#s o$ Tr#as*r% !i""s There are different types of Treasury bills based on the maturity period and utility of the issuance like4 Ad- oc Tr#as*r% (i""s> 8 &ont s> ? &ont s and 16&ont s Tr#as*r% (i""s #tc.
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In India, at present, the Treasury +ills are issued for the following tenors D(#days, (B0#days and 1:8#days Treasury bills. C aract#ristic o$ tr#as*r% (i""s 2 For& 2 The treasury bills are issued in the form of promissory note in physical form or by credit to )ubsidiary &eneral Cedger @)&CA account or &ilt account in dematerialized form. Mini&*& A&o*nt O$ !ids 2 +ids for treasury bills are to be made for a minimum amount of 2s 09EEEL# only and in multiples thereof. E"igi(i"it% 2 !ll entities registered in India like banks, financial institutions, /rimary 7ealers, firms, companies, corporate bodies, partnership firms, institutions, mutual funds, "oreign Institutional Investors, )tate &overnments, /rovident "unds, trusts, research organizations, ,epal 2ashtra bank and even individuals are eligible to bid and purchase Treasury bills. R#.a%&#nt 2 The treasury bills are repaid at par on the expiry of their tenor at the office of the 2eserve +ank of India, 'umbai. A-ai"a(i"it% 2 !ll the treasury +ills are highly li6uid instruments available both in the primary and secondary market. Da% Co*nt 2 "or treasury bills the day count is taken as 1:9 days for a year.

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T # ad-antag#s o$ Tr#as*r% !i""s2 T#bills remain one of the safest investments for investors. The advantage of purchasing these short terms, li6uid instruments, is access to your funds at any time, with the peace of mind knowing that your funds will not be tied up in long term investments, should an emergency arise. T#bills can be held to maturity, with constant roll over into other T# bill purchases, or can be sold at any time an investor chooses. $ompared with commercial banks and other financial institutions rates, the Treasury +ills sometimes offer the highest interest rate available. Treasury +ills provide a regular income or cash flow which can be used to supplement your existing income or provide an income if you are retired. Treasury +ills can easily be converted to cash on maturity, or they may be sold if you need the money before the maturity dates. !s Treasury +ills are an income generating asset, they can be used as collateral for loans from banks and other financial institutions. Treasury +ills offer a simple mode of preserving J protecting your investment T # disad-antag#s o$ Tr#as*r% !i""s2 The main disadvantage of Treasury +ills is that income from Treasury +ills is fixed for the term of the investment. In times of high inflation, the purchasing power of your money will be reduced.

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The only downside to T#bills is that you wonKt get a great return

because Treasuries are exceptionally safe. $orporate, certificates and money market funds will often give higher rates of interest. %hats more, you might not get back all of your investment if you cash out before the maturity date.

