UNIT - 1 [Autosaved].pptx

FINANCIAL
INSTITUTIONS AND
SERVICES

Unit 1
School of Allied Sciences,
DMIHER (DU)

Objectives
After completing this session, you will be able to:
UNDERSTAND the Financial Systems and Financial Markets.
DMIHER (DU)

CO-PO MAPPING
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School of Allied Sciences DMIHER (DU)

FINANCIAL SYSTEM
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A financial system is the set of global, regional, or firm-specific
institutions and practices used to facilitate the exchange of funds.
Financial systems can be organized using market principles,
central planning, or a hybrid of both.
Institutions within a financial system include everything from
banks to stock exchanges and government treasuries.

DEFINITION OF FINANCIAL SYSTEM
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In the worlds of Van Horne, “financial system
allocates savings efficiently in an economy to
ultimate users either for investment in real
assets or for consumption”.

FUNCTIONS OF FINANCIAL SYSTEM
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1. Regulation of currency
2. Banking functions
3. Performance of agency services and custody of cash reserves
4. Management of national reserves of international currency
5. Credit control:

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6. Ensure stability of the economy
7. Supply and deployment of funds for productive use
8. Maintaining liquidity
9. Price determination
10. Information aggregation and coordination

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11. Risk sharing
12. Improve efficiency
13. Ensure long term growth to itself:

COMPONENTS OF FINANCIAL SYSTEM
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1. Regulatory Authorities
2. Financial Institutions
3. Financial Markets
4. Financial Instruments
5. Payment and Settlement Infrastructure.

REGULATORY AUTHORITIES
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The main component of any financial system is the
regulatory system it has. In any economy, the financial
system is regulated by the central banking authority of
that country. In India, the central banking bank is named
as the Reserve Bank of India.

REGULATORY AUTHORITIES
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Reserve Bank of India (RBI): The regulation and supervision of banking institutions is mainly governed by
the Companies Act, 1956, Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980,
Bankers' Books Evidence Act, Banking Secrecy Act and Negotiable Instruments Act, 1881.
Securities and Exchange Board of India (SEBI): The Securities and Exchange Board of India was made a
statutory body on April 12, 1992 in accordance with the provisions of the Securities and Exchange Board of
India Act, 1992 to protect the interests of investors in securities and to promote the development of, and to
regulate the securities market and for matters connected therewith or incidental thereto.
Insurance Regulatory and Development Authority (IRDA): Insurance Regulatory and Development Authority
regulates and supervises the insurance industry-insurance companies and their agents and insurance
brokers to protect the interests of the policyholders, to regulate, promote and ensure orderly growth of the
insurance industry and for matters connected therewith or incidental thereto.

Financial Institutions
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The financial system consists of many financial institutions. While most of them are
regulated by the Reserve Bank, there are some which it manages just indirectly.
Institutions regulated by the Reserve Bank of India
The institutions regulated by the RBI are:
1. Nationalised Commercial Banks
2. Specialised Banks
3. Registered Finance Companies
4. Registered Finance Leasing Establishments
5. Micro-finance Institutions

Financial Institutions
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Institutions not regulated by the Reserve Bank of India
Certain financial institutions are not regulated by the Reserve Bank of India. These include
securities firms, investment banks and mutual funds which come under the purview of the
SEBI, Insurance Companies and Insurance Brokers which are regulated by the IRDA, etc.

Financial Markets
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The Financial Market, which is the market for credit and capital, can be divided into the Money Market and the Capital Market. The
Money Market is the market for short-term interest-bearing assets.
Examples:
1. Treasury bills
2. Commercial paper
3. Certificates of deposits
The major task of the Money Market is to facilitate liquidity management in the economy. The Capital Market is the market for
trading in medium-long-term assets.
Examples:
1. Treasury bonds
2. Private debt securities (bonds and debentures)
3. Equities (shares)

Financial Markets
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The main purpose of the Capital Market is to facilitate the raising of long-term funds.
The main issuers in the
1. Money Market are the Government, banks and private companies, while the main
investors are banks, insurance companies and pension and provident funds.
2. Capital Market are the Government, banks and private companies, while the main
investors are pension and provident funds and insurance companies.

