Financial Services | Meaning | Importance

Table of Contents [hide]
 Meaning of financial services
 Importance of Financial services
o 1. Promoting investment
o 2. Promoting savings
o 3. Minimizing the risks
o 4. Maximizing the Returns
o 5. Ensures greater Yield
o 6. Economic growth
o 7. Economic development
o 8. Benefit to Government
o 9. Expands activities of Financial Institutions
o 10. Capital Market
o 11. Promotion of Domestic and Foreign Trade
o 12. Balanced Regional development
Financial service is one of the component of the financial system, Lets look at the meaning and
its importance.

MEANING OF FINANCIAL SERVICES

Financial service is part of financial system that provides different types of finance through
various credit instruments, financial products and services.
In financial instruments, we come across cheques, bills, promissory notes, debt instruments,
letter of credit, etc.

In financial products, we come across different types of mutual funds. extending various types
of investment opportunities. In addition, there are also products such as credit cards, debit
cards, etc.

In services we have leasing, factoring, hire purchase finance etc., through which various types

of assets can be acquired either for ownership or on lease. There are different types of leases as
well as factoring too.
Thus, financial services enable the user to obtain any asset on credit, according to his
convenience and at a reasonable interest rate.

IMPORTANCE OF FINANCIAL SERVICES

It is the presence of financial services that enables a country to improve its economic condition
whereby there is more production in all the sectors leading to economic growth.

The benefit of economic growth is reflected on the people in the form of economic prosperity
wherein the individual enjoys higher standard of living. It is here the financial services enable
an individual to acquire or obtain various consumer products through hire purchase. In the
process, there are a number of financial institutions which also earn profits. The presence of
these financial institutions promote investment, production, saving etc.

Hence, we can bring out the importance of financial services in the following points:

Importance of Financial Services

 Vibrant Capital Market.
 Expands activities of financial markets.
 Benefits of Government.
 Economic Development.
 Economic Growth.
 Ensures Greater Yield.
 Maximizes Returns.
 Minimizes Risks.
 Promotes Savings.
 Promotes Investments.
 Balanced Regional Development.
 Promotion of Domestic & Foreign Trade.

1. Promoting investment
The presence of financial services creates more demand for products and the producer, in order
to meet the demand from the consumer goes for more investment. At this stage, the financial
services comes to the rescue of the investor such as merchant banker through the new issue
market, enabling the producer to raise capital.
The stock market helps in mobilizing more funds by the investor. Investments from abroad is
attracted. Factoring and leasing companies, both domestic and foreign enable the producer not
only to sell the products but also to acquire modern machinery/technology for further
production.

2. Promoting savings
Financial services such as mutual funds provide ample opportunity for different types of
saving. In fact, different types of investment options are made available for the convenience of
pensioners as well as aged people so that they can be assured of a reasonable return on
investment without much risks.
For people interested in the growth of their savings, various reinvestment opportunities are
provided. The laws enacted by the government regulate the working of various financial
services in such a way that the interests of the public who save through these financial
institutions are highly protected.

Financial Services offered by various financial institutions

 Factoring.
 Leasing.
 Forfaiting.
 Hire Purchase Finance.
 Credit card.
 Merchant Banking.
 Book Building.
 Asset Liability Management.
 Housing Finance.
 Portfolio Finance.
 Underwriting.
 Credit Rating.
 Interest & Credit Swap.
 Mutual Fund.

3. Minimizing the risks

The risks of both financial services as well as producers are minimized by the presence of
insurance companies. Various types of risks are covered which not only offer protection from
the fluctuating business conditions but also from risks caused by natural calamities.

Insurance is not only a source of finance but also a source of savings, besides minimizing the
risks. Taking this aspect into account, the government has not only privatized the life
insurance but also set up a regulatory authority for the insurance companies known as IRDA,
1999 (Insurance Regulatory and Development Authority) .

4. Maximizing the Returns

The presence of financial services enables businessmen to maximize their returns. This is
possible due to the availability of credit at a reasonable rate. Producers can avail various types
of credit facilities for acquiring assets. In certain cases, they can even go for leasing of certain
assets of very high value.

Factoring companies enable the seller as well as producer to increase their turnover which also
increases the profit. Even under stiff competition, the producers will be in a position to sell
their products at a low margin. With a higher turnover of stocks, they are able to maximize
their return.

5. Ensures greater Yield

As seen already, there is a subtle difference between return and yield. It is the yield which
attracts more producers to enter the market and increase their production to meet the
demands of the consumer. The financial services enable the producer to not only earn more
profits but also maximize their wealth.
Financial services enhance their goodwill and induce them to go in for diversification. The stock
market and the different types of derivative market provide ample opportunities to get a higher
yield for the investor.