CHAPTER.D- DE5ELOPMENT OF FINANCIAL SYSTEM IN INDIA2 )ome serious attention was paid to the development of a sound financial system in India only after the launching of the planning era in the country.
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!t the time of independence in (D8>, there was no strong financial institutional mechanism in the country. There was absence of issuing institutions and non#participation of intermediary financial institutions. The industrial sector also had no access to the savings of the community. The capital market was very primitive and shy. =n the whole, chaotic conditions prevailed in the system. %ith the adoption of the theory of mixed economy, the development of the financial system took a different true so as to fulfill the socio#economic and political ob ectives. The government started creating new financial institutions to supply finance both for agricultural and industrial development and it also progressively started nationalizing some important financial institutions so that the flow of finance might be in the right direction. NATIONALISATION OF FINANCIAL INSTITUTIONS2 !s stated earlier the 2+I is the leader of the financial system. +ut, it was established as private institution in(D19. It was nationalized in (D8B. It was followed by the nationalization of the Imperial +ank of India in (D9: by renaming it as )tate +ank of India. In the same year, 089 life insurance companies were brought under government control by merging all of them into a single corporation called Cife Insurance $orporation of India. !nother significant development in our financial system was the nationalization of (8 ma or commercial banks in (D:D.!gain, : banks were nationalized in (DBE. This process was then extended to &eneral Insurance $ompanies which were reorganized under the name of &eneral Insurance $orporation of India. Thus, the important financial institutions were brought under public control. ROLE OF FINANCIAL SYSTEM IN ECONOMIC DE5ELOPMENT2
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The pace of economic development and the rate of growth of the economy are entirely dependent upon the extent of financial development in a country. %hile financial development becomes a part of the overall economic development of a country, it enables the economy from within to realize its potential development. In the absence of financial development, the gulf between actual development and potential development would be very wide. E3. The Indian economy of the (Bth century and that of the present century. 7evelopment of the financial system entails setting up of a variety of financial institutions in the country so that all possible real resources in the economy are mobilized with the help of monetary resources. !lthough monetary resources are only a claim on the real resources, the development of real resources in the economy cannot be imagined without the monetary resources. T #r# ar# t,o di$$#r#nt -i#,s #3.r#ss#d ,it r#gard to t # r#"ations i. (#t,##n $inancia" d#-#"o.&#nt and #cono&ic gro,t . According to on# -i#,, an efficient financial system#effectively mobilizes scarce financial resource and allocates them to their best possible use through the market mechanism. According to t # ot #r -i#,, financial development takes place as a result of economic developments. 5owever, it is a fact that both economic development and financial development are mutually complementary. It means that while economic development leads to financial development, it is also led by financial development. In fact the role of financial development in accelerating the process of economic development cannot be simply denied. The role of financial system in relation to economic growth can be explained in terms of the ability of the financial markets to reduce risks and uncertainty and make
8B

the best possible or the most profitable use of resources. The financial system must also reconcile the re6uirements of efficient use of resources and the development re6uirements of the economy. This however cannot be achieved through the market mechanism and hence the role of the government in the financial system is warranted so that scarce resources in the economy are also used for obtaining economic development in such a manner that the competing re6uirements of e6uity and efficiency in financial allocations achieved. The banks and non#banking financial companies on the one hand and the stock markets on the other facilitate mobilization and allocation of resources. %hile market financial systems have played important role in the economic growth and development of countries like ;)! and ;*, bank# based financial system has dominated the financial systems of countries like Hapan and &ermany. 4EA0NESSES OF INDIAN FINANCIAL SYSTEM2 !fter the introduction of planning, rapid industrialization has taken place. It has in turn led to the growth of the corporate sector and the government sector. In order to meet the growing re6uirements of the government and the industries, many innovative financial instruments have been introduced. +esides, there has been a mushroom growth of financial intermediaries to meet the ever growing financial re6uirements of different types of customers. 5ence, the Indian financial system is more developed and integrated today than what it was 9E years ago. Oet, it suffers from some weaknesses as listed below4 LAC0 OF CO-ORDINATION !ET4EEN DIFFERENT FINANCIALINSTITUTIONS2
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There are a large number of financial intermediaries. 'ost of the vital financial institutions are owned by the government. !t the same time, the government is also the controlling authority of these institutions. !s there is multiplicity of institutions in the Indian financial system, there is lack of co# ordination in the working of these institutions. MONOPOLISTIC MAR0ET STRUCTURES2 In India some financial institutions are so large that they have created a monopolistic market structures in the financial system. ?x. The entire life insurance business is in the hands of CI$. The ;TI has more or less monopolized the mutual fund industry. The weakness of this large structure is that it could lead to inefficiency in their working or mismanagement or lack of effort in mobilizing savings of the public and so on. ;ltimately it would retard the development of the financial system of the country itself. DOMINANCE OF DE5ELOPMENT !AN0S IN INDUSTRIAL FINANCIN12 The development banks constitute the backbone of the Indian financial system occupying an important place in the capital market. The industrial financing today in India is largely through the financial institutions created by the government both at the national and regional levels. These development banks act as distributive agencies only, since, they derive most of their funds from their sponsors. !s such, they fail to mobilize the savings of the public. This would be a serious bottleneck which stands in the ways of the growth of an efficient financial system in the country. "or industries abroad, institutional finance has been a result of institutionalization
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of personal savings through media like banks, CI$, pension and provident funds, unit trusts and so on. +ut they play a less significant role in Indian financial system, as far as industrial financing is concerned. 5owever, in recent times attempts are being made to raise funds from the public through the issue of bonds, units, debentures and so on. It will go a long way in forging a link between the normal channels of savings and the distributing mechanism. INACTI5E AND ERRATIC CAPITAL MAR0ET2 The important function of any capital market is to promote economic development through mobilization of savings and their distribution to productive ventures. !s far as industrial finance in India is concerned, corporate customers are able to raise their financial resources through development banks. )o, they need not go to the capital market. 'oreover, they dont resort to capital market since it is very erratic and inactive. Investors too prefer investments in physical assets to investments in financial assets. The weakness of the capital market is a serious problem in our financial system. IMPRUDENT FINANCIAL PRACTICE2 The dominance of development banks has developed imprudent financial practice among corporate customers. The development banks provide most of the funds in the form of term loans. )o there is a preponderance of debt in the financial structure of corporate enterprises. This predominance of debt capital has made the capital structure of the borrowing concerns uneven and lopsided. To make matters worse, when corporate enterprises face any