FINANCIAL MARKETS
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The term ‘financial markets’ refers to those marketplaces where financial assets are bought
and sold. Financial assets include instruments like stocks and bonds. Broadly speaking, the
financial markets include various smaller marketplaces like the stock market, the bond
market, the forex market, the commodities market and the derivatives market.
Some financial markets are regulated, while some may not be. And as with any
marketplace, the prices of the financial assets traded in financial markets also keep
fluctuating based on a number of factors. Interested traders and investors can take
advantage of these price movements to earn returns on their investments

Functions of financial markets
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They enable the mobilization of money
They help determine the price of assets
They ensure liquidity of the assets
They help save time and money

Advantages
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It offers a platform for businesses to raise funds for both long and short-term investments.
Companies may obtain financing at a lesser cost than if they took out a high-interest loan from a commercial bank. Furthermore,
commercial banks do not provide large loans.
Companies have the freedom to obtain money from the market as needed until their authorized share capital is depleted.
Financial market intermediaries, such as banks and financial institutions, give financial and strategic advice to both corporations
and investors. They give information, advice, and professional services that might otherwise be unavailable.
It offers a platform for simultaneously trading and dealing with various shares, equities, bonds, derivatives, and other financial
instruments.
Financial market laws and regulations that are stricter assist to strengthen the economy by instilling trust in both investors and
businesses.
Provide a platform for worldwide money lending and borrowing in several currencies.

Disadvantages
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We can observe some of the financial market's drawbacks here.
Too many procedures imposed by regulatory organizations might lengthen the process.
Due to strict laws and restrictions, certain businesses are unable to access the financial
sector. They are unable to establish resources that need constant monitoring and
compliance checks.
Investors may lose money owing to a lack of knowledge or because they are uninformed of
the situation.
Companies may shift from being investor-driven to being profit-driven. It's critical that the
Board of Directors makes choices that benefit all of the company's stakeholders and avoids
manipulating investors' funds for personal gain.

Primary Market
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A primary market means the market for new issues of
securities, as distinguished from the secondary market,
where previously issued securities are bought and sold. A
market is primary if the proceeds of sales go to the issuer
of the securities sold. Buyers buy securities that were not
previously traded.

How Does A Primary Market Works?
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A primary market is a capital market that puts securities for sale initially. These assets enter the next
market when the primary buyers trade them further. This next marketplace becomes their secondary
market. In short, the primary market is the platform wherefrom investing begins.
Firms introduce new shares, bonds, bills, and notes in the market and sell them to investors for the
first time to raise capital. The investment banks set the initial price, which receives a fee in return for
undertaking sales. However, the remaining proportion of the earnings goes to the issuers.
Companies file statements with the Securities and Exchange Commission (SEC) and other agencies
as required to start with the primary market transaction. As soon as the stocks, bonds, and other
securities are traded for the first time in the primary market, they enter the secondary market for further
sale to other investors

Functions of Primary Market
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New Issue Offer
Underwriting Services
Distribution of New Issue

Types of Primary Market Issuance
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Public Issue
Private Placement
Preferential Issue
Qualified Institutional Placement
Rights and Bonus Issues

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Public Issue
Public issue is the most common method of issuing securities of
a company to the public at large. It is mainly done via Initial
Public Offering (IPO) resulting in companies raising funds from
the capital market. These securities are listed in the stock
exchanges for trading.

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Private Placement
When a company offers its securities to a small group of investors, it is
called private placement. Such securities may be bonds, stocks or
other securities, and the investors can be both individual and
institutional.
Private placements are easier to issue than initial public offerings as
the regulatory stipulations are significantly less. It also incurs reduced
cost and time, and the company can remain private.

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Preferential Issue
A preferential issue is one of the quickest methods available to
companies for raising capital. Both listed and unlisted companies can
issue shares or convertible securities to a select group of investors.
However, the preferential issue is neither a public issue nor a rights
issue.
The shareholders in possession of preference shares stand to receive
the dividend before the ordinary shareholders are paid

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Qualified Institutional Placement
Qualified institutional placement is another kind of private placement where
a listed company issues securities in the form of equity shares or partly or
wholly convertible debentures apart from such warrants convertible to equity
shares and purchased by a Qualified Institutional Buyer (QIB).
QIBs are primarily such investors who have the requisite financial
knowledge and expertise to invest in the capital market.