6. Economic growth
The development of all the sectors is essential for the development of the economy. The
financial services ensure equal distribution of funds to all the three sectors namely, primary,
secondary and tertiary so that activities are spread over in a balanced manner in all the three
sectors. This brings in a balanced growth of the economy as a result of which employment
opportunities are improved.
The tertiary or service sector not only grows and this growth is an important sign of
development of any economy. In a well developed country, service sector plays a major role and
it contributes more to the economy than the other two sectors.

7. Economic development
Financial services enable the consumers to obtain different types of products and services by
which they can improve their standard of living. Purchase of car, house and other essential as
well as luxurious items is made possible through hire purchase, leasing and housing finance
companies. Thus, the consumer is compelled to save while he enjoys the benefits of the assets
which he has acquired with the help of financial services.

8. Benefit to Government
The presence of financial services enables the government to raise both short-term and long-
term funds to meet both revenue and capital expenditure. Through the money market,
government raises short term funds by the issue of Treasury Bills. These are purchased
by commercial banks from out of their depositors’ money.
In addition to this, the government is able to raise long-term funds by the sale of government
securities in the securities market which forms apart of financial market. Even foreign
exchange requirements of the government can be met in the foreign exchange market.

The most important benefit for any government is the raising of finance without offering any
security. In this way, the financial services are a big boon to the government.

9. Expands activities of Financial Institutions

The presence of financial services enables financial institutions to not only raise finance but
also get an opportunity to disburse their funds in the most profitable manner. Mutual
funds, factoring, credit cards, hire purchase finance are some of the services which get
financed by financial institutions.
The financial institutions are in a position to expand their activities and thus diversify the use
of their funds for various activities. This ensures economic dynamism.

10. Capital Market

One of the barometers of any economy is the presence of a vibrant capital market. If there is
hectic activity in the capital market, then it is an indication of the presence of a positive
economic condition. The financial services ensure that all the companies are able to acquire
adequate funds to boost production and to reap more profits eventually.

In the absence of financial services, there will be paucity of funds which will adversely affect
the working of companies and will only result in a negative growth of the capital market. When
the capital market is more active, funds from foreign countries also flow in. Hence, the changes
in capital market is mainly due to the availability of financial services.
 11. Promotion of Domestic and Foreign Trade
Financial services ensure promotion of domestic as well as foreign trade. The presence
of factoring and forfaiting companies ensures increasing sale of goods in the domestic market
and export of goods in the foreign market. Banking and insurance services further contribute
to step up such promotional activities.

12. Balanced Regional development

The government monitors the growth of economy and regions that remain backward
economically are given fiscal and monetary benefits through tax and cheaper credit by which
more investment is promoted. This generates more production, employment, income, demand
and ultimately increase in prices.
The producers will earn more profits and can expand their activities further. So, the presence
of financial services helps backward regions to develop and catch up with the rest of the
country that has developed already.

Types of Financial Services in India

Table of Contents [hide]
 Types of Financial services in India
o Facilitating type financial service
o Investment oriented financial service
o Promotion oriented financial service
o Return or Income oriented financial service
o Linking type financial service
o Trade oriented financial service
o Credit oriented financial service:
o Performance appraisal service:
TYPES OF FINANCIAL SERVICES IN INDIA
Various financial services in India can be brought under the following types. Meanwhile do
read about the Major Players in the financial services industry where you get a list of players
who mold the economy of a country.

 Facilitating type
 Investment-oriented
 Promotion-oriented
 Return or Income oriented
 Linking type
 Trade oriented
 Credit oriented
 Performance appraisal

Facilitating type financial service

Hire-purchase finance companies facilitate consumers in the purchase of consumer
goods while lease companies facilitate traders in the purchase of capital goods. Hence, they
come under facilitating type.
Investment oriented financial service
Merchant bankers promote investment by helping investors in fulfilling various formalities
such as issue of shares and debentures. They also advice the promoters on the quantum of
capital to be raised through issue of different types of securities.

Promotion oriented financial service

Promoting new ventures is taken up by the venture capital companies. Underwriters also help
in the sale of securities which promote companies. The bankers also help entrepreneurs
through project finance. Hence, they all come under promotion type.

Return or Income oriented financial service

For those investors who do want to take risks yet but want to ensure a reasonable return for
their investment, mutual fund companies are the best source which come under this type of
financial services.

Linking type financial service

Promoters, investors, public, foreign investors and government are linked by certain companies
such as merchant bankers. They not only link these people but also ensure that each one is
satisfied with his/her return on investment. The merchant bankers act as the brain in
coordinating the various entities.

Trade oriented financial service

For the purpose of increasing the sales, both domestically and abroad, factors play a major role
in financing the traders by financing a major part of the value of the traded
goods. Forfaiting companies do the same while selling goods across the borders.

Credit oriented financial service:

Financial services which provide credit to consumers will come under this category. Credit card
companies and even hire purchase companies come under this category.