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financial crisis, these financial institutions permit a greater use of debt than is warranted. It is against the traditional concept of a sound capital structure. 5owever, in recent times all effort have been taken to activate the capital market. Integration is also taking place between different financial institutions. E3. The ;nit Cinked Insurance )chemes of the ;TI are being offered to the public in collaboration with the CI$. )imilarly, the refinance and rediscounting facilities provided by the I7+I aim at integration. Thus, the Indian financial system has become a developed one.

CHAPTER.E- RE1ULATORY SYSTEM2 The government of India is responsible to regulate the financial market in India. The two important regulatory institutions of the government of India
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are the 2eserve +ank of India and the securities and exchange board of India. The 2eserve +ank of India is the central bank of the country and as the apex monetary authority, it performs the following central banking and development functions4 It provides currency and operates the clearing system for the banks It formulates and implements the monetary and credit policies It serves as the bankers bank It supervises the operations of credit institutions It regulates foreign exchange transactions. It controls the fluctuations in the exchange value of the rupee. It seeks to integrate the financial system in India It encourages banking development in India It influences the allocation of credit, and It promotes the development of new institutions. T # S#c*riti#s and E3c ang# !oard of India is responsible for dealing with various matters pertaining to the capital market. The )?+I is responsible for the following4 2egulate the business in stock exchanges and any other securities markets 2egister and regulate the capital market intermediaries @brokers, merchant bankers, portfolio managers, etcA 2egister and regulate the working of mutual funds /romote and regulate self#regulatory organizations /rohibit fraudulent and unfair trade practices in securities markets

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/romote investors education and training of intermediaries of securities markets 2egulate substantial ac6uisition of shares and takeovers of companies /rohibit insider trading in securities. CONCLUSION The word MsystemM in the term Mfinancial systemM, implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. The financial system is concerned about money, credit and finance#the three terms are intimately related yet are somewhat different from each other. Indian financial system consists of financial market, financial instruments and financial intermediation. It refers to sources of raising revenue for the activities and functions of a &overnment. 5ere some of the definitions of the word KfinanceK both as a source and as an activity i.e. as a noun and a verb. !n efficient functioning of the financial system facilitates the free flow of funds to more productive activities and thus promotes investment. Thus, the financial system provides the intermediation between savers and investors and promotes faster economic development.

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