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Rights and Bonus Issues
Another issuance in the primary market is rights and bonus issue, in which the company
issues securities to existing investors by offering them to purchase more securities at a
predetermined price (in case of rights issue) or avail allotment of additional free shares (in
case of bonus issue).
For rights issues, investors retain the choice of buying stocks at discounted prices within a
stipulated period. Rights issue enhances control of existing shareholders of the company,
and also there are no costs involved in the issuance of these kinds of shares.
For bonus issues, stocks are issued by a company as a gift to its existing shareholders.
However, the issuance of bonus shares does not infuse fresh capital.

Advantages of Primary Market
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Companies can raise capital at relatively low cost, and the securities so issued in the primary market
provide high liquidity as the same can be sold in the secondary market almost immediately.
The primary market is an important source for mobilisation of savings in an economy. Funds are mobilised
from commoners for investing in other channels. It leads to monetary resources being put into investment
options.
The chances of price manipulation in the primary market are considerably less when compared to the
secondary market. Such manipulation usually occurs by deflating or inflating a security price, thereby
deliberately interfering with fair and free operations of the market.
The primary market acts as a potential avenue for diversification to cut down on risk. It enables an investor
to allocate his/her investment across different categories involving multiple financial instruments and
industries.
It is not subject to any market fluctuations. The prices of stocks are determined before an initial public
offering, and investors know the actual amount they will have to invest.

Disadvantages of Primary Market
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There may be limited information for an investor to access before investment in an IPO since unlisted
companies do not fall under the purview of regulatory and disclosure requirements of the Securities and
Exchange Board of India.
Each stock is exposed to varying degrees of risk, but there is no historical trading data in a primary market
for analysing IPO shares because the company is offering its shares to the public for the first time through
an initial public offering.
In some cases, it may not be favorable for small investors. If a share is oversubscribed, small investors may
not receive share allocation.
With this information regarding the primary market, individuals can make a well-thought-out decision
regarding investment in the market. It also makes way for the creation of an investment portfolio with
diversified risk.

SECONDARY MARKET
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A secondary market is a financial market where previously issued financial
instruments are traded. Investors trade in securities that have already been traded in
primary market. Instead of the original issuing identity, investors are freely involved
in trading within the secondary market.
Unlike the primary market, the original issuers of the securities do not participate in
the transactions of secondary market. Instead, the transactions take place between
investors, facilitated by intermediaries such as stock exchanges, brokerage firms,
and investment banks. Secondary markets provide liquidity to investors, allowing
them to easily buy and sell securities based on investing needs and objectives.

How does the secondary Market work?
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Functions of The Secondary Market
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Liquidity
Market Efficiency
Price Discovery

Types of Secondary Markets
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The Stock Exchange: Stock exchanges are secondary markets of a massive scale that a
high percentage of the population participates in for trading. In India, the best examples of
secondary markets are the National Stock Exchange and the Bombay Stock Exchange.
Over-The-Counter Market: The over the counter secondary market is a place where the
stock exchange is not involved. This is a platform where investors trade among themselves
with the shares that they own. Since there is no regulatory authority or compulsion involved
with this manner of trading, the counterparty risks in over the counter trading are typically
high. Also, there is no standardization of share prices, since it varies from one owner to
another (the buyer and the seller directly deal with each other regarding all terms and
conditions of a trade contract).