Performance appraisal service:

In order to enable the public to know the financial strength of companies before investment, we
have credit rating companies which provide ratings on the basis of the performance of the
companies from various aspects. Thus, the strength of companies is known beforehand which
will not only help the companies to get more finance but also to improve their performance in
course of time.
Major Players in the financial services industry
The ocean of financial service sector comprises of the following major players who mold the
economy of any country. They are as follows

PLAYERS IN FINANCIAL SERVICES SECTOR

1. Financial service sector comes under the tertiary sector in which banks play a major
role. For the growth of financial services industry, banks are led by the central
bank of the country followed by commercial banks, co-operative banks, development
banks, foreign ban
2. Hire purchase financier is also a player in the financial service sector as he enables
the consumer to buy the product on credit basis.

3. Leasing companies through financial and operating lease ensure the acquiring of assets by
producers on a long-term basis at a reasonable charge.

4. Factoring enables the seller to obtain 80% value of sales from the financial companies
undertaking factoring services.
5. Underwriters and merchant bankers are additional players who promote not only
companies but also ensure dynamic activity in the capital market.

6. Book-builders help companies in allotting shares to different categories of investors.

7. Mutual funds ensure investment by the public and also ensure tax relief to the investor.

8. Credit cards, another important player in the financial services, ensure the circulation of
plastic money and enable purchase on credit by the consumer.
 9. Credit rating companies play an important role by giving different credit ratings to
companies to mobilize public deposits.

10. Housing finance companies and insurance companies also promote investment in the

economy as they also form a part of the players in the financial services.

11. Asset liability management company enables mutual funds to undertake proper

investment in different types of companies.

12. Finance companies in general and also as a part of non-banking finance

companies provide additional funds to the above players so that there is more activity in the
economy.
In addition to the above players, the government acts as the umpire and the various
enactments as rules for playing a fair game in the field of financial services.

Financial Instruments – What It Is, Types And More?

A financial instrument could be any document that represents an asset to one party and
liability to another. It can be a contract or a document like a bond, share, bill of exchange,
futures or options contract, cheque, draft, or more. Financial instruments carry a monetary
value and are legally enforceable. One can also create, modify and trade such instruments,
which represent a binding agreement between two or more parties.
As per the definition by International Accounting Standards (IAS), financial instruments are
any “contract that gives rise to a financial asset of one entity and a financial liability or equity
instrument of another entity.” Accounting treatment of the financial instruments is governed
by IFRS 9.

Table of Contents [hide]
 1 Types of Financial Instruments
o 1.1 Derivative Instruments
o 1.2 Cash Instruments
 2 Why So Many Financial Instruments?
TYPES OF FINANCIAL INSTRUMENTS
There are mainly two types of financial instruments: Derivative Instruments and Cash
Instruments.

DERIVATIVE INSTRUMENTS
We derive the value of such instruments from the value and characteristics of the asset they
represent. Or in simple words, these instruments are securities that we link to other securities.
Such instruments can represent assets like interest rates, indexes, shares and more. Examples
of such instruments are futures and options contract. Derivative instruments can either be
exchange-traded or over-the-counter (OTC) derivatives.

CASH INSTRUMENTS
Cash instruments are the instruments whose market value is available directly. Market forces
directly determine and influence the value of such instruments. Such securities are readily
transferable as well. Shares, bonds, cheques are some examples of these instruments. Deposits
and loans are also cash instruments if lender and borrower agree over its transferability.

We can also classify financial instruments based on the asset class they represent, i.e. if they
are based on the equity or debt. Based on the asset class there are two types of financial
instruments – Debt-based and Equity-based financial instruments. The former represents
ownership of an asset, while the latter represents a loan by an investor to the owner of the
asset.

Debt-based financial instruments can also be of two types based on the tenure – long term
and short term. Long term debt instruments can be bonds, bond futures and options, Interest
rate swaps and more. Short term debt instruments can be T-bills, Interest rate futures and
forward rate agreements.

There is one more type of financial instrument on the basis of the asset class –  Forex
instruments. These instruments include forex futures, forex options, currency swaps and
more.

WHY SO MANY FINANCIAL INSTRUMENTS?

As we all know that necessity is the mother of all inventions, and same is the case with the
financial instruments as well. Each of the financial instrument serves a different purpose and
meet a specific need of the investor. For instance, investors who prefer safety over returns can
park their funds in bonds. Bonds are less risky and safer, but they offer lower returns than
what one would expect from equity.
Likewise, investing in the currency market also depends on the choice and objective of the
investor. For instance, from a business point of view, it is better to invest in currencies as it
allows investors to hedge currency risk. On the other hand, bonds and stocks might prove
better than the currencies when the objective is to save funds for retirement.

Equity Linked Security

An equity-linked debt issue whose returns are keyed to the performance of a common
stock (initially the stock of Digital Equipment Corporation). Equity linked securities (ELKS)
are fixed-income debt securities with intermediate term. Interest on each ELK security is
payable on a quarterly basis. In the case of ELKS, and unlike ordinary debt, the principal
payable upon maturity is not fixed but is based on the price of underlying common stock.
The principal amount payable at maturity will be the lesser of two amounts: (1) 135% of the
 issue price; (2) the average closing price of the underlying common stock for the 10 trading
days immediately prior to maturity.
Given that the payoff of an ELK is determined based on the average stock price, this
instrument can be viewed as an average-price Asian option.

Fixed-Interest Security

DEFINITION of Fixed-Interest Security

A fixed-interest security is a debt instrument such as a bond, debenture, or gilt-edged
bond that investors use to loan money to a company in exchange for interest payments. A
fixed-interest security pays a specified rate of interest that does not change over the life of the
instrument. The face value is returned when the security matures.

In the UK, fixed-interest securities are referred to as ‘gilts’ or gilt-edged securities.

BREAKING DOWN Fixed-Interest Security

The fixed interest to be paid on a fixed-interest security is indicated in the trust indenture at
the time of issuance and is payable on specific dates until the bond matures. The benefit of
owning a fixed-interest security is that investors know with certainty how much interest they
will earn for the duration of the bond's life. As long as the issuing entity does not default, the
investor can predict exactly what his return on investment will be. However, fixed-interest
securities are also subject to interest rate risk. Since their interest rate is fixed, these securities
will become less valuable as rates go up in a rising-interest-rate environment. If interest rates
fall, however, the fixed-interest security becomes more valuable.

For example, let’s assume an investor purchases a bond security that pays a fixed rate of 5%,
but interest rates in the economy increase to 7%. This means that new bonds are being issued
at 7%, and Tom is no longer earning the best return on his investment as possible. Because
there is an inverse relationship between bond prices and interest rates, the value of the
investor’s bond will fall to reflect the higher interest rate in the market. If he decides to sell his
5% bond in order to reinvest the proceeds in the new 7% bonds, he may do so at a loss, since
the bond’s market value would have dropped. The longer the fixed-rate bond’s term, the greater
the risk that interest rates might rise and make the bond less valuable.

Floating Rate Bonds

Table of Contents [hide]
 1 Definition / Meaning

 2 Impact of Interest Rate Fluctuations

 3 Floating Rate Bond Funds and ETF

 4 Floating Rate Bond Duration

 DEFINITION / MEANING
Floating rate bonds, also known as floating rate notes, are a type of bond characterized by
floating rate of interest. Floating rate of interest means a rate of interest that is derived using a
benchmark or reference rate which could be any external rate of interest like U.S. Treasury Bill
Rates, LIBOR, EURIBOR, Federal Funds Rate etc. Normally, there is a margin or spread added
to the reference rate and the coupon rate is denoted like ‘LIBOR + 1%’, ‘EURIBOR + 1%’, or
‘Federal Funds Rate + 1%’.
Since, these bonds are having semi variable rate of interest, they are also called floaters. They
are complete opposite to fixed rate bonds. These types of bonds are normally issued by
government organizations, institutional investors, mutual funds etc. for tenure between 2 to 5
years.

IMPACT OF INTEREST RATE FLUCTUATIONS

When interest rate rise, fixed rate bonds lose value whereas these floaters are not impacted
because the interest receivable to the investor also rise with rise in market interest rate. On the
other side, when the market interest rates fall, fixed rate bonds gains value but there is no
beneficial impact because the interest receivable on floaters also reduces.

The value of these bonds are not affected much when the interest rate market fluctuate. In
other words, they are free from interest rate risk as far as the investors are concerned.

FLOATING RATE BOND FUNDS AND ETF

There are fund which are only investing debt instruments having floating rate of interest and
these funds are called floating rate bond funds or floating rate funds. To add to the concept,
when these funds are traded in open market, they are called Floating Rate Bond ETF where
ETF stands for exchange traded funds. Some of the examples of top funds of the US in this
category are as follows:

 iShares Floating Rate Bond ETF (FLOT)

 SPDR Barclays Capital Investment Grade Floating Rate ETF (FLRN)

 VanEck Vectors Investment Grade Floating Rate ETF (FLTR)

 Advisor Shares Pacific Asset Floating Rate ETF (FLRT)

FLOATING RATE BOND DURATION

It should be noted that the duration is not same as maturity of a bond. Maturity is simply that
time remaining before receiving the final payment.  On the other hand duration of a bond is
arrived based on complicated formula.  The essence of calculating duration is to gauge the
sensitivity of a bond with respect to the changes in interest rate market. Both duration and
maturity are denoted in years. In case of zero coupon bonds, the maturity and duration are
both same.