Examples of Secondary Market Transaction
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Stock trading.
Bond trading
Mutual fund investment

Advantages of Secondary Market Transactions
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• Liquidity
• Price discovery
• Transparency
• Risk transfer
• Capital raising
• Diversification

Disadvantages of the Secondary Market
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• Volatility
• Market manipulation
• Counterparty risk
• Limited access
• Regulatory risk
• Price discrepancies

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BASIS FOR COMPARISON PRIMARY MARKET SECONDARY MARKET
Meaning The market place for new shares is called
primary market.
The place where formerly issued securities are
traded is known as Secondary Market.
Another name New Issue Market (NIM) After Market
Type of Purchasing Direct Indirect
Financing It supplies funds to budding enterprises
and also to existing companies for
expansion and diversification.
It does not provide funding to companies.
How many times a security can
be sold?
Only once Multiple times
Buying and Selling between Company and Investors Investors
Who will gain the amount on
the sale of shares?
Company Investors
Intermediary Underwriters Brokers
Price Fixed price Fluctuates, depends on the demand and supply
force
Organizational difference Not rooted to any specific spot or
geographical location.
It has physical existence

MONEY MARKET
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Money market basically refers to a section of the financial
market where financial instruments with high liquidity and
short-term maturities are traded. Money market has
become a component of the financial market for buying
and selling of securities of short-term maturities, of one
year or less, such as treasury bills and commercial
papers.

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Money Market Functions
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The market helps to bring a balance between the demand and supply of short-term funds,
bringing a monetary equilibrium.
By making funds available to various different participants in the market, the market
promotes economic growth of the economy.
Governments can keep a check on the liquidity in the country by influencing the money
supply. In addition, as explained above it helps keep a control on deflation or inflation.
Also, the market promotes saving and investment by giving a platform to wholesale as well
as retail investors for investing/borrowing of funds.

TYPES OF MONEY MARKET
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CAPITAL MARKET
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A capital market is a financial market where long-
term debt or equity-backed securities are bought
and sold. Suppliers are people/organisations with
the capital to lend or invest. Banks and investors
are common examples.

Two types of markets
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Primary market: It is the new issue market, where companies issue shares for the first time
through an Initial Public Offering (IPO). Once the IPO is successful, the shares of the
company get listed on the stock exchange. Money in the primary market is raised through
private placement, rights issues, and prospectus. The money is raised for the growth and
expansion of the company.
Secondary market: It is a market for trading listed shares and securities. A stock exchange
is usually the marketplace for buying and selling securities. In India, the major stock
exchanges are National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE)
and a majority of equity trading and investments take place on these two exchanges. NSE
and BSE are perfect examples of secondary markets.

Instruments
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Stocks
Bonds
Exchange Traded Funds
Derivatives
Currency

Features of a Capital Market
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Safety
Channelizes savings
Long term investment
Wealth Creation
Helps intermediaries

Functions of a Capital Market
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• A capital market is for long-term financial assets. It plays a crucial role in mobilising resources and
allocating them to useful channels. Therefore, the capital market helps a country’s economic progress.
• It transfers savings from parties in cash and other forms to the financial markets. It fills the gap between
those who provide capital and those who require it.
• Investors can profit more from greater risks.
• Capital Markets also assist in stabilising stock prices in addition to facilitating the mobilisation of capital.
For instance, exchange instruments like stocks are liquid for participants.
• Therefore, the availability of funds is a continuous process. Platforms like the National Stock Exchange
and Bombay Stock Exchange help accomplish this. It lowers the price of information and transactions.
• Intermediaries like brokers and traders enable the transfer of capital and shares between two investors.
This aids them in running their business.

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Basis of
comparison
Money market Capital market
Definition Money market is a place where we invest for the short
term on instruments like trade credit, commercial paper,
certificate of deposit, treasury bills etc.
Capital Market is a type of financial market in which the
company or government securities invest for the long
term in the instruments such as bonds, stocks, etc.
Nature Money markets are casual in nature. Capital markets are formal or official. It is known for
dealing in mutual stocks and bonds.
Instruments Commercial Papers, Treasury certificates of deposits,
Bills, Trade Credit, etc., are included in the money
market.
Bonds, Debentures, splits, Asset Secularization,
Retained Earnings, Euro Issues, etc., are included in the
capital market.
Types of
investors
Commercial banks, non-financial institutions, central
banks, chit funds, etc., are the primary investor types.
Stockbrokers, insurance companies, Commercial banks,
underwriters, etc., are the primary investor types.
Liquidity of
market
Money markets are incredibly fluid. Capital markets are relatively more minor liquid.
Security Money markets have low risk. Capital markets have a significant risk in comparison to
money markets.
Time Instrument matures in a year. Instruments take much time to get mature.

Reference